U.S. stocks have rallied over 20% since April 8. What’s been driving the gains, and when you look below the surface, what’s actually working?
The S&P 500 successfully climbed the proverbial “wall of worry,” which was built in the form of trade policy uncertainty, interest rate volatility, and geopolitical risk. The initial pivot on April 9th was attributed to a 90-day pause instituted shortly after the tariffs were announced, and subsequent trade deal announcements sent risk assets higher. What’s worked since markets bottomed in early April has been a familiar story. Within US equities, growth has outpaced value by 15% and large caps have outpaced mid and small caps by over 2%. Within fixed income, investment-grade and high-yield have outperformed treasuries and securitized sectors.
As we approach the July 9th tariff implementation, do you think markets are fully pricing in the potential impact of trade policy? What are you watching most closely?
At 22x forward earnings, markets have seemingly priced out anything other than a positive outcome from the trade policy and are somewhat unprepared for a disappointment on this front, as net tariffs will likely be higher after July 9th.
At this point, markets are likely looking beyond trade policy and turning their focus on the remaining policy priorities of the administration, which will likely be more constructive for both the economy and markets moving forward in the second half of this year, as deregulation and tax policy continue to advance.
In light of the evolving trade and tax policies, we continue to monitor a challenging dynamic that has developed between the U.S. dollar and long-term Treasury rates, as the dollar has continued to weaken despite long-term Treasury rates moving higher. Given that this dynamic has historically been experienced in emerging markets, it is definitely a concern and worth monitoring moving forward.
With bond yields now offering income above cash, plus the element of diversification versus riskier assets, how are you positioning fixed income within portfolios?
We’re excited about the opportunities available in fixed income today as we are able to achieve desirable levels of income without having to sacrifice credit quality or take on additional interest rate risk, which, for much of the decade preceding 2022, were the only ways to achieve similar yields to those available today in the investment-grade landscape.
Specific to our positioning, the relative valuations and credit enhancements available in the securitized sector combine to make it an emphasis across portfolios today. The bulk of our duration exposure remains in the 1-10 year part of the curve, as we’re intentionally underweight longer-term Treasuries due to the uncertainty within the bond market, particularly around the challenging fiscal policy dynamic moving forward.
How are you thinking about active versus passive management in today’s market? Are you leaning more in one direction than the other?
From our perspective, the opportunity set for active managers truly couldn’t be better, as elevated interest rates, changes to trade policy, and upcoming changes to tax policy will continue to create an environment that benefits some companies more than others and rewards management teams that can adapt and manage accordingly. Combined with a bifurcated valuation backdrop, the opportunity for active management is really attractive moving forward.
For example, on the valuation front, the S&P 500 is trading at 22x forward earnings, which is at the top end of its historical range. Meanwhile, the equal-weighted index is trading at under 17x forward earnings, and the S&P 400 Mid Cap index is trading just under 16x. So, while valuations are stretched at the headline level, there is plenty of opportunity below the surface.
Within fixed income allocations, we prefer to be active and employ active managers within credit, as spreads are currently tight. There are numerous intricacies in the bond marketplace today that we believe experienced fixed income teams are better positioned to capitalize on than purely passive strategies.
So ultimately, across portfolios today, we are expressing this view by allocating more to active managers and enhanced strategies, while de-emphasizing purely passive exposure at this time.