March 2025: The BakerAvenue Prudence Indicator

BakerAvenue Prudence Indicator Says... 

Long Term: Positive  |   Short Term: Neutral

The Growth Scare: Signals and Noise

"Nothing is so firmly believed as that which we least know."
- Michel De Montaigne

We think the recent market selloff is centered on growth concerns as a package of softer U.S. economic data has emerged in the past several weeks. At the same time, events continue to unfold at a breakneck speed around the world as the new administration uproots the geopolitical and financial status quo. Markets once preoccupied by the potential inflationary consequences of the new policies have grown increasingly anxious about their growth implications. Comments hinting at a “transition period” with some economic pains have further stoked those fears. While the ground keeps shifting underneath investors’ feet, we are staying focused on key signals, while discounting the noise, to help navigate the uncertainty.

While it is prudent to raise the odds of a more pronounced slowdown, our base case continues to assume slow, but non-recessionary growth. Encouragingly, the tariff discourse is happening at a time when economic and earnings growth is decent. Unemployment is low, balance sheets are in good shape, and earnings results have been solid this quarter (e.g., expectations were for 9% year-over-year growth this past quarter, and recent revisions now have that number closer to 15%). While our optimism is bridled somewhat by all the policy uncertainty, we continue to see more positives than negatives as we enter the new year.

The backdrop is ripe for active oversight with plenty of room for stock and sector selection. Last year ended with the fewest number of stocks outperforming the market in history. The narrowness was justified by the strong fundamental profile of the secular leaders, but recent trends point to a broadening market. Performance dispersion is increasing, valuation gaps are wide, and thematic trends (e.g., power infrastructure, increasing capital spending, improving capital markets, etc.) remain investible. We think it is a good time to be selective.

In times like these, it is important to have an investment process in place that removes emotion from the equation – a process that focuses on key signals, and removes the noise, if you will. At BakerAvenue, we maintain analytical independence from pre-written market narratives. We remove preconceived biases and defer to our analytical output. Ultimately, our views are only as optimistic or pessimistic as our technical, fundamental, and macro analyses indicate. Currently, our short-term metrics are in a balanced (neutral) position while our longer-term view is positive.

For those who have been following our market updates (view previous market update videos and commentaries), you will be familiar with several of our key concerns and opportunities. We have continually stated our expectations of slow, but non-recessionary, growth. Given the volatility, there are adjustments to consider, but our overarching views remain the same. Ultimately, another year of economic and earnings growth will support a continued grind higher in equities. We believe it is a good time to be active and want to be thoughtful regarding portfolio construction and risk control.

The Technical Perspective

From a long-term perspective, price trends have moved quickly back to key (upward sloping) support levels. However, tactical signals have deteriorated with the increased volatility. Leadership has flipped with defensive sectors outpacing pro-growth groups recently. As profit-taking has increased in former leaders (e.g., technology), equally weighted indices have started to pick up and have helped to broaden the market. There is work to be done here, and it remains an opportunity for tactical repositioning as leadership shifts. We are intently focused here as we consider portfolio tilts.

While we have embraced the growth momentum (we own several of the secular leaders), we expect other asset classes to continue to close the performance gap. Healthier markets tend to have strong participation rates, so we are on the lookout for improvement here. We are encouraged by the higher performance dispersion within sectors and industries, as it supports more active oversight. The recent pullback has shown a light on this development. We expect the lower correlations backdrop will continue as we start the new year, an environment we welcome.

Encouragingly, investor sentiment is now negative (e.g., bull-bear surveys reflect a decidedly negative bias). Bull markets tend to die on euphoria, not skepticism, so we like this update. We have been noting that positioning (e.g., investors have poured well over $7 trillion into money market funds) should act as a buffer to sizable pullbacks. The recent pullback may test this view in the coming weeks. While not the overriding factor, investor positioning often influences the order of magnitude in market moves (higher or lower). While there is certainly a high bar for allocations given elevated risk-free rates, our view is that investors have room to increase equity exposure.

