Note April 13,2025: Pandora’s Box, Volatility and Rough Road To Value

Note April 13,2025: Pandora’s Box, Volatility and  Rough Road To Value – In a Pandora’s Box, overall capital market volatility beckons on a rough road to value. Policy and revenue angst is building with momentum market behavior now being over tariff jousts. It underscores rising systemic risk. As political, economic and corporate realities translate into hard data, we expect valuation metrics to play greater roles.

Despite exhortation by the IMF, OECD and the BIS, salient fiscal budget challenges remain obscured in the public discourse in most G20 countries. We favor shorter duration and up to 10 year maturity in Fixed Income. In Asset Mix we also favor gold bullion amid increased currency volatility and central banks adding to physical reserves,.

With results and 2025 expectations deluges imminent, corporations appear globally to be in a pincer of revenues moderating while costs rise and, interest cost uncertainty appears. Systemically, tariffs are paid through global growth and not by the proverbial “Man on the Moon”. Our expectations are reduced to at best 5% earnings growth for 2025 for the S&P500. Adding to volatility, equity valuations are not low low and momentum exists. We would favor quality of delivery and conservative balance sheet structure.

Amid capricious tariff risk, in information technology and related areas, we see software as better insulated than media. Defense and infrastructure potential spending patterns favor industrials. Worldwide now, consumers endure higher costs. Purveyors of basics appear better positioned than aspirational areas, even in erstwhile defensive drinks/cordials businesses. On strategic imperatives, materials and energy should override erstwhile cyclical designations. Banking and liquidity strength are even more crucial during volatile capital markets.  

Existent during 2024 and now into early 2025, capital market notions are often narrowly based on the short term. They need still to be disabused about political economy facets not being of impact. In a modern twist, it all seems like a 21^st century replay of that of earlier centuries in which the great powers of the day were tardy in conceding leadership or even change in military or economic might. They appeared more willing to confront all the way to massive economic and even war damage rather than trying to negotiate win-win or at worst standstill positionings. Even while avoiding the duress of the 1980s/90s, overall and across segments of capital markets appear in 2025 to have increased potential for the reestablishment of higher risk premiums.

Geopolitically, the wars from the eastern peripheries of Europe to the volatile Middle East show lethargic reluctances to fully disengage. To which can be added ongoing dominance feints in the Asia Pacific as sources of tension. Unlike the so-called peace dividend of the end of the 20^th century, these realities are likely to demand large and sustained increases in defense spending for small and large countries. Meantime and despite exhortation by the likes of the IMF, OECD and the BIS, most G20 countries face salient, ongoing fiscal budget challenges that remain obscured in the public discourse.

In a global GDP growth environment of only 3% per annum, there appears to be little margin for error. It underscores rising systemic risk. Competitive stresses were at hand well before the early 2025 acute trade tariff thrusts by the U.S. administration. It has been ratcheted up for the global trade in manufacture and services. Rather than the multilateral tilt existent since the 1950s, , sundry and often regional agreements have unfolded subsequent to the credit crisis and pandemic episodes. They seem likely to further extend into building up bilateral agreements. Systemically however, tariffs are paid through global growth and not by the proverbial “Man on the Moon”. In feverish competition from high technology to consumer goods with often sharp feints, the two largest economies of the United States and China hurled on the other, 125-145 % tariff gauntlets.

Seemingly derided have been the heft of economic entities like the European Union, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). Also appears the emergence of ASEAN into being far more than manufacturing export hubs. Then in the present imbroglio over tariffs in manufacturing, seemingly overlooked is that services as a proportion of workforces are expanding. They account for example in advanced countries already close to 80% in the U.S. and 60% in emergent Brazil. In the tariff wars that have now become narrowly defined, the emergent policy mix is likely to accentuate volatile fragility between consumer consumption and savings. In the often heated discourses, such fragilities appear being  under appreciated by governments and capital markets.

Central banks appear positioning to balance growth and employment versus their hard won inflation gains over almost half a century. At the basic policy level and even within the G7, we see monetary policy bifurcation as developing. Considering subsequent comments and the last March 2025 FOMC statement,  we expecting pursed lips over tariffs and fiscal policy. The Federal Reserve may well maintain Fed Funds at 4 ¼% through 2025 and then engage in modest 25 bp increments as the U.S. economy recovers. Domestic pressures elsewhere and uncertainty about global tariff regimes are already acute. It has been sufficient enough for China to potentially front load the stimulus measures targeted for late 2025 in its just concluded March 2025 NPC. Delicate choices also reside elsewhere in Asia, in Europe as well as in already fragile Latin America and Africa.

As growth demonstrates fragility, pressures could occur that have been muted for three decades and which add to systemic riak. In numerous emerging areas and in advanced countries, political intervention into monetary policy could tempt myriad fragile governments. In our scenario of Fed Funds at 4 ¼% and a benchmark level of 5% for 10 Year U.S. Treasury Note yields, there is room for considerable currency and fixed income volatility.

Over the first four months of 2025, it is noteworthy that fixed income and currency market momentum morphed from a fixation on the Federal Reserve to fixation on change aspirations on tariff policy. In turn, U.S. dollar exchange rates rose and then dropped while being accompanied by spreads widening markedly for CCC 10 year Corporates versus U.S. 10 year Treasury Note yields Sovereign advanced country yields are well below those of the United States and so offer limited defensive risk. Amid policy and revenue angst building, we favor shorter duration, diversification and up to 10 year maturity in Fixed Income. In Asset mix, we also favor gold bullion alongside currency volatility that demonstrates increases with central banks adding to physical reserves,.

For equities, the road has remained rough to becoming more valuation oriented. There has been a shift of note from central bank pronouncements, especially on Federal Reserve policy. Rather than engineering to becoming risk premium or valuation driven, equity and indeed overall capital market behavior appears morphed. Acute volatility has emerged in trading momentum based on tariff threats and feints. As political, economic and corporate realities translate into hard data, we expect valuation metrics to play greater roles.

The 2024 year end corporate result and upcoming prospect discussions by companies will soon be a deluge. Over the last quarter century and across the global markets, there has been a breathtaking expansion in sector diversity. It makes all the more important, the widely disclosed corporate developments such as in the S&P 500. For operating S&P 500 earnings, our expectation has been for 5-10% gains for 2025, even when consensus appeared to be for twice that. Corporations appear to be in an operating level pincer of revenues that are moderating while costs rise and at the bottom line level, interest cost uncertainty appears. Tariff wars of whatever duration would add to such pressures. We believe that to be realistic, likely now is at best 5% earnings growth for 2025 for the S&P500.  Severe volatility potential looms as valuations are still not low and momentum still exists. We would favor diversification with premium being placed on quality of delivery and conservative balance sheet structure.

Amid tariff joust risk being acute, in information technology and related areas of growth, we see software as being better insulated than media. Long spending imperatives favor defense and infrastructure driven industrials while the last cycle favored consumer areas. With consumers faced with already inbuilt higher costs, purveyors of basics appear to be better positioned than aspirational areas, even in the drinks/cordials once considered defensives. Tariff jousts appear in pharmaceuticals but less so in services. As strategic imperatives, materials and energy should override erstwhile cyclical designations. Amid capital market volatility in ascension, banking and liquidity strength are even more crucial.  

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