Market Thoughts: Don’t blink

Angsty trading is a fair characterization of broad markets today. One thing to keep a close eye on is longer dated government bonds. In the U.S., the faster yields fall, the more volatile markets become. Animal spirits in retreat. In Europe, the opposite’s happening… animal spirits reigniting.

Risk assets have held in better than expected given the headlines. Investors are twitchy, but for the most part credit and equity markets continue to trade in the same ranges we’ve been in the past few months.

A trade war is bad for the global economy. It raises prices. It stalls growth. The inflationary impact of tariffs slowly fades as growth stalls, demand wanes. Uncertainty ultimately weighs on sentiment, consumption and investor confidence. Also, on earnings, hiring and capital expenditure.

Eventually the Fed steps in and cuts rates, ideally before the economy falls into recession. It usually happens after. All of that paints a broad picture of the ‘uncertain reality’ ahead. Investors hate uncertainty. As proxy, count how many times you hear the word “stagflation” thrown about.

The operative question is: What’s the U.S. end game on tariffs? Investors came into the year believing deregulation and tax cuts were the guiding principles of this administration, not an extended trade war. Tariffs were meant to be the stick to get to the negotiating table. That storyline is wavering.

U.S. government bonds are rallying because of fear, not greed. If we spiral into a trade war the Fed will need to cut rates to keep a slowing U.S. economy from turning into recession. For the moment, the Fed should remain on hold. There’s no reason for them to do anything currently.

While Washington continues to taunt with tariffs, the response from Chancellor-elect Merz in Germany was extraordinary. The 500bn euros earmarked for funding of public investment is desperately needed. Loosening spending at a state level and a commitment to increase debt spending as well. It’s a ‘big bazooka’ stimulus moment if delivered as promised.

Germany can afford to lean into spending because they haven’t. Merz referenced in his address Mario Draghi’s 2012 refrain the ECB would do “whatever it takes” to preserve the integrity of the euro. If he delivers on what he’s promised, it’s a game changer. My sense is that long-term rates in Europe remain under pressure for the ‘right’ reason, with the euro well supported.

With U.S. equity market exceptionalism in doubt, I’d expect inflows into European equity and credit markets can continue. How long it lasts depends on what the Bundestag delivers. Also, what the European Commission does with regard to spending. A nudge from Germany might go a long way.

I’m going to say something obvious but it’s worth emphasizing in a moment where markets are bumpy, and emotion can get the upper hand. Emotionally, separate short and long term investing. Long term money is the ‘easiest’ to manage if you know your investment goals. Focus on time horizon.

Understand your ‘threshold of pain’ in a market drawdown. At what point in a sell-off will you blink? Everyone has one. Draw that line and let it inform your strategic asset allocation, so you stay invested. My long term compensation is invested in the funds my team and I manage. The same is true for my senior team. I’m a firm believer in mutually aligned interests. Also, in long term investing.

Short term money—tactical asset allocation—is more challenging. It tests nerves. It can quickly spiral into raw emotion. Emotion should have nothing to do with investing. Easier said than done for many, but important to be reminded of. Tactically, it’s not a moment to be overreaching for risk. We’re not.

We’re at a place where it’s just about impossible to have an informed opinion about the short term market path ahead. It’s a fool’s errand given the jumpy policy landscape. Steady hands prevail.

Risk assets are expensive, but I’d argue for the right reasons. They’ve been driven higher by the strength of free cash flows, strong and stable balance sheets. That’s meant as a simple observation about market strength and valuation at a broad level. There’s always a lot going on in every market. Some good, some not.

With markets expensive and the near term outlook uncertain, I don’t believe it’s a moment to be leaning hard into risk. If markets were to sell off sharply, I’m a better buyer at lower prices. We’ve done that repeatedly over the past few years across the portfolios we manage.

I’m generally amused by pundit prognostications of where markets are heading. Every investor should have a well-informed base case view. Also, understand the tail risk around that view. But as markets become jittery it’s important to remember the shrill becomes more alarming. It’s what sells.

The louder the noise, the more likely investors will overreact and blink. When the Madigan twins were very young, they used to love having staring contests. I was very hard to beat. Don’t blink.