The Macro Perspective

Uncertainty surrounding new policies (e.g., tariffs) has raised slowdown odds, but a global easing cycle and decent economic growth will serve as offsets. Some real-time economic models have flipped negative for the first quarter (note: the adjustments have to do with tariff-related accelerated inventory adjustments and should self-correct). We see sluggish growth for the balance of the year. Globally, last month saw further encouraging signs of economic optimism, particularly out of China (stimulus related) and increasingly Europe (also stimulus related). For some time, macro worries have centered on slow global growth and still tight financial conditions (i.e., restrictive monetary policy). We can now add tariffs to the list. We understand the concerns but continue to see plenty of growth optionality and view easing central bank policy as a sustained catalyst.

Interest rates will continue to carry outsized significance. We believe ultra-low interest rates are a thing of the past and investors should embrace more normalized levels. We expect lower, but not low, interest rates going forward with a milder cutting cycle in which the Fed recalibrates the policy rate. With decent growth, the Fed doesn’t need to be aggressive with the size and number of rate cuts. The Fed is trying to find a neutral rate, which in their eyes is neither accommodative nor restrictive, and we suspect they find it this year. The recent growth concerns have raised rate cutting odds (and lowered the dollar). For some time, one of the most pressing questions for investors has been: Can the Fed find a neutral policy rate without causing a deep recession? So far, so good.

Geopolitical and political events will represent increasingly material considerations for investors. While particularly difficult to position for, we have several market- and non-market-based factors to lean on that help assess materiality and support positioning. We are aware of the uncertainty associated with a new administration, but see counterbalances (e.g., tariff uncertainty vs. deregulatory tailwinds) ultimately offsetting any impact. Macro themes will remain important, no doubt, but we anticipate markets to sharpen their focus on specific security characteristics as the year progresses (e.g., company fundamentals, asset class relative strength, etc.). Security selection, identification of investable themes, and traditional bottom-up analysis will play an expanding role and help portfolios ride out the lingering macro-induced market gyrations.

The Fundamental Perspective

Fundamentally, we continue to focus on the trend in corporate profits and credit metrics. Headwinds, such as higher financing and input cost pressure, have been more than offset by acceptable demand trends. Estimates for revenues and profits have been revised higher over the past several quarters and remain a stalwart defense against any recession forecast. We expect earnings growth rates to accelerate this year.

Valuations are now back to their long-term averages. The pullback has shaved 1.5x turns off the market's valuation (P/E), the quickest reset in years. However, valuation dispersion within sectors and industries remains elevated with a historically sizable gap between the highest- and lowest-priced assets. We see opportunities in both groups (continued leadership in one, reversion to the mean in the other). Several of the secular growers are commanding high multiples, but also market-leading profitability. Value-oriented pockets offer opportunity, but investors will need to be selective.

The credit backdrop will be important to monitor as a check on fundamentals and a proxy for risk tolerance. Credit spreads have widened with the selloff in stocks, but remain manageable. One of the defining criteria between recessions and slowdowns has been the behavior of the credit markets. Both investment-grade and high-yield spreads vs. Treasuries are stable and remain well below recessionary levels. Corporate cash flows remain healthy and capital market activity (e.g., M&A, IPO’s, etc.) is showing signs of picking up.

Concluding Thoughts

The market is trying to navigate a growth scare. At the same time, policy uncertainty is adding to investor angst, and volatility is elevated. A challenging backdrop, but on balance, we continue to see more positives than negatives. Economic growth has proven to be resilient, earnings are still poised to accelerate, and investor sentiment looks overly skeptical. However, following '23-'24's breakneck pace, the odds of more normalized returns have increased. We have championed an active approach of investing with secular winners, while simultaneously allocating capital toward assets that will benefit most in a sustained recovery. We see no reason to alter that view. Our forecast for a maturing but sustained economic expansion strengthens our belief that investor focus should be on “how” one is positioned, not “if” they should have exposure at all.

Our investment philosophy is based on a dual mandate of growing and protecting client assets. We are staying active, using volatility to harvest losses while opportunistically deploying capital where appropriate. At this point, our cash weightings remain residual in nature, and we are focusing on strategy positioning vs. our respective benchmarks to control risk. Of course, should the backdrop destabilize further, we will take a more defensive stance.  

Should you have any questions or comments, please contact BakerAvenue. We are happy to share our thoughts in greater detail, and we welcome the opportunity to speak with you.