Chad Padowitz

Investors ‘buying the dip’ are at risk of missing broader economic threats including sticky inflation, artificial intelligence, private credit and higher energy costs off the back of oil price volatility, Chad Padowitz, co-chief investment officer at Talaria Capital says.

“In equity markets, we often see an extreme reaction to a short-term problem. And right now, it seems investors are driven by a fear of missing out,” Padowitz says.

“There is an enormous amount of capital flowing into AI, and while there is opportunity, the long-term winners and losers remain uncertain. Market enthusiasm may be hiding how uncertain long-term success really is.

“It’s extremely difficult for investors to analyse these companies with conviction, and that creates risk.

“If the AI hyperscalers who dominate the US and Global indices fail to achieve optimistic future earnings forecasts or the benefits take longer to materialize, that will likely be a headwind for investors.”

Padowitz highlights private credit as another area of growing concern, with the current economic conditions highlighting the fragility of the sector.

“The term private credit is really just another way of saying shadow banking or unregulated lending. Private credit has expanded rapidly, but it lacks transparency and is often built on leverage,” Padowitz says.

“As inflation and interest rates stay elevated, write-downs from larger players are emerging, which suggests that credit stress is beginning to surface.”

“In this environment, liquidity and transparency are even more important. We feel investors should look beyond the noise and focus on longer-term valuation opportunities.”

“It’s likely that we see a higher-than-normal oil price for the next few months and even years regardless of the outcome of the conflict in the Middle East.

“That said, this isn’t the worst energy crisis ever. It wasn’t that long ago when oil was at this price for several years in a row.

“Despite these potential risks, the market is again at near all-time highs indicating there is enduring optimism about many companies’ ability to ride out these concerns.

“At this stage, from an investment perspective, I’d caution against getting caught up in the headline story of the moment. There are good opportunities for investors willing to take a prudent, long-term approach.

“Real assets, for example, are an extremely important asset class to consider in a world of AI disruption, sticky inflation and high debt. They offer better valuations and more resilience than the highly speculative growth stories we have become accustomed to.”

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Chad Padowitz

The US Federal Reserve’s (the Fed’s) pivot to interest rate cuts is likely a signal of underlying economic weakness that historically leads to a prolonged downturn cycle, Chad Padowitz, co-chief investment officer at Talaria Capital says.

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Chad Padowitz

Structural labour shortages in the US pose a more persistent risk to inflation, corporate earnings and market stability than tariffs, Chad Padowitz, co-chief investment officer at Talaria Capital says.

While recent market gains have been supported by easing trade tensions and confidence that inflation and interest rates are manageable, Padowitz warns that workforce constraints are a deeper and longer-term challenge.

“Labour shortages affect inflation, earnings, competitiveness, and growth. The ‘Magnificent Seven’ may dominate headlines, but they won’t shield portfolios from the silent erosion of labour costs,” Mr Padowitz said.

“These issues will remain long after the headlines about tariffs have faded.”

Labour now accounts for more than 60 per cent of US corporate costs and comes at the same time the US labour force is shrinking, fuelled by retirements and falling net migration.

Padowitz warns that unlike tariffs, these shifts cannot be addressed by the Federal Reserve through interest rate changes.

“When you have more retirees than new entrants, wage inflation becomes endemic,” Mr Padowitz said.

“Also, with US debt-to-GDP projected to reach 200 per cent in coming decades, the fiscal burden of labour scarcity is only set to grow.”

The recent US-Japan agreement, which boosted Japanese equities, illustrates how quickly tariff headwinds can dissipate. In contrast, Padowitz points to entrenched demographic trends, including ageing populations, low birth rates, and a smaller post-Covid workforce, which he says are driving sustained wage pressures and constraining productivity.

“Labour market imbalances are structural, not cyclical. That makes them far harder to solve and more disruptive to profits,” Mr Padowitz said.

