As we enter what we believe will be a pivotal month for markets, we share our latest End of Goldilocks: Back to School Outlook Report with critical insights for navigating the shifting landscape ahead.
We expect September to be a pivotal month, establishing a trend for markets that is likely to last for some time – our bias is to the downside for equities and to the upside for duration and volatility. We expect value to outperform growth in the short-term. A weakening economy is unlikely to be rescued in a hurry by lower interest rates. While earnings remain a bright spot, ever rising valuations require a consistently higher bar to beat. Besides, with jobs weakness to the fore, can consumption and earnings even hold up?
Our aggregate model score continues to deteriorate and now suggests a "neutral" positioning in equities and underweight in bonds, with downside risks to both. Rotational trends, from growth to value, are likely to prevail. Internationally, China remains best positioned.
Lighthouse Canton Proprietary Equities Model
Source:Lighthouse Canton
Key Themes:
- Macro Outlook – Slow Burn, Downside Risks: Goldilocks (stable economy, resilient jobs, inflation in control and easy financial conditions) has lasted longer than expected – the trend is clearly deteriorating now. Our proprietary economic nowcaster has now steadily deteriorated across most parameters with the notable exception of labor market indicators that remain resilient albeit also cooling off. On current indications, a recession is not looking likely, even as we expect growth to continue to slow.
- Earnings & Valuations – Valuations Extrapolate Growth: Second quarter earnings topped low-ball expectations, yet again, delivering a 12% growth following a 13% growth in the first quarter. Most drivers of our earnings model are positive and stable to strengthening, a key factor in driving strength in equities. That valuations are expensive is a statement that could have been made a year back and still been true. Clearly valuations extrapolate current earnings trends, and growth remains well rewarded.
- Market Signals – Trend Is Your Friend: Our market signals model, substantially influenced by trend following indicators, is unsurprisingly at elevated levels given the strength in trend. Interestingly though, momentum while strong, is decelerating suggesting a pause in trend. Even as the trend weakens, breadth conditions suggest a rotation opportunity.
Asset Allocation Summary:
- Equities – Neutral/Downside Risks: We recommend clients adopt a neutral stance in equities — staying invested but with a balanced risk posture. US Equities favor value and defensives in the near-term, with rotational trends likely to benefit defensives and value sectors, at the cost of Tech. Internationally, China remains best positioned with a preference for domestic consumption and tech.
- Fixed Income – Can Spreads Go Lower?: Credit spreads at record lows (77bp for investment grade and 280bp for high yield) suggest inadequate compensation for risk. Underweight corporate bonds except European Financials. Treasuries are expected to perform better in aggregate. Steepener trades are now attractive.
- Alternatives: A muddled economic backdrop, expectations of rising uncertainty and volatility in equities and expensive valuations across asset classes underscores the case for alternative, uncorrelated strategies. Macro managers who can capitalize on dislocations, Event-driven strategies that exploit accelerating M&A activity, and Long/Short managers exploiting dispersion, are our preferred positioning.
- Currencies, Gold & Bitcoin: Dollar weakness expected to resume with GBP and EUR best placed. Gold, after being stuck in a 3200-3400 range for four months, has broken out decisively and is our preferred currency play. Bitcoin, in addition to Gold, is our preferred currency diversifier.
Bullish views need continuation of economic strength, particularly jobs, inflation in check, strong earnings trajectory accommodative monetary policy – While Goldilocks has lasted a lot longer than we expected, this trade is now fading.
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