We are pleased to share the latest edition of Lighthouse Canton Investment Guide.
Our aggregate model score continues to deteriorate and now suggests a "neutral" positioning in equities and bonds, with downside risks to both. While earnings remain a bright spot and the uptrend still in place, stretched as it may be, weakening macro conditions, especially consumption and housing warrant caution. Additionally, valuations, while not a catalyst, point to below average returns in years ahead. Our focus remains on catalysts – on the downside, labor will hold the key for the economy and sentiment (market signals) while revival in housing and consumption can reverse the softening trend.
Economic Cycle – Momentum Decelerating; Labor is the Key: Risks for the US economy are tilted towards a further slowdown with 4 of 6 components in negative territory. Stretched households and a persistent drag from housing, are partially offset by relative resilience in business activity and labor conditions, although these too face challenges at the margin, reflected in higher bankruptcies and slowing payrolls and rising jobless claims. Inflation in the meantime has remained sticky, edging up in recent months but more importantly tariff related headwinds cloud the forward view. Our economic model already is below neutral levels – labor markers create downside risk while any revival in consumption and housing can reverse the recent downtrend.
Earnings Cycle – Another Solid Quarter: Earnings momentum is strong and improving, with another solid quarter, significantly outperforming forecasts (12% vs. 5% consensus), reinforcing confidence in the underlying corporate profitability. Growth indicators - EPS, sales, operating profit, and return on equity are all trending higher, driving positive revisions. While earnings remain a bright spot, the forward view will be determined by how broader economic conditions, consumption and labor specifically, evolve and how responsive is monetary and fiscal policy.
Valuations – Expensive Equities and Bonds: Equity valuations remain elevated across most metrics in a historical context and relative to other bonds. That said, while valuations are rich, they have been stable in recent months. Unlike earlier in the year when metrics were trending higher, most ratios have flattened, keeping the overall aggregate view at average (stable) rather than deteriorating further. While not a near-term catalyst, valuations will determine medium-term returns for equities. Corporate bond valuations continue to be stretched.
Market Signals – Strong Trend, Weaker Momentum: Equities remain in an uptrend even as momentum indicators appear stretched. For now, neither is breadth stretched nor is sentiment at extremes, suggesting support for the trend. Under the hood though, the trend for tech appears to be faltering with rotation into discretionary and communication services, albeit in very early stages.
Asset Allocation
Equities: Our proprietary nowcaster is "NEUTRAL" in equities, progressively deteriorating in sync with a weakening economy and elevated valuations. For now, Tech remains the only overweight sector, led by earnings strength and a persistent uptrend. Growth remains favored though even with nascent rotation into communications and discretionary sectors. Internationally, Europe after unwinding YTD outperformance (vs. SPX) appears to be finding a bid. India too appears to be stabilizing although earnings outlook remains a concern. China remains favored.
Fixed Income: With credit spreads on both HY and IG corporate bonds back to record lows, other than European financials, corporate bonds do not appear attractive. As for treasuries, yields remain in balance – potential inflationary threats (from tariffs and easy financial conditions) offset by decelerating growth. Adding duration is recommended.Currencies: Consensus view on the dollar is bearish citing risks from loss of US' haven status as well a European/ EM revival. While the arguments for dollar bearishness appear sound, the runaway DXY depreciation in 1H appears exhausted.
Gold, Oil and Bitcoin: Gold is stuck in a range for the last three months – it needs resolution out of the 3200-3400 range. Should the bullishness in equities continue, the case for being long Gold remains weak, at least in the short-term. Trend for oil is weak, as the long-term outlook. Bitcoin remains a preferred currency diversifier.
Alternatives: With a dominant macro narrative, such strategies remain a preferred positioning. Volatility, currently depressed, is expected to rise and challenge trend following approaches. Relatively non-correlated strategies – insurance, life settlement and to a large extent private credit, remain a preferred positioning.
Report Sections
- 4 Pillars Investment Framework - Economic Cycle, Earnings Cycle, Market Signals, and Valuations
- Economic Cycle Nowcaster - Decelerating Momentum; Labor is the Key
- Earnings Cycle Analysis - Another Solid Quarter – The One Bright Spot
- Valuation Assessment - Expensive – Both Equities and Bonds
- Market Signals Review - Market Signals – Still Strong, But Weakening
- Sentiment Analysis - Sentiment Bullish but Not Egregious
- Sector Recommendations - Growth Has Momentum – BUT – Discretionary and Communications Leading Tech
- S&P Technicals - Uptrend in Place – BUT - Stretched
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