Going forward, we will be introducing a risk and exposure scoring system based on a 100 point scale. This “speedometer” system monitors macro, corporate micro, consumer, and technical factors that roll up into a score that will help inform what our exposures to risk should be. This updated risk dashboard is quant/qual informed. We want the data, our qualitative opinions and the portfolios we manage around it, to all be tied at the hip. We are excited to introduce these new tools and improve them over time. Having an unemotional set of variables to assess and that drives us into the prudent portfolio allocations, should add a significant amount of value to portfolios and in our calls with clients and partners. Stay tuned!
Commentary:
Its been a wild 5 weeks as Trump2.0 has gotten off to a very odd & rocky start. We should expect a VIX premium tied to Trump and their approach to leading, at least for now. There were more frequent sharp drops and rebounds during Trumps first term as well. The odds of a recession have now moved from <10% to 25-35%. The markets are reacting to the odds rising. Markets had a strong January but February has been all about defense across the bond and stock markets, a welcome change as these historical "defensives" generally weren't acting defensive when inflation and rates where rising. At least we have the negative correlation of duration and traditional defensive equities now. For how long is anyone's guess. It's clear the market has been extrapolating policy changes into economic weakness as uncertainty causes businesses and consumers to pull back on the throttle short-term. Yes, the administration is playing a dangerous game, there's clearly some arrogance in the believe they can micro manage a $23 trillion economy without knock-on effects. Now that Trump has started a trade war, it could escalate. Or it could de-escalate. Either way, uncertainty has increased significantly, as evidenced by the sharp decline in stock prices. That makes this marketing tricky for both long and shorts given headlines drive daily trading direction. Short-term, markets seem ready for a bounce is my short take.
After a few interviews last week, it's become clear what the administration is focused on: 1)creating uncertainty with rapid-fire, shoot from the hip policy updates happening daily, 2)tariffing everyone, there is no country that seems safe - we need the extra revenue and we want better deals with other countries no matter what the short-term cost to our relationships or the economies in question, 3) austerity in government via DOGE - the govt spending has gotten out of control and needs to be reigned in, bloat is everywhere so they are using a shovel approach to taking out the garbage. There are sure to be negative knock-on effects here, 4) nationalism, protectionism, isolationism, aka the opposite of globalization, which is responsible for much of the economic growth around the world the last 2 decades, 5) lower rates and inflation by forcing consumers and corporations to slam on the brakes as the rules of the road are being created literally on the fly, 6) forcing a slowdown offers the Fed the air cover it needs to start cutting rates again which could begin to stabilize the economy and allow confidence to make a positive u-turn. This will take time, so for the next 2-3 months at minimum, I suspect markets and all asset classes will stay volatile and commitment on the part of long-term investors will be tested. We seem to be in 2 steps backward, 1 step forward mode for now. As far as inflation is concerned, any near-term reductions should be short-lived given most of the policies being adopted are inflationary at their core. I'm not sure we could find all the workers for all the new manufacturing plants we want to build anyway so a lot of this feels more like noise.
The Technical Take:
This week will be very telling given we kissed the 200DMA and bounced on Friday. Some follow-through early this week would be a positive development. We are starting to see some positive divergences develop that are hinting at a rally attempt but the strength of any rallies are what will be most telling. Are they narrow or are they broad? Are they happening on heavier than normal volume or lighter? Are they 1-day wonders or last multi-day? Do we get over the downtrend lines or fail around those levels, at least the first time up? More on that next week once we see what happens.
