Some Wondering Thoughts
Outside of some momentary bouts of intraday volatility, U.S. equities have been on a one-way train higher since April 9th, when Trump announced a 90-day reprieve to the implementation of reciprocal tariffs. One could liken this to an arsonist being applauded for putting out a fire he started—and you wouldn’t be wrong—but investing with a heavy reliance on ideology and political bias is often an inhibitor to investment returns. Furthermore, for a President who claims not to be paying attention to the stock market, he sure seems to be acutely aware of what it's doing and has impeccable timing for dropping trade ‘deal’ headlines to bolster asset prices.
I know some of my readers may cringe when reading this next statement, but you do have to give President Trump credit for being flexible. While I think the manner and strategy behind the rollout of realigning global trade through this administration's eyes was clumsy, chaotic, and confusing, I’m glad they backed off (caved, pivoted, panicked…pick your adjective) because if they hadn’t, we’d be in much worse place than we are today. That being said, don’t get overly complacent on this file as President Trump made clear in his interview on Meet the Press that tariffs are cornerstone to his personal beliefs and this adminstration’s policy agenda:
“The tariffs are going to make us rich. We’re going to be a very rich country.”
“I don’t think that a beautiful baby girl needs — that’s 11 years old — needs to have 30 dolls. I think they can have three dolls or four dolls because what we were doing with China was just unbelievable. We had a trade deficit of hundreds of billions of dollars with China.”
“They don’t need to have 250 pencils. They can have five.”
“But they said today they want to talk. Look, China — and I don’t like this. I’m not happy about this. China’s getting killed right now. They’re getting absolutely destroyed. Their factories are closing. Their unemployment is going through the roof. I’m not looking to do that to China. Now, at the same time, I’m not looking to have China make hundreds of billions of dollars and build more ships and more army tanks and more airplanes.”
This doesn’t sound like a President who is going to back down from his aggressive tariff file, but there is some recognition that this hurts both the U.S. and China, and that a change to the status quo is necessary.
Nevertheless, we’ve moved into the deal announcement phase of trade negotiations, where we now have daily headlines about “deals” in the works in a covert effort to stimulate investors’ “animal spirits,” with it being a very effective strategy, so far. Nobody knows who is actually talking to who or what is contained in any deals that are in the works, but Japan is now saying that an agreement will be penned as early as June, India apparently has finalized terms of reference for a bilateral trade deal, a thaw has developed at least in terms of rhetoric between Washington and Beijing, and President Trump is set to begin talks tomorrow with newly-elected Canadian Prime Minister Mark Carney.
At some point, the details of these deals will matter, but we’re not there yet. This is why equity markets have recouped the entire slide of the post-liberation day sell-off. I'm not saying this is bullish over the intermediate to longer term, but for the near term, bear markets require bad news and bad data, neither of which we’ve been getting over the last two weeks, during which the S&P 500 has rallied 18% from its April 7th lows. As of Friday, the S&P 500 is riding a nine-day winning streak, where the percentage of stocks in the S&P 500 above their respective 20, 50, & 200-day simple moving averages is now 88%, 56%, and 41%, a significant improvement from where they were just two weeks ago.
However, the S&P 500 is hitting some short-term resistance as it trades above its 50-day moving average, but below its 200-day at 5,770 (and falling). The death cross (when the 50-day falls below the 200-day) is still in place, but the last time we got the death cross (back in 2022), the S&P 500 experienced a significant short-squeeze that pushed it above the 200-dma before rolling over and losing some 20% over the following 6 months. The past is rarely a perfect analog for the future, but it does provide informative context.
The bulls are getting plenty of signals from market price action that they would want to see to confirm such a view: beyond the rally in equities, we have credit spreads tightening back in rather dramatically. Furthermore, since inauguration day, we have the U.S. dollar off 9%, the yield on the 2-year Treasury down 70bps, and oil prices down 20%. This amounts to a dramatic easing in financial conditions, not to mention Q1 earnings and economic data coming in better than feared market expectations… all of which more than offsets the recession concerns being fueled by depressed soft data. While I admit to being skeptical of equity prices in this 5,600 – 5,850 range on the S&P 500, I’d be remiss in not admitting that risk assets could very well look through a transitory bout of economic weakness brought on by trade policy uncertainty while focusing on growth initiatives like deregulation, tax cut extensions, and reshoring coming down the pipe. Not to mention that both Trump and China, the trade relationship that represents the biggest risk/opportunity, are looking for a way to save face. Both sides recognize that this is not sustainable for more than another couple of weeks, as an extended continuation of what amounts to embargo-level tariff rates that inflict significant economic pain on both countries.
Sentiment is another data point that lines up in support of the bull camp. Let me remind you that sentiment from an investment perspective is interpreted from a contrarian lens. With that in mind, there are still plenty of skeptics around, which is what a bull loves to see. The latest results from the Investors Intelligence poll show a 28.8% share in the bull camp (up from 23.5%), which is still lower than the 32.7% in the bear camp (though this came down from 35.3%). The AAII investor survey has bears outpacing bulls by almost 3:1 – bears at 59.3% vs. bulls at 20.9% (the bull reading was at 43% earlier in the year as the S&P 500 was making new highs). Even with the S&P 500 ripping higher over the past two weeks, the CNN Fear/Greed index remains in the “Fear” zone, although it has moved out of the “Extreme Fear” terrain. All I’m getting at here is that with sentiment and positioning data still handily skeptical of this rally, there remains some fuel that could push this rally further to the topside.
