NEW YORK: President Donald Trump’s mercurial approach to his signature tariffs whipsawed markets last week.
And investors trying to position their equity portfolios to manage this ongoing uncertainty found the playbook from his first term offered little help.
What hasn’t changed is Trump’s strategy of pledging aggressive levies on trading partners and then quickly backtracking, either delaying them or cancelling them completely. What has changed is basically everything else.
For starters, the tariffs he’s proposed are going to impact a wider range of goods than during his first term.
But more importantly, investors are in a completely different paradigm. Volatility is higher.
The S&P 500 Index is on a red-hot winning streak, rising 53% combined in 2023 and 2024 and pushing valuations to lofty bull market levels.
Compare that with 2017, when the S&P was coming off a combined gain of just 8.7% over the previous two years, giving stock prices far more room to run as Trump took office.
To Tim Hayes, chief global investment strategist at Ned Davis Research, that means a defensive approach to allocating risk assets.
He said the firm’s investment model will likely call for cutting equity allocations “if tariffs produce a trade war that leads to rising bond yields, a worsening macro environment and an exodus” from the technology sector and the US markets more generally.
The caution underscores how the macro setup has changed too. Inflation is running hotter.
Interest rates are much higher. And the federal deficit is a far bigger headache than it was eight years ago.
Taken together, the backdrop for stocks is significantly more fraught, even as the economy hums along.
“We are in an environment of really high expectations in the third year of a bull market, whereas in 2017 we were coming out of a bear market,” said Todd Sohn, ETF and technical strategist at Strategas Securities LLC.
“When you have any form of fragility, any catalyst can upset markets.”
Asset managers’ exposure to equity futures is currently above the 40th percentile, according to data compiled by Mislav Matejka, head of global equity strategy at JPMorgan Chase & Co.
In 2017, it was below the 10th percentile. This means investors now have less dry powder to buy equities in the months ahead than they did the first time Trump took office.
By one barometer, investors’ expectations for the stock market have never been this high at the start of a presidential term.
The cyclically adjusted price-to-earnings ratio, more commonly known as the Cape ratio, stood at nearly 38 in late January, an “extremely high” level, according to Charlie Bilello, chief market strategist at Creative Planning.
“Historically, that has meant below average future returns for stocks when looking out 10 years,” he added.
Positioning tells a similar story. The US equity risk premium (ERP), a measure of the differential between the expected returns of stocks and bonds, is deep into negative territory, something that hasn’t happened since the early 2000s.
Whether that’s a negative indicator for share prices depends on the economic cycle. A lower number can be seen as indicating that corporate profits are going to rise. Or it could mean that stocks are climbing too rapidly and are far above their actual value.
Yet, the fourth-quarter earnings season so far has shown a troubling trend.
Fewer US companies are topping their earnings estimates, tariff talks are dominating earnings calls and outlooks for 2025 have already started to take a hit.
Shares of Ford Motor Co and General Motors Co tumbled after the carmakers reported, amid concerns about how these levies would hurt earnings this year.
Industrial giant Caterpillar Inc, which is considered a proxy for trade tensions, warned that revenues will be lower amid demand pressures, and higher prices for the big-ticket equipment it sells will only make that situation worse.
Meanwhile, some investors are looking at niches within the stock market where valuations are less frothy and historical patterns more S&P 500 favourable.
Scott Welch, chief investment officer at Certuity, is reallocating funds into a forgotten corner of the market that usually shines when the US Federal Reserve (Fed) cuts interest rates: mid-cap stocks.
“Megacap tech has been priced for perfection so it wouldn’t take much to cause a disruption,” Welch said in an interview.
“They’ve bounced back because they have strong earnings and cash flows. But nothing lasts forever.” — Bloomberg
