Note Feb 21, 2025: Capital Markets, Trade And Own Goals

Note Feb 21, 2025: Capital Markets, Trade And Own Goals – Chockful in tensions with wars, trade and political economies rending potentially from friend and rival alike, the risk is rising of that called an own goal in soccer and hockey parlance. The February 14/16 2025 Munich Security Conference was notable in its breadth of concerns raised. It is appropriate in investments to review balance between momentum versus risk premium cushions being hitherto ignored. We would recall that in 1985, super power rivalry, trade tensions then with Germany and Japan spilt into calls for currency and rate management which was followed by capital market hubris about so called “portfolio insurance” that was anything but.  

Capital markets have been momentum oriented with dependence on a backstop of globally congruent central bank policy that presently shows bifurcation. Classical creative obfuscation in balancing inflation versus growth parameters was buttressed in Semiannual Congressional testimony over February 14/15 2025 by the Federal  Reserve Chairman. Bellicose trade tariff positioning and many fiscal worldwide uncertainties likely add support for such a shift.

We expect Fed Funds rates at 4 ¼ % through 2025 with a potential 25 basis point increase in late 2026 as visibility improves. We see 5% yields as also likely for 10 year Treasury Notes, as risk benchmark. Central banks from Europe to Britain to Canada to Australia have cut rates on domestic weakness, despite common concerns about inflation. Multifactor considerations favor precious metals in strategic asset mix. Monetary and fiscal policy bifurcation could lead to currency stresses even for the G7. In Fixed Income, we prefer positioning on high quality and up to 10 year in maturities.

We expect the implications for equities worldwide of risk premiums based on 5% 10 year T-Note yields to be to drive down valuation, increase volatility and curb momentum. The reestablishing of risk premiums is precisely to recognize that all is not known in advance. The slicing and dicing of risk may have sartorial elegance but reality is messy for example in the 1985/87 currency/so called insurance debacle and the 2008 credit/subprime international debacle when political economy permutations also loomed large.

Even were a soft landing to be achieved, we expect volatility as corporate delivery and valuation incorporate higher than present risk premiums. Already in the early 2025 result releases, corporate managements have appeared more circumspect on prospects than have appeared to be capital markets. It is seen from luxury, staples, health and now even basic necessity companies otherwise regarded as better managed; from several automobile companies ranged from the U.S. to Europe to Asia; in banking; and even in momentum favorite information technology.

With trade and tariff uncertainty globally, we favor sector diversification and quality of operating delivery. Even at low rates and amid momentum fever abating, financial and corporate cash flow management is likely to be critical. It is likely to be a period of strategic heft of defense and infrastructure refurbishment being emphasized by governments and companies. Within sector diversification, we assess energy, industrials and materials to be especially underappreciated.

Chockful in tensions with wars, trade and political economies rending potentially from friend and rival alike, the risk is rising of that called an own goal in soccer and hockey parlance. it is appropriate in investments to review balance between momentum versus hitherto ignored risk premium cushions. We would recall that in 1985, super power rivalry, trade tensions then with Germany and Japan spilt into calls for currency and rate management which was followed by capital market hubris about so called “portfolio insurance” that was anything but.  

Subsequent to the credit crisis, from 2008, capital markets have been momentum oriented with dependence on a backstop of globally congruent central bank policy. This assumption started to be challenged as far back as March 16, 2022, alongside a then initiated increase in Fed Funds rates and lesser quantitative quantum of solace. Into end 2024, capital markets remained central bank momentum driven, albeit now stop and go. In 2025, capital markets have not yet caught up with the clear signs of bifurcation among central banks. The Federal Reserve has a shift from being so called data driven and towards a more classical stance of creative obfuscation in balancing the parameters of inflation versus growth. Semiannual Congressional testimony over February 14/15 2025 by the Federal  Reserve Chairman leads us to confirm such a policy engagement shift as do the contents of the January 2025 FOMC minutes. Bellicose trade tariff positioning and fiscal uncertainties worldwide with many unknowns likely add support for such a shift.

Our stance is one of expecting Fed Funds rates to remain at 4 ¼ % through 2025 with a potential 25 basis point increase in late 2026 as visibility improves. We see 5% yields as also of likely potential for 10 year Treasury Notes, widely used globally as risk benchmark. While the Federal Reserve has presently left rates unchanged, several other major central banks from Europe to Britain to Canada to Australia have cut rates likely on domestic concerns, despite the commonality of also pointing to concerns about inflation. We assess that multifactor concerns favor precious metals as part of strategic and asset mix. Monetary and fiscal policy bifurcation could lead to currency stresses that have generally been absent for the G7. In Fixed Income, we prefer positioning on high quality and for up to 10 year in maturities.