Mr Padowitz stresses the importance of strategic positioning in companies and assets less exposed to labour-driven cost pressures.

“For investors, the implications go beyond short-term market cycles,” Mr Padowitz said.

“Investors need to look beyond tech giants and consider labour-light sectors that offer resilience in an age of structural scarcity.”

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Chad Padowitz

A shift from global integration to a new era characterised by increasing nationalism and the return of manufacturing to domestic locations could harm the returns on equities, according to Chad Padowitz, co-chief investment officer at Talaria Asset Management.

Talaria’s latest quarterly outlook says that the global economy is moving from a period of global integration, which began in the early 1990s, towards a period of heightened nationalism and trade protectionism, led by the US.

“Geopolitical events, including economic nationalism and onshoring, require a fresh assessment of capital, risk, and how countries depend on each other,” Mr Padowitz said. 

“We are in the midst of a fundamental change to the global integration we’ve witnessed in the past three decades.”

Governments globally are increasingly influencing capital movement through policies that encourage domestic investment. Examples include the UK’s Mansion House reforms, which aim to direct up to US$65 billion into domestic projects by 2030, European proposals for defence bonds, and changes to the Australian Future Fund’s mandate.

“All these initiatives are designed to reduce the flow of capital to other regions or countries,” Mr Padowitz said. 

“This trend shows a broader increase in economic nationalism, a force that has grown stronger and is causing governments to direct capital within their own borders.”

The COVID-19 pandemic highlighted the dangers of long overseas supply chains and showed that western domestic manufacturing was not resilient enough, accelerating the shift towards internal focus. US policy changes this year under the Trump administration have fast-tracked this move towards nationalism and onshoring.

“A shift in US policy, America First, has further driven a turn inward, firstly in the US but then in other countries that had previously been happy to rely on overseas production,” Mr Padowitz said.

For investors, Talaria says all this may mark the end of a period of strong asset price increases, where nominal cash flow growth and the cost of funding moved in ways that significantly increased the value of many assets.

“There is a lot of noise in financial markets today. The broader battle for attention that now drives the media has resulted in a distracting cacophony,” Mr Padowitz said. 

“Beyond the noise there are several significant developments for investors to consider, but if we had to identify a single item not to lose sight of it would be this: as the monetary regime transitions, the conditions that underwrote rising valuations across a range of assets are no longer in place.

“Our approach for this new environment is to prioritise resilience. This means focusing on short duration assets, companies with strong balance sheets, exposure to real assets, and strong diversification to manage investments in a world characterised by fragmentation and increased uncertainty.” 

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Chad Padowitz

Rising US debt and greater volatility in global markets demands that investors seek more resilient assets such as companies with strong balance sheets that can better weather economic uncertainty, according to Chad Padowitz, co-chief investment officer at Talaria Capital. 

Padowitz notes that the nonpartisan Congressional Budget Office predicts US debt will increase at a rate more than twice as fast as the growth of the US economy, potentially reaching 200 per cent of GDP by 2047. This trajectory reflects underlying demographic and economic trends, including an aging population requiring increased healthcare and social security spending.  

“To be forewarned is to be forearmed, and perhaps this time US debt is a signal that things are changing in a way that will have more profound effects on the way people invest their money,” Mr Padowitz said.  

“Each year, the US is borrowing more and more money just to pay its interest bill. The country required US$1.9 trillion in foreign capital inflows last year to balance its external accounts, with foreign investors holding around US$62 trillion in US assets. To maintain current financing patterns, foreign investors would need to add roughly US$2 trillion annually to their holdings.

“In addition, interest rates are significantly higher now than when the US last borrowed heavily after the GFC, and during the COVID pandemic. The interest payments on existing debt have become a major budget category, exceeding federal spending on Medicare and national defence in fiscal year 2024.  

“With higher interest rates prevalent in the current economic environment, the debt service burden compounds rapidly.” 

