Is Dust Settling?
Risk happens fast! Identifying investment regime changes and opportunity is the most important part of asset allocation. Narratives and headlines are the symptoms of underlying fundamentals. The economy was slowing and overvalued. The tariff noise has been the catalyst. We believe there is a playbook to navigate this volatile environment.
Tariff Tantrum
The US President and his advisors implemented broad based tariffs against its trading partners with far ranging goals from reindustrializing the US to isolating China. Thus far, they’ve only created panic to global growth estimates and heightened policy uncertainty. The equity market melted 15% in less than a month, credit spreads widened, the dollar moved lower, and interest rates moved higher. There were very few places for asset allocators to hide.
More recently, markets found refuge when Donald Trump announced a 90 day pause on tariffs on all countries except China. Markets rallied sharply and volatility receded from extreme levels. (Chart 1)
CBOE Volatility Index: Last 12 Months
Chart 1. Source: Bespoke Investment Group. Period: 04/15/2024 – 04/15/2025
Has the dust settled? Let’s examine potential catalysts and starting points.
Federal Reserve Sitting on its Hands (for now)
So far Jay Powell and the Fed have stayed quiet during this whole episode – although he is on record saying he thinks Trump’s tariffs will be inflationary. In addition, the first thing to realize is that the Fed is an inflation fighting institution and the current leadership still seems committed to its 2% target. Therefore, we expect Powell to conduct monetary policy based on his assessment of the inflation outlook and how it relates to that 2% target. That means there is very little incentive for the Fed to cut rates or use other measures to ease monetary policy. This does not mean that the Fed will not cut rates under any circumstances. However, it would take a deflationary shock like a big rise in unemployment or a systematically important financial institution to fail. Like in many cases, the Federal Reserve will likely be a day late and a dollar short responding to the ongoing panic.
However, if rates are cut, and cut aggressively, a lot of money could exit money market funds and go into equities. This could be a major turnaround catalyst. (Chart 2)
There is a lot of liquidity sitting in US money market funds
Chart 2. Source: Gavekal Research/Macrobond. Period: 01/01/2004 – 03/31/2025
With the Fed likely not stepping in until we see more pain, what will stave off the sell-off in risk assets?
Short-Term Capitulation
First, it’s important to evaluate the anatomy of a market bottom. The same way selloffs start from all-time highs, markets will always bottom before the worst is over. For example, risk assets bottomed out in the middle of the worst of the Covid crisis. We believe that much of the damage to growth and sentiment related to tariffs has already happened.
Second, it’s important to illustrate how rapid the decline has been. The S&P 500 got more than three standard deviations below its 50-day moving average during the March/April sell-off. (Chart 3) Oversold levels that extreme have historically been followed by stronger-than-average returns over the next three, six, and twelve months. In fact, in instances where the S&P 500 dropped 10%+ from all-time highs in less than four weeks, in all but one of six instances the S&P made an all-time high at some point in the next year.
S&P 500 Price vs 50-DMA (Standard Deviations) Since 2020
Chart 3. Source: BCA. Period: 03/01/2020 – 03/31/2025
Our market capitulation indicators all point to similar conclusions. This kind of broad-based shakeout is consistent with other crises outside of deep recessions, and strongly suggests a selling climax may already be behind us.
Ultimately, this episode took a lot of the fat out of the market and reset valuations to a more digestible investment environment. Just as we said at the beginning of the year – starting points matter; the same is true now. While soft economic data has been weak, it’s mostly been a function of policy induced uncertainty while hard economic data has held up better than expected. We do not believe this will trigger a deep recession. We believe draconian tariffs are unlikely after Trump’s 90-day reprieve. Trump cannot afford to trigger a deep recession or continued market crash that would all but ensure heavy Republican losses in the 2026 midterms. A dismal showing would leave him a lame duck, confronting a hostile Democratic Congress and a real risk of removal. In short, political self-preservation suggests Trump will not tank the economy over tariffs. Based off his most recent backpedal, a drop in the S&P 500 around 20% and the 10-year yield moving above 4.5% seem to be a line in the sand. The takeaway for portfolio strategy is that we resist the urge to get more bearish on stocks and risk assets, even if they remain prone to sharp, headline-driven drops.
Tactical Asset Allocation Matters More Than Ever
In the shift from the “2% world” to the “5% world,” multi-asset breadth and especially tactical asset allocation have the potential to boost returns without increasing volatility. We believe that consensus allocation methods are likely to fare worse, e.g. “buy the whole market”, target date funds, and 60/40 allocations.
We believe that tactical asset allocation will be critical to clients meeting their long-term objectives. Therefore, we continue to stress the importance of tactical management. In today’s environment, advisors are challenged to rethink foundational elements of investor portfolios – which means seeking out strategies that bolster the “core” going forward. We will continue to provide solutions for the next generation of investing.
Fundamental Portfolios
As we enter the second quarter of 2025, our portfolios are positioned slightly overweight to risk. As markets have melted down, we have added equity positions and are prepared to adjust positioning as the year evolves. Recently, we continued to transfer equity exposure into larger market capitalization areas of the market and increased our exposure to international equities. We decreased credit exposure in our fixed income positions and invested in short-term cash equivalents. We expect to remain tactical with our exposure, shifting between credit and duration risk. We will adapt as the facts change and focus on catalysts for investment regime change. As always, we will continue to position our clients for the next generation of investing and will evaluate products for best fit in the global tactical suite.
(Positioning as of 4/15/2025)
Rules Based Portfolios
The technical picture for equities remains mixed but long-term trends remain intact. Our Momentum strategy remained fully invested in equities throughout the quarter. While we experienced the brunt of the drawdown, we expect a turnaround in equities. The strategy’s performance ranked in the top 4% in its category for 2024 . The technical picture for growth stocks remains in an uptrend and would need to see quick price deterioration to trigger a more defensive posture. Our Dividend strategy remained fully invested in equities throughout the quarter and fared better in the risk-off environment. The technical picture for value remains in an uptrend and would likely need to see quick price deterioration to trigger a more defensive posture. We believe that dividend stocks could be poised to outperform broader equities for the remainder of 2025. After being allocated to longer duration treasuries to start the year, our Treasury strategy shifted towards shorter duration instruments during the quarter. We were able to take advantage of this environment. Rate volatility has created some choppiness but we expect to allocate to longer duration bonds more frequently for the remainder of 2025 due to our 6-12 month cyclical outlook.
(Positioning as of 4/15/2025)
Blended Portfolios
The blended portfolios are a proprietary mix of our fundamental macro portfolios and our rules-based quantitative portfolios. Through this combination, we were able to take advantage of the volatile market environment in the beginning of 2025. Our top-down asset allocation mirrored our fundamental outlook as we overweighted our tactical allocation and tactical income funds in the strategies. Heading into the rest of 2025, our top-down asset allocation mirrors our fundamental outlook – beginning to overweight risk. Our equity rules-based strategies are currently fully invested, and our fixed income funds are positioned in near cash equivalents while we evaluate opportunities. We will adapt as the facts change and focus on catalysts for investment regime change.
(Positioning as of 4/15/2025)
You can get more information by calling (800) 642-4276 or by emailing [email protected].
Best regards,
John A. Forlines III
Chief Investment Officer
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