Sailing the straits while strapped to the mast

Somewhat fortunately, or perhaps presciently, our first market memo of the year (A baker’s dozen of risks) highlighted that, unlike 2024, the investment waters of 2025 looked to be choppier. For sure, the balance of risks, in our view, remains positive given President Trump’s pro-growth agenda and the rise of AI against the backdrop of a relatively healthy, though underperforming US economy. And as stated more recently in Strapped to the mast, our balanced portfolios are sticking with our overall overweight to equities and especially to “the broadening-out trade,” even as we are keeping extra cash (i.e., money markets) on the side for adding to these positions in a deeper sell-off. We are funding this cash via a big underweight to bonds, which seem the least attractive of the three big asset classes. This barbell positioning makes particular sense to us given that the balance of risks seems to be tilted negatively in the short term yet positively in the long term.

This memo updates the risk outlook in light of the fast-moving events of the past few weeks. Let’s go quickly through several that we highlighted in the Baker’s Dozen:

Downside risks

1. Ugly sausage-making underway with reefs everywhere. Unlike the sleepy last four years, the press corps in D.C. is working day and night keeping track of the president’s latest moves on multiple fronts to implement his agenda. Like a fast-moving snowplow barreling down a highway, he’s forging ahead as the smaller plows clean up behind him. News-driven market players are reacting accordingly. This week alone we’ve had tariffs implemented, then delayed, on Canada and Mexico as deals were made consistent with the president’s border agenda. Whole federal departments and/or agencies (think Education and USAID) have come under fire, with speculation mounting of their being shuttered. Meanwhile, news flow on the tax-cutting plan has been light, as politicians focus on finding “pay-fors.” Markets started down big, then up big, and are up again. We’d expect all this noise to continue, though markets seem to be getting better at not overreacting to the president’s deal-making style, at least on tariffs. We will probably be getting more headlines on this whole topic later this week, when the net trade figures for December are released, projected to show the trade deficit maintaining its nearly $1 trillion annual level. That is sure to elicit some entertaining posts on Truth Social, along with an impromptu press conference or two from the Oval Office.
2. Earnings are coming through, but as expected, guidance has been less optimistic than hoped for—for now. Even as earnings come pouring in ahead of reduced expectations for this earnings season (net net we are about 7% above previously reduced consensus numbers as I write this memo), guidance has not. In the all-important AI space, given the sudden announcement of a cheaper form of AI in China’s DeepSeek, the long-term hyper-growth view on chip prices and volumes has now come into question, impacting the AI trade from Nvidia through the power companies' need to fill the power gap that AI is projected to create. On the banking side, managements have proven reluctant to quantify the impact that deregulation could have on earnings, especially since the new rules that could help them have yet to be promulgated by the incoming members of the administration, many of whom have yet to clear the Senate approval process. Ditto, more broadly, on the positive earnings impact of the yet-to-be formulated tax cuts to come and/or the impact of lightened restrictions on energy exploration and higher liquefied natural gas (LNG) export volumes. You get the picture. In total, projected earnings for 2025 and 2026 haven’t budged at all since November, and few analysts have even begun to focus on our $350 estimate for 2027. Importantly for the broadening-out trade, the narrowing growth gap for the back half of 2025 between the Mag 7 and the “Forgotten 493” has actually narrowed modestly further, though barely, to a mere 5% despite the still wide valuation differential . No management team seems inclined to stick their necks out on forward earnings with so many balls in the air back in D.C.
3. The Fed, and the bond-market vigilantes, have quieted down for now but seem to be lurking in the weeds. Following his somewhat militant presser last December, Chair Powell has fortunately been saved from himself by the blackout period around the jobs number. So, no foreboding comments. At the same time, the bond vigilantes have been cheered by improved inflation data and, perhaps, by gradually coming to terms with the president’s chess-playing strategy. So far, bonds are quiet. We’ll see. A larger-than-expected auction could come up, if either there is a revenue blip over a sudden policy change in D.C. and/or if new Treasury Secretary Scott Bessent accelerates his plan to lengthen the duration of the Treasury’s debt structure.
4. The cancellation of Biden-era spending programs, along with rising announcements of federal government layoffs, is starting to get some attention. Trump and DOGE have put what they believe to be excessive and redundant government spending in their sights. With the recent “buyouts” offered to government employees and talks of reorganizing many departments, there is potential to see a short-term increase in the unemployment rate. However, this could be tempered through implementation by giving employees a long runway with phasing out their contracts and resigning later in the year, providing ample time for them to line up new jobs. While this could provide some short-term pain, we think this creates opportunity for lower deficits and healthier markets in the long run.