In such an environment of rapidly rising US government debt, Padowitz said the playbook for investors should include short duration fixed income assets, real assets and companies with strong balance sheets and cash flows that are better able to survive economic downturns. 

“In a world where the cost of capital matters again, paying attention to the timing and certainty of cash flows becomes critical,” Mr Padowitz said.  

“Financial markets are now characterised by higher volatility and less predictability, so a portfolio that draws from uncorrelated sources of return and has exposure to ‘under-owned’ assets will be more resilient and Important for investors to achieve. 

“To that end, companies with low leverage and strong cash flows are better positioned to manage higher refinancing costs and economic volatility and should be a core inclusion to investors’ portfolio.

“Real assets will also be key. Exposure to physical or inflation-linked assets like commodities, and infrastructure assets can help preserve purchasing power if inflation is persistent and diversification will remain important.”

According to Padowitz, without substantial policy changes from the US government, the world’s largest economy faces a future of either dramatically higher interest costs, forced fiscal consolidation, or potential financial instability as financial markets and investors question the rising US government debt. 

“The combination of increased debt issuance and potentially reduced foreign demand creates significant market risks. If foreign appetite for US assets weakens, pressure could mount on bond, currency and equity markets. Higher yields on US long-term bonds would increase borrowing costs across the economy, affecting everything from mortgage rates to corporate financing,” Mr Padowitz said. 

“In such an environment, shorter duration assets are less vulnerable to capital losses when interest rates are rising, and are another important addition for portfolios.”  

 

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Chad Padowitz

As the Trump Administration passes tax cuts amid an already dire US debt situation, increased tariffs and government efficiencies won’t alter the debt trajectory significantly, posing a long-term structural challenge, Chad Padowitz, co-CIO at Talaria Capital says.  

“US debt has got progressively worse, and that trend is certainly not slowing down fast enough, if at all,” Mr Padowitz said.  

“The tax cut that the Trump administration has passed would currently add about 0.9 per cent to GDP debt, so even if Elon Musk’s DOGE efficiencies were successful, in addition to the added revenue raised through higher tariffs, they wouldn’t come close to plugging this gap. 

“The US essentially has a long-term problem of spending too much money relative to its tax take.” 

Mr Padowitz pointed to Moody’s Ratings that has recently downgraded the US credit rating, citing an inability of the nation to address large and growing deficits. 

“While I don’t expect the Moody’s downgrade to have a material impact on government operations or yields, it is an indication that long term it’s unsustainable.” 

Mr Padowitz said fluctuating tariffs over the course of the past two months haven’t yet had a significant impact on the economy, but will be a headwind to future growth. 

“The current tariff rate is around 12 per cent, which means they are hovering around the highest tariffs have been in decades. ” 

Mr Padowitz said as US markets rally despite no corresponding earnings upgrades, European equites seem more attractively priced compared to their US counterparts.  

“US interest rates remain elevated, and inflation remains sticky. Current equity valuations are pricing in a far more optimistic outcome than in the past,” Mr Padowitz said. 

“Times like this call for sound investment decisions – companies with solid leadership, strong balance sheets and stable business models.” 

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Chad Padowitz

The prices of US equities, property and high-yield bonds have risen significantly over the past 30 years but moving ahead, the uncertainty weighing on financial markets stemming from Donald Trump’s tariffs and the significant trend towards deglobalisation could weigh on the earnings of US companies, according to Chad Padowitz, Co-CIO at Talaria Capital. 

“Over the past 30 years, equities have gotten more expensive as measured by the price-earnings ratio. The same thing has happened to real estate and high-yield bonds; they have all gotten more expensive,” Mr Padowitz said, pointing to the chart below. 
 

“That has meant that savers and investors have enjoyed strong tailwinds over this period, despite three drawdowns in the US equity market, as long as investors held on, they would have been better off.” 

