Stay the Course
Two factors have contributed to market weakness over the past two months:
- The release of Chinese AI DeepSeek in late January drove a fundamental rethink of the multi-year AI infrastructure trade.
- The selloff has since “broadened out” to include cyclicals like retailers, financials, and industrials as worries around policy uncertainty and a shaky consumer have taken hold.
While we see evidence of meaningful de-risking among retail and “fast money” hedge funds, it’s too early to know how longer-term investors are confronting likely months of tariff, tax, and fiscal noise ahead.
What does this mean for investors?
From a fundamental perspective, we think downward earnings revisions can continue. We will be watching for any negative pre-announcements in the coming weeks ahead of the Q1 earnings season, which could foreshadow a more challenging April-May.
3 Things to Know
If the US sneezes, Will the World Catch a Cold?
Year-to-date, global diversification has helped dampen equity portfolio downside. More supportive government policy in Asia and Europe has helped boost earnings expectations in certain sectors like China tech and European cyclicals.
Our concern, however, is that a potential US-led slowdown, coupled with impending tariffs, will eventually hurt global firms with exposures in the US.
In particular, shares in the UK and Europe generate roughly a quarter of revenues in the US.
While emerging market stocks make less money in the US with a greater share of equity float held by local investors, a sustainable bull market will likely depend on whether global investors would be willing to allocate meaningful funds during a US slowdown.
For the Fully invested, High Quality Is Important Amid Uncertainty
Except in ’08-’09 or the Spring of 2020 when indiscriminate selling was met with an unprecedented policy bazooka, we’ll pretty much always want to seek quality.
Our call to look at small cap, for example, came with the caveat to consider profitable businesses preferably using active management. That said, even S&P 600 (profitable small cap) earnings will depend on a solid domestic economy.
The current US growth outlook is more uncertain. Credit spreads remain relatively tight, lagging the jump in equity volatility.
For clients who are already fully invested with a long-term horizon, we believe they should consider a higher quality tactical mix biased towards free cash flow generation, manageable leverage, and stable earnings.
Energy and Health Care Have Outperformed Over the Past Month
Energy and health care shares are roughly flat since the market peaked in mid-February. Health care’s resilience is perhaps unsurprising, as it meaningfully lagged other defensives in 2024.
Energy’s 8% YTD rally is more notable in the context of falling oil prices. In our view, the sector has dramatically improved its standing in recent years with cleaned-up balance sheets, attractive free cash flow yields, and deregulatory tailwinds. Energy also remains under-owned among global investors.
See our weekly CIO Strategy Bulletin for more details