Underwhelmed

Underwhelmed
 

The market has been underwhelmed lately, either from an AI disruption perspective or geopolitical fears. Even with NVIDIA posting better than expected results and a strong forward guidance, it was not enough to stabilize the market with the US equity continuing its underperformance year to date.

It has been obvious that there is a rotation out of US equity stocks into Emerging markets and Europe. There is no outflow per se, but there are less inflows versus last 3 years and that makes a big difference given the support levels and elevated valuations. If we zoom out, that makes sense and it is a view we have been implementing in our portfolios and AMC from the end of the last quarter. Valuations in EM and Europe trade at a steep discount as in the last 2 years the US has outperformed due to the AI and technology momentum. The market is diversifying away from the high concentration risk of technology stocks into value stocks with an emerging market bias, as the market believes there will be a vertical integration of AI in other industries which help lagging companies increase productivity and by default earnings. Of course, there will be winners and losers, but companies which can adapt and recalibrate their business model will gain a good upside. Furthermore, the AI disruption narrative has taken more momentum with the US software sector down more than 20% year to date. For now, the market hasn’t made up its mind yet in terms of who is going to benefit from the AI inclusion, so the sector is moving lower across the board. We do think that there are some bargains here to be made but it seems that positioning is still heavy, so we are not fading the move yet.

On the tariff side, in a 6-3 decision last week, the US Supreme Court declared President Donald Trump’s use of an economic emergency powers law, illegal. This implies that more than $170 billion in tariffs are liable to be paid back to the corresponding companies. Now, whether this money will be sent back is something that the lower courts will decide upon and most probably this will entail a legal battle with the current US administration. President Trump immediately acted to charge a 15% blanket tariff for all countries, a move which created further uncertainty and confusion. Countries such as Japan and Europe, asked for further clarity before ratifying their existing trade agreements. We expect further action from the US administration to counterbalance the lost tariff income, but in all essence, this has opened the door for a lower tariff perspective which could imply further disinflation momentum.

Moving over to geopolitics, the Iran-US saga continues as officials have agreed to reconvene nuclear talks as soon as next week, with technical discussions to resume in Vienna. Iran said it won’t allow any of its highly enriched uranium to be moved out of the country, while officials have signaled Iran would have to send such stocks to another nation or dilute them. The tail risk here is a short-term escalation which hopefully can be avoided if diplomacy prevails.

On the market side, we are seeing US equities continuing their underperformance this week, trading 0.5% lower with European equities moving anywhere between 0.25-1.25% higher on the week. Metals have reconvened their upward trajectory with Gold and Silver trading 1.4% and 6.4% respectively on the week. EURUSD continues its tight trading range in the 1.175/1.185 context. On the rates side, the 10yr US Treasury has crossed the 4% psychological level with German 10yr bunds following at 2.68% yield. The steepening bias in Europe continues with the long end of the curve, feeling quite offered.

Looking ahead…

Obviously, the follow up meetings between Iran and US will define the risk mode of the week and depending on the outcome risk assets will behave accordingly. On the data side, we have US NFP next week along with ISM Manufacturing numbers and PMI. The absolute numbers per se do not count as much, rather than the trend we can define. So far data has supported the risk on momentum nevertheless positioning and geopolitical fears seem to matter more for the market as of now. We are also moving into black out period as earnings will kickstart in the next couple of weeks with the banking sector taking the lead.

Written by: Michael Konstantinou, Senior Portfolio Manager