However, US equities may not enjoy such strong gains moving forward. US equities have P-E multiples which are high by historic standards, corporate profits as a percentage of GDP sit at all-time highs and share market concentration is unprecedented. On top of that, US government debt has risen to record levels, which means bonds are likely to provide limited long-term real returns, at best, according to Padowitz.  

“As we move forward, there is a headwind to rising asset prices, or at least the tailwind which has existed may have gone, so the conditions which allowed rising prices to happen may have changed,” Mr Padowitz said. 

“With Trumps tariffs and deglobalisation, we could move into a period where there is a real headwind to asset prices rising in the years ahead, and the tailwind to asset valuations rising could disappear entirely, if we see an acceleration in the deglobalisation trend. That could fundamentally change the return outlook.” 

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Chad Padowitz

As the global economy grapples with high interest rates and around $100 trillion in global debt set for refinancing, European equites are more attractively priced compared to their United States counterparts, Chad Padowitz, co-chief investment officer at Talaria says.

Recent analyses indicate that European stocks are attracting increased investor interest due to their relative undervaluation compared to U.S. counterparts.

The MSCI EMU index, representing European equities, trades at approximately 14 times expected earnings, while the S&P 500’s multiple stands at 21. This valuation gap presents compelling opportunities for investors seeking value in the European market. ​

“With inflation remaining sticky and interest rates not coming down as quickly as we anticipated, this has been a headwind to economic growth. Despite this, we see substantial opportunities in European markets,” Mr Padowitz said.

“Despite the U.S.-centric ‘America First’ policy, the NASDAQ 100 derives approximately 51 per cent of its revenue from outside the U.S., while the S&P 500 earns around 40 per cent from international markets. This means that U.S. economic policies affecting global economies, such as tariffs, also significantly influence the domestic equity market.

“With that, we believe the current equity valuations in the U.S. are pricing in a far more optimistic outcome than has historically been the case.

“This significant valuation gap suggests that European equities may offer greater potential for long-term returns, particularly in a high-interest-rate environment. That’s why we see increasing opportunities in European markets, with indices like Germany’s DAX reaching record highs.”

Mr Padowitz says current global economic uncertainty reinforces the need to invest companies around the world with strong balance sheets and stable business models rather than chasing already hyped largely US stocks like the Magnificent Seven.

A prime example of a well-performing company that is overlooked by many investors is German chemical distributor Brenntag (ETR: BNR), renowned for its strategic acquisitions and asset-light approach, which positions it favourably amid economic fluctuations.​

“Companies like Brenntag showcase the resilience and strategic adaptability needed to navigate global economic uncertainty. Its strong balance sheet and asset-light approach make them attractive investments in today’s market,” Mr Padowitz said.

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Chad Padowitz

The recent surge in US equity markets, particularly the S&P 500’s 23 per cent increase in 2024, is largely due to valuation expansions. This has created significant risks for investors, as these expansions are arguably not justified and in turn exposes them to a greater risk of a paying too much for shares that may fall in value over time.

Early in 2025, the resultant risks are in plain sight. The chart below shows that while 7 per cent earnings per share (ESP) growth contributed to US share market gains last year, the much larger driver of rising share prices was an expansion in valuation multiples, as investors were willing to pay significantly more for each dollar of companies’ sales or earnings.

Source: Talaria, Bloomberg. Talaria return is only local performance of gross capital at risk of holdings as of 31 December 2024 for illustrative purposes. 

While continued enthusiasm for mega tech may have made sense, what arguably went against logic was the degree of enthusiasm for a broader cohort of US stocks.  The S&P 500 Equal Weighted index saw a 10 per cent rise last year driven almost entirely by valuation, despite only a 1 per cent increase in earnings per share (EPS).

Even more striking was the S&P 1500 Equal Weighted, which reflects a broader and more representative sample of US listed companies. EPS for these companies fell by 15 per cent, yet the index still delivered an 8 per cent return, driven by a dramatic multiple expansion.