Six weeks into the first quarter of 2025, much is in flux in the political economy and the investment landscape. We expect a shift for equities worldwide to be towards the implications of risk premiums based on 5% 10 year T-Note yields. They would likely be driving down market valuation and curbing consensus preferences away from momentum. The spectacular rise of gold bullion prices, developments in fixed income markets and bifurcation in administered interest rates contrast with the seeming complacency that manifests itself in in equity markets valuation and which has not been limited to the fabulous. The slicing and dicing of risk may have sartorial elegance.  Much more messy were such events in the past, as the 1985/87 currency/so called insurance debacle and the 2008 credit/subprime international debacle. As well as capital market interactions being less well understood at the time, political economy permutations loomed also large at the time. The eventual result was the reestablishing of risk premiums, precisely in order to recognize that all is not known in advance.  At present, risk premium readjustment again seems overdue.

Since at least the Covid 19 crisis and which was building before the pandemic, part of the global political economy environment has been a potent amalgam of elections, trade stresses and slow growth. The Munich Security Conference of February 14/16 2025 was anything but a sedate affair. In signaling radically different stances compared to the past, the U.S. has laid bare a wide spectrum of issues of import. They included a more fractious posture towards allies, especially on increased defense spending. It underscored at least initially, a more bilateral dialog with Russia with inclusion of Ukraine and Europe pegged only as second step. Finally and overtly, it emphasized a transactional rather than rule based trade posture at odds with almost eight decades of work and that now seemingly appears to be bilateral about strategic materials and energy as well as now seems running in parallel with prioritizing general trade equivalence.

Into the cauldron, the new U.S. administration has taken a bellicose approach to all of trade, the size of government activity and to international relations. It includes strategic military and industrial footprints. Ongoing wars and the vying for spheres of influence has appeared most overt in the eastern part of Europe, across the Middle East and around sea lane access into the south China seas. These realities have been striking in part due to world GDP annual growth being only around 3% even in post pandemic  recovery. Drilling deeper, annual GDP growth in China appears to be around 5% – half of its locomotive status earlier in the century. Key European countries like Germany appear to be in recession territory. Even without autarky, this amalgam represents a further step away from freer trade. After an eighty year buildup of support, freer trade optimism likely peaked in the first decade of the 21^st century. We assess that in gorging on near term momentum driven in part by prior central bank quantitative largesse, current building political economy stresses add to capital markets being overdue in incorporating into risk premiums,.

Irrespective of artificial intelligence and its potential generative derivative, requiring monitoring in particular is actual bottom line delivery in the near term via business efficiency and corporate productivity. Afterall as examples of prior change, in apparel, dispersion of manufacturing into lower cost centers offered consumers lower cost at equivalent quality. Higher up the complexity scale, quality and delivery even at premium pricing have long characterized businesses like German Mittelstand companies such as in precision machine tool manufacture improving company operations. Consumers and companies benefitted from such change. Despite the populist appeal to retribution for having been somehow taken advantage of, tit-for-tat tariff trade wars run significant and still un-delineated risks.

An annual corporate result and operations release is globally underway for 2024 and the outlook into 2025/2026. Even prior to the trade tariff salvos from the new U.S. administration, from a broad range of industries, corporate managements have appeared to be far more circumspect on prospects than have appeared to be the capital markets. Illustrations of the breadth of concern include the corporate assessments emanating from luxury, staples, health and now even basic necessity companies otherwise regarded as better managed; from several automobile companies ranged from the U.S. to Europe to Asia; in banking; and in information technology –  not withstanding the recent years of capital  market momentum effusiveness.

For the equity markets themselves and using the S&P 500 as benchmark, consensus appears to expect a year of 10-15% annual operating earnings growth for 2025 while we would expect 5-10%. Global GDP annual growth of 3% appears to be slow and highly bifurcated. In the early stages of recovery from a business bottom, companies do benefit from revenue growth; in the form of higher operating margins in utilizing their most productive personnel and assets. After the credit crisis, such occurred in 2009/10 and again in 2020/21 in recovery from pandemic. The present situation in 2025 hardly matches that post an imminent bottom but instead is five years beyond. Instead of a cyclical recovery environment,  companies are likely in a classical slower expansion phase. Furthermore as challenges, tariff wars potentially loomfor operating plans and costs appear to have risen.

Even were a soft landing to be achieved, we expect enhanced market volatility while corporate delivery and valuation decisions incorporate higher risk premiums. For instance, a 200 basis point risk premium that is historically not unusual. It would mean valuation contraction not just for the S&P 500 but elsewhere as well  (such as in Europe) where administered rates are much lower. At the cusp of world trade and tariff uncertainty, we favor focus on sector diversification and quality of operating delivery. Even at lower than historical rates and amid momentum fever abating, financial and corporate cash flow management is likely to be critical as well. It is likely to be a period of strategic heft of defense and infrastructure refurbishment being emphasized by governments and companies. Within sector diversification, we assess energy, industrials and materials to be especially underappreciated. E.o.e.  Copyright Reserved