Upside risks developing but still not concrete enough for markets to get a grip on

1. Talk of the omnibus “Trump agenda” bill has been sidelined by all the Oval Office announcements on the border, tariffs, China and Iran. This news flow is likely to pick up once the confirmation hearings on the president’s cabinet choices are completed, but for now, there’s been little incremental (positive) news.
2. Trump’s tariff war counterparts seem to be trying to play chess; early signs seem net positive. The quick response of Mexico’s President Sheinbaum, instantly conceding to Trump’s border agenda with the deployment of 10,000 troops, was instructive. It seems she’s made a list of the president’s most likely next moves and has already developed a counter list she can concede rather than fight. Canada’s Trudeau to the north is trying to learn from her, but his days in office are literally numbered so, until a successor is chosen, Trump may choose to hold his fire. Most encouragingly, China’s Xi did not follow the “checkers” strategy of Trump’s first term (where the premier countered with threats of massive tariff hikes), and instead this time seems to be trying to pursue a deal and dial-down the rhetoric. Comforting for markets, at least for now. In the meantime, China’s announcement this week of (modest) moves against US mega caps such as Google and Apple highlights that the collateral damage in the trade wars is more likely in our big national champion Mag 7 names and less in the domestically oriented value and small-cap names we favor. 
3. Inflation numbers are holding steady, and even the Fed has noticed that the year-over-year (y/y) comparisons are entering a favorable period. The math, which we’ve been focused on for some time and which Powell himself appears to have discovered, is interesting. In particular, the first three months of 2024 printed 0.4% month-over-month (m/m) on Core CPI, while the last three months have averaged 0.3%. That means that simply replacing the first quarter 2024 numbers with monthly growth that is, on average, 0.1% lower could see the y/y rate of Core CPI drop from 3.2% to 3.0% by April. Likewise, the Fed’s preferred measure, Core PCE, jumped 0.36% each of the first three months of 2024, while we are currently averaging just half of that—leading to the potential for significant y/y improvement on Core PCE. For now, this is likely to limit the potential for a Fed mistake, i.e., a “pre-emptive hike” focused on the inflationary pressures from one element of the Trump agenda (tariffs) while ignoring the broader policy mix, which is deflationary, in our view.
4. Talk of capital markets re-opening is in the air but not yet happening. The US IPO market saw a large pickup in activity in 2024 with the number of IPOs up roughly 40% from the prior year; however, it still remains below normal historical levels, especially when measured by deal size not volume. We have seen some green shoots in the space in 2025 and have a potentially conducive environment for growth given Trump’s proposed polices and agenda. While we have yet to see major progress, this remains a large upside risk along with M&A activity, which should accelerate once policy uncertainty recedes later this year.
5. Geopolitical risks seem to be moving in the right direction. As predicted, the mere threat of Trump’s return to Washington was enough to spur a cease fire deal in Gaza; the next step could be a more permanent resolution. (However out-of-the-box yesterday's suggestion that the US take over Gaza might be, it's a positive sign that the president is focused on a permanent solution.) Ukraine is next but, so far, all has been quiet at that front. If Trump further pressures Russia with additional sanctions, as well as offering Europe increased US LNG exports as a substitute to Russian gas, we are hopeful that an end to that war, as well, could be in sight. The peace dividend, along with the massive Ukraine rebuilding campaign, could finally spark a growth rebound in the moribund European economy. All of this is still on the horizon.
6. A more permanent immigration fix could be next. The media has been obsessed, for sure, with the high-profile deportation activities already underway, as promised during the election. Establishment economists continue to preen about the inflation impact of the lost labor force, though one wonders how much accretive GDP was being created by the violent criminals currently being targeted by ICE. The big potential upside surprise cited in our Baker’s Dozen memo—a better system to increase the controlled flow of tax paying, legal immigrants into the country—is not currently getting any attention. Look for that later in the year, as well.

When you add it all up, it’s not surprising that despite the day-to-day volatility we’ve been experiencing since November, little market progress has been made. Indeed, since the initial week-long post-election bounce, the S&P 500 has basically been flat. The Nasdaq is up just 2%, and the Russell 2000 is actually down from the initial big bounce it took and is now even off a percentage point or so from November 5. Similarly, the Russell 1000 Value index, a key component of our “broadening out” call due both to its high-dividend payors alongside its cyclical industrials and banks, has been up big, down big, then up big again in three multi-day cycles since the election; overall, call it flat, also.

In news-flow-driven markets like these, with a cycle that is almost unprecedented, our advice remains strapped down: stay tilted toward the broadening out that is likely ahead, given our starting point in valuations, the productivity benefits of AI expanding through the broader economy, and the pro-growth, supply-side agenda that is currently being implemented.

And if we do get lucky and strike a small reef that temporarily feels like a large one, get ready to buy more. With markets as jittery as they’ve been of late, that opportunity could come at any time. It’s what happens when you’re sailing the straits.