In hindsight, adding more defensives quicker would have been very valuable as we have given up our lead in the month of February. It's still early in the year so I'm not worried about it for now. Along with the risk scoring system we will be rolling out, I'm contemplating being more systematic about swapping portions of offense for defensive brands once the indexes break the 10 month moving average on a monthly closing basis (we are slightly under this level now but we need a monthly close under it) as well as de-risking on breaks of the 21DMA. When stocks or indexes break this shorter term moving average, lots of momentum money leaves quickly. More on that in upcoming posts. Make no mistake, the selling has been fierce across most of the market, particularly the names with strong momentum and beta. In 1 month the high beta style factor went from the 99th percentile of performance to the 5th percentile. Almost ALL of the relative strength has now been removed and the selling has been aggressive. It’s very rare to see equity sentiment this negative. These readings tend to provide solid forward return even if markets remain volatile for a period of time. The chart below highlights the de-risking by the hedge fund, CTA's and fast money crowd has been more severe than any time in over a decade. Put buying has been extreme. AAII bullish percent is extremely low, bearish extremely high. Fear/Greed index registering extreme fear. Is there any wonder why stocks can't catch a bid? The good news: There will come a time when uncertainty will improve on a rate of change basis, economic growth will re-accelerate, and a pro-business focus will be more evident. The market has been sniffing out the slowdown from uncertainty and tariffs. It will also sniff-out a positive pivot at some point and all the money that left in a hurray will want back into the US markets also in a hurray. One of my key market rules will come into play: Waterfall declines get retraced. It's just one of those little rules that happens almost like clockwork. The timing is just uncertain. Savvy investors will use these bouts of weakness and uncertainty to accumulate great businesses on sale so the time to full recovery contracts from buying the dips.
I've been a bit gun-shy about defensive equities given they haven't acted defensive for the last few years, but this appears to have changed, even if yields are a bit oversold and TLT is a bit overbought short-term. Last week, most indexes tested the 200 day MA and have held for now. We are pretty oversold but not max oversold in most assets. We have extremely poor equity breadth but its not quite at full wash-out levels yet. We can have an oversold bounce at any point, but until a firm catalyst arrives, I suspect rallies will get sold and markets will stay volatile with the VIX staying in the high teens to mid 20's. If the markets continue downward, I would suspect the indexes could see another 5% down quickly which would get VIX into the mid 30's and breadth to reach fully washed out readings. Its there that a more meaningful bounce could occur. We have rebalanced the offshore dynamic brands fund and added significant "defensive brands" exposure based on some research i've been doing the last few weeks.
I look forward to presenting a new Defensive Brands Portfolio that can be used as a side-car to other brands core portfolios or be the go-to brands model when us or clients want to stay engaged in equities but with alot more defensiveness. I'll show some great new datapoints at IC this week.
36% Defensive positioning now: Autozone, Berkshire Hathaway, Coca-Cola, L'Oreal, Mcdonalds, Nextera Energy, Pepsi. We will monitor the relative performance to the SPY on down days and can add even more defensiveness if we are not outperforming on down days. Ex-some large cap-gain restraints in HSUTX, we will do the same in the fund, particularly on any rallies that allow us to sell and reposition into more defensive brands on a pullback in these bond proxies. Any back-up in rates could offer solid entries into defensives at better prices as they reach overbought conditions at the same time the higher beta brands reach oversold. The International Brands portfolio is the leader YTD by a country mile, a tribute to the high quality nature of these brands and the heavy exposure to the regions of the world that are trouncing the US, at least for now. Trump seems convicted to drive flows out of the US given the uncertainty hes creating so Trump really is MAKING THE REST OF THE WORLD GREAT AGAIN. At least for now. I see no pro-business focus yet from Trump, first he needs to create the storm that he can say he saved America from.
The Good News:
If you have some duration, 2025 is shaping up to deliver wonderful buying opportunities to build bigger positions in high quality companies and brands. Buying when they are on sale is the only way solid returns happen. We advise to buy in tranches as prices come down and be willing to absorb some volatility along the way. Valuations are being re-set, that helps forward return expectations. America still has the most innovative companies and they are being put on sale as we speak. Its very hard to know where the market goes short-term, but this current bout of uncertainty is self-induced and the administration will not push this uncertainty theme forever. They have stated their goal is to cause uncertainty now so we can have more certainty and better economic growth with a better trade and deficit situation long-term. If the end is accomplished, the means that causes short-term pain and VOL will be worth it, particularly for those willing to step-in and add on these dislocations. Better prices near term, for better appreciation in assets longer term. Strap on your seat belt, the captain (Trump & Elon) is flying right into the storm in order to reach the desired destination more swiftly and on better footing. This plan is not without risks and the current environment likely warrants more defensive exposures in portfolios, which we are deploying now. Once we see a more reliable washout signal or a policy pivot, we will be happy to swap defense out for more offense at better prices so the stock recovery can be just as swift. Until that time, we intend to stay focused, stay balanced, and will upgrade the portfolio as prices get too hard to ignore. Buy fear, it’s when prices are the most attractive!