However, there are pockets of non-confirmations worth considering in what is adding up to be a considerable rally in risk assets. Oil prices have collapsed -27% from the nearby highs: this has not happened because of “drill baby drill” (rig counts are down year-over-year), and only part of the story relates to OPEC+ allowing increased production. Part of it also has to be a result of demand destruction, if not, then the Transport stocks, which historically are inversely correlated to oil prices, would be rallying hard. Instead, they are still locked in a fundamental bear market, down more than -20% from their recent highs. Well, Corey, didn’t you hear that global trade is shutting down? That explains the decline in transportation stocks. Perhaps, but aren’t we also constantly being told the narrative of inventory stockpiling occurring in anticipation of tariffs, yet Q1 earnings results for this industry didn’t reflect increased activity.
Let me add a brief comment on the energy sector, as I think this is one area of the market most aggressively priced for a recessionary outcome. If that ends up being the case, then I would guess we might see the price of oil slip into the 40s for a brief period, but that would mark the lows for the cycle. However, if we don’t get a recession, then this sector has a lot of ground to make up on the topside. Moreover, big money investors have abandoned the sector. According to BofA’s research team, long-only investors are more underweight Energy than any other sector vs. historical norms. Additionally, hedge funds are carrying one of their most aggressive energy shorts in history. Not to mention the S&P energy sector just posted its worst monthly decline in years with capitulative market action on full display. Those willing to take a longer-term view of the sector can take comfort in the fact that management compensation is now tied to cash return, not production growth, making dividends sacrosanct and undermining the “drill baby, drill” narrative where the price of the commodity matters to investments being made. Lastly, the sector’s free cash flow yield is currently over 6%, well above average, and argues that an ample margin of safety exists for investors willing to endure the headline risk.
Getting back to another signal not confirming the equity rally is the -9% slide in the U.S. dollar coinciding with commodity prices in general sliding more than 10% from their nearby peaks – typically, a weaker dollar is a tailwind to higher commodity prices as commodities are priced in dollars, but this is not the case today. The slide in the U.S. dollar also begs the question of why FX investors are not buying into the U.S. exceptionalism trade being back in vogue? If they were, we’d see a U.S. dollar trading flat or higher along with U.S. equities. Instead, we're seeing foreign equities outperforming, which signals that money is being repatriated home and being put to work in regional equity markets. Just looking to call some attention to the inconsistencies, as a lot of bad news gets priced out during this renewed risk-on rally.
Which brings me to the conundrum with analyzing and interpreting incoming data. Last Friday’s jobs data and the Q1 GDP report were solid enough to relieve investors of any anxiety that the economy was breaking down. Sure, Q1 GDP printed negative, but the internals of the report showed the consumer was strong, and much of the weakness stemmed from the sharp, import-induced widening in the trade deficit. Investors would be well served to recognize that we have not yet seen all the tariffs and uncertainty hit the hard data. We may not see that until we are well into the summer because of all the preordering, inventory building, and consumer stockpiling that took place in anticipation of tariffs. This pulls forward a lot of GDP growth that potentially creates a data vacuum in the months and quarters ahead. What has not hit the data yet, for example, is the fact that ocean container bookings from China to the United States have plunged -60% since early April. Many businesses reliant on shipments from China have halted inbound orders.
Let me wrap up with some closing thoughts. For starters, I’m not a willing buyer of the broad equity market with the S&P 500 trading around 5,700. Certain areas of the stock market still intrigue me, but I think it's time to exercise patience and discipline with any further allocation into equities. Admittedly, this could end up being unwarranted caution if the S&P 500 pushes above 5,900, I’ll question my view, and if it makes new all-time highs, I’ll know I was wrong. Otherwise, I’ll be waiting and watching with the expectation that sometime in the Summer or Fall, patience will pay off as we’ll get another shot at deploying capital into stocks at lower levels. My skepticism is well short of a bearish view. I don’t think investors should be selling everything, going to cash, and/or shorting the market. I just think the risk/reward is not too compelling at current levels.
Make no mistake, the objective this administration is looking to achieve with its policies is extremely disruptive to the existing system as we know it. And as much as I’d like to buy into the idea that such a transition can occur without a hitch, such a scenario continuously checks out as a low probability outcome in our work. Take, for example, the walking back of tariffs. It's nice to see Trump and this administration taking a more practical position, but at the end of the day, to make the math work on the budget and tax cuts they are trying to pass, they need revenue offsets, which have to come from tariffs. We’ve recently learned from Elon Musk and DOGE that they could only come up with $160 billion in cuts (great, that’s not nothing), but it’s nowhere close to the $1 – $2 trillion they were throwing around. Furthermore, it confirms how difficult it is to cut federal spending – you don’t get elected by taking a government program away from someone it was promised to. It may come as a surprise to many, but the federal deficit through March is outpacing every year in the past decade except 2021 (a year of heavy Covid stimulus)
Bottom line, tariffs are an added expense that someone has to pay. This is a liquidity drain on the global financial system that redirects funds from the private sector to Uncle Sam’s coffers. Coffers that need to be funded by something, otherwise we will be back in the soup with Treasury yields spiking like they did in the U.K. when Liz Truss attempted to abandon even the appearance of fiscal responsibility. But make no mistake. The fiscal stance is about to change, and not in a manner that is unequivocally supportive of risk assets, although that is the way equities are acting.
In a nutshell, I’m back in the camp that advocates investors hold a broadly diversified portfolio of stocks, bonds, gold, commodities, a little bit of bitcoin, and cash. However, this portfolio should be managed with just 60-70% of the typical exposure you would carry, with the residual in cash or cash-like holdings. I don’t see a major asset class today that looks compelling to me at the moment. I believe the catalyst for the next part of the stock market decline will most likely be when/if we get confirmation of the economic “hard” data outright weakening. Until then, we’re all at the mercy of the latest policy announcement.
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