Destructive ambiguity

The centrepiece of this week was a sharp but still only partial unravelling of some of the most popular momentum trades of the last few years. Bitcoin, AI baskets, and the Magnificent Seven were all prominent on the loser board. There are, as usual, many potential ways to interpret this downdraft in various risky assets. The one that you choose to emphasise will help inform how you respond.

Whodunnit?

The swoon in US economic data, including a head fake from the Atlanta Fed Nowcast¹, has certainly contributed. The US economy exited last year at a more than healthy clip. Some of the softer data, outside of this warping surge of gold and other imports, may simply turn out to be payback for that strength – part of the normal ebb and flow of the economic cycle, with some nasty weather and other one-offs thrown in.

At the same time, there is a policy sequencing story. There is overlap between some of the more economically hostile parts of President Trump’s policy flotilla and the unilateral powers of the office. Various acts and statutes give the President a lot of room on the implementation of tariffs without recourse to Congress, as we have already seen.

The uncertainty created by both actual announcements, the intervening jawboning and backtracking will chill investment and hiring decisions almost instantaneously. On the other hand, the tax package needed to offset the expiring Tax Cut and Jobs Act by the end of the year, requires a broad and complex legislative effort, with any effects (positive or negative) surely a bit further off still.

The high stakes game of trade chicken being played over all of our heads will thus have an immediate economic cost, whether the Oval Office is bluffing or not. The former remains the widely shared suspicion – that all of this sound and fury remains part of an elaborate bluff – President Nixon’s (unsuccessful) madman² strategy repurposed to force better ‘deals’ for the US, with a Nobel peace prize for garnish.

Underneath all of this, and perhaps most important of all, the previously unassailable US corporate titans have wobbled a little. The eyewatering increases in AI infrastructure spending from the biggest names are so far juxtaposed with the expectation of a sharp slowdown in earnings growth. Perhaps these hundreds of billions of dollars will ultimately prove a public good, but in the shorter term, it is conceivably a giant act of broligarchic hubris with an uncertain return.

End of America?

The end of the American century is not here yet. Even with this more disruptive force in the Oval Office highchair, the sheer diverse dynamism of the US corporate sector and wider society remains unmatched anywhere in the world. Even with some fraying at the edges, US institutions can also still be said to prevent formidable barriers to capture by despots and tyrants.

However, what we have seen so far this year is a healthy correction to sentiment extremes. Notably, credit spreads have been reasonably well behaved in this latest episode. Historically, you’d expect to see them widen more than they have given the magnitude of the sell-off in equities – some (tentative) evidence that this correction is, so far, more about reducing some froth within equity markets, rather than substantial economic weakness on the horizon.

The US is still exceptional, but there is a returning realisation that exceptional should not be confused with infallible. Business leaders there can buy into their own hype just as anywhere else. Clever and well-informed Americans are as capable of misdiagnosing their own successes and failures as brains elsewhere.

If too much was expected of the US, then not enough was expected of parts of Europe and Asia. That fact helps to explain much of the constellation of returns seen so far this year in the world’s capital markets. This has been brewing for some time, as indicated by the fact that shares in European banks have beaten those of the fabled Magnificent Seven in the US since the summer of 2022 (Figure 1).

Figure 1: European banks have outperformed the fabled Magnificent Seven in the US since the summer of 2022

Source: Bloomberg, Barclays. Note that past performance is not a reliable guide to future performance.

Rising earnings estimates in Europe and the nascent signs of a cyclical upturn will be watched closely. However, the real action to watch in this next couple of weeks will be in the German Parliament. Can Europe begin to behave as a coherent region? Wise investors will want to make sure they are well diversified across asset classes and regions for the coming period.

Appendix

Discrete annual returns (%, USD)

Source: Bloomberg, Barclays. Note that past performance is not a reliable guide to future performance.