Those high valuations have left little room for error for investors in the broader US stock market. The S&P 500’s forward price earnings ratio is significantly higher than its historical averages. For example, the latest forward price-earnings (P/E) ratio of 21.7x is 1.9 turns higher than the five-year average and 3.4 turns higher than the ten-year average.

This highlights that the rationale for paying more for many US shares is not solely related to recent and near-term fundamentals. Instead, it appears to rely on optimistic assumptions around further margin expansion, earnings and continued multiple expansions across the board, which may not be realised.

Lowering risks should be a key focus

While the risks associated with this trend are growing, calling an end to it is not our focus. Instead, we think investors would be wise to prioritise sectors with attractive valuations rather than chase the momentum. Practically, this means for every incremental dollar moving away from the current enthusiasm for mega technology companies to reduce investment risk
into those stocks with less balance sheet risk including companies with lower refinancing risk, and lower vulnerability to credit spreads. Portfolios with higher initial earnings yields may also be more attractive, even if their projected growth rate is slightly lower.

It will be important for investors to avoid overreacting to short-term market fluctuations and focus on long-term performance, especially with the potential for more share market volatility from rising bond yields and the second Donald Trump led US government.

A critical point for Australian investors

With valuations in mind, the coming year presents a critical moment for Australian investors. The temptation to follow market momentum will be strong, but long-term performance requires patience and rationality.

By Chad Padowitz 

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Chad Padowitz

High margins across stocks, sectors, industries, and regions are a major but not insuperable challenge to generating solid investment ideas in global equities Talaria Capital co-chief investment officer Chad Padowitz says.

“Many stocks are expensive because some investors are capitalising future cash flows by extrapolating recent high profitability. To make matters worse, others are capitalising even higher levels of profitability based on optimistic consensus forecasts,” Mr Padowitz said.

“We are researching opportunities all the time, but it’s true that most stocks we look at are priced off very high levels of profitability. The good news is that this is only temporary; we know that things will change, and that the opportunity set will grow.

“Not all stocks are pricing in unrealistic numbers, or numbers that provide a poor starting point for an investment idea, but generally high margins imply a current risk to earnings’ expectations.”

EBIT margins for the S&P 500 are forecast to rise to 18.5 per cent by 2026, up from 16.3 per cent in 2023. Similarly, the STOXX Europe 600 is expected to see margins increase to 16.7 per cent, up from 15.8 per cent, while the FactSet Japan index is projected to reach 10.0 per cent, up from 8.1 per cent.

Mr Padowitz said “Economic releases, including key leading economic indicators such as the most recently published ISM manufacturing index, suggest challenges for the economy and, by extension, for corporate profits. There’s always room for debate but given the data, you can understand therefore why we are sceptical that these indexes will hit the forecasts.

If we were forced to explain the optimism, we might turn to deficit spending.  Economic growth is obviously heavily influenced by government fiscal policy and most notably in the US there is little sign of political will to rein in spending.

For example, there now seems to be bipartisan support in the US for extending the Tax Cuts and Jobs Act of 2017, which might mean a $4.7 trillion reduction in revenues and an additional $800 billion in costs over the next decade.  This means the deficit could rise to more than 8 per cent of GDP by 2033, up from the 6.8 per cent projected under current law. This trajectory moves us further away from a sustainable fiscal policy, which requires the ratio of debt held by the public to GDP to be stable or declining over the long term.

The risks associated with high debt-to-GDP ratios are significant, including lower levels of absolute growth, economic instability, higher interest rates, reduced financial flexibility in crises, intergenerational unfairness, and potential social and political unrest.

Padowitz pointed to the 2022 experience of the Truss-led UK government as a real-world example of the market’s response to perceived fiscal irresponsibility.

“With debt doves flying high, and all other things being equal, continued deficit spending may be one mechanism underwriting the forecast profit growth that we otherwise find hard to explain. In the meantime, as bottom-up investors we keep ploughing our furrow.”

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