by Jurrien Timmer, Director of Global Macro for Fidelity Management & Research Company
The Strike Price has Been Found.
It has now been 10 weeks since the Tariff Tantrum hit the market, and while we hardly know most of the answers (or any for that matter), we have learned a few things from the price action.
There have now been two instances where the Administration had to walk back from its more radical actions. Not only do we once again know that metaphorically speaking, there is a put in the market, but we also know the strike price.
The most recent one was when the S&P 500 index went from a 10% markdown to a 20% markdown. That was enough for the Administration to walk back some of its more extreme retaliatory tariff plans. So back to a 10% tariff we are, which seems to be a scenario that the markets can live with.
And just like that, the markdown went from -20% back to -10%. It appears that 10% tariffs = 10% derating. It may be an oversimplified way of thinking about these very complex issues, but thereâs an elegance to simplicity.
The other metaphorical put, triggered the week before, was in the bond market. When long-dated Treasuries started to unravel (with the long bond hitting 5% in short order), the Treasury Department took notice and again walked back some of the rhetoric.
So, this is potentially good news, for it suggests that there are breaking points in both equities and bonds which will presumably work as a circuit breaker.
Correction Analogs
The 1998 LTCM analog has continued to track and we are now at that âscene of the crimeâ point, above which the market will presumably get the all-clear accordingly to the 1998 LTCM analog. Â If the current market doesnât continue to track, it might head back down in what could be a retest of the lows. The markets will never give us such an easy layup, so my guess is that this analog will soon fail, as they always do eventually.
Still, a rally above 5500 next week would give us at least a shot at retesting the old highs. With that in mind, I have added two more analogs below that might serve as a roadmap of sorts. This chart shows the price action after the market has fallen 20%. The orange line (1968-1970 bear market and recession) is the bear case, the blue line is the 1998 analog from above, and the purple line is the 2018 analog, when the market fell 20% and staged a V-bottom once the Powell Pivot was triggered. From there, the market never looked back (until COVID hit a year later).
I donât know which one it will track, but I wouldnât want to dismiss 1968 if a trade war does end up triggering a recession and a period of de-dollarization (see last weekâs report). As always, the tape doesnât lie and we will see what happens. The 2018 analog seems the least likely to me.
Anatomy of a Bear Market
The table below shows an update of all bear markets and serious corrections over the past 150 years. I wouldnât call the current 21.5% drawdown a bear market just yet, since we have had these abrupt mini bears in the past that did not turn into a recession or typical bear market cycle. So, we will see. In any case, non-recession bears have tended to be swift and short and produced a drawdown of 22% over 4 months, much like we have just done.
GDP Haircuts
Even if we donât get a trade war and a 10% reciprocal tariff is as bad as it gets, there will be some pain in the economy. That is already reflected in the GDP forecasts (from Bloomberg), which show hefty markdowns in the estimates for the next few quarters.
Earnings
If GDP growth weakens, earnings are likely to follow, which we can see in the chart below. While Q1 earnings seasons has been just fine so far (with 178 companies reporting and 75% beating by 1000 bps on average), Q2, Q3, and Q4 are all seeing significant mark downs (300 bps).
This is affecting the calendar year 2025 estimate, which is down to 7.8% from 12.4% a few months ago. Makes sense, and given how much valuations have derated (from 25x to 19x), the market has some ability to absorb a slower earnings trajectory.
Another bright spot is that credit spreads have improved quite a bit from a few weeks ago. That tells me that credit analysts do not yet see a lot of economic pain coming our way.
Mag 7 & Concentration Risk
One big question that continues to loom over us is the fate of the Mag 7, or the mega growers in general. While the market is quite top heavy with the top 10 stocks comprising 37% of the market cap (at the recent high), it is also true that mega cap dominance can persist for years or even decades. So, this is not a phenomenon that is guaranteed to suffer from imminent mean reversion.
Having said that, if the Mag 7 does lose its leadership it will be difficult for the major indices to stay afloat. The chart below (right panel) shows that when the Nifty 50 has declined in absolute and relative terms, the market has almost always gone down. Hence my emphasis on the alpha vs the beta.
Looking at this another way, below I show the risk-vs-return for all the major asset classes. The Mag 7 has been way out there with its outsized returns. Were that to ever mean-revert back towards the S&P 500 or non-US equities, there will likely not be a lot of beta to extract out of the major indices.
Not Expensive Anymore
The good news is that the Mag 7 has been significantly derated over the past 9 weeks, with itâs trailing P/E-multiple falling from 43x to 27x and its forward multiple falling from 40x to 25x. Thatâs progress. Earnings are flatlining right now, which would be a big risk if this cohort was trading at 2x the broader market (as the Nifty 50 did in 2000 and 1973), but that is not the case. At 25x, the M7 is a third more expensive than the broad market.
Asset Allocation for a New Era
How do we think about asset allocation if we are heading into a regime where the alpha becomes a lot more important than the beta? We have all been spoiled by the easy 60/40 days of yesteryear, where we just had to own some S&P 500 and Bloomberg Agg and it produced a 9% CAGR with a 9% vol. Whatâs better than that?
Alas, with bonds now positively correlated to equities, and with the risk of the global world order becoming less US-centric, those days might be behind us. Instead, I would paint the spectrum of asset classes with a much broader brush, emphasizing uncorrelated assets as well as stores of value.
Looking at 5-year Sharpe ratios and correlations (using weekly data), we see that alts have really produced the goods, in terms of risk-adjusted returns as well as a lack of correlation. Gold and Bitcoin have been stars as well.
Gold & Bitcoin as Hedges Against Bonds and Fiscal Shenanigans
Gold has been following the global money supply closely in recent months, although it likely put in a trading high when the Trump Administration walked back from its more extreme tariff plans. It has been the ultimate hedge in a market cycle in which stocks, bonds, and the dollar are all for sale.
Gold as Hedge Against the 40
I look at gold not so much as a hedge against the 60 in the 60/40, but against the 40. The chart below shows that over the long term bonds and gold have been competitive (even though bonds produce a yield and gold does not), and that gold has shone the most when bonds have not done well.
Dr Jekyll & Mr. Hyde
Bitcoin is slightly different, since it has this Dr Jekyll & Mr. Hyde personality where you never quite know which Bitcoin is going to show up to the party. Will it be the exponential gold Bitcoin (hard money and store of value), or will it be a NASDAQ-like speculative asset?
The chart below shows Bitcoin against the global money supply. The bottom panel shows the rate of change in the money supply as we well as the S&P 500.
Note that when M2 has grown and the stock market is rallying, Bitcoin has been off to the races because it has both attributes working for it. But when M2 has grown and equities are correcting, not so much. Gold, on the other hand, is just one thing, and you always know what it is. Itâs not as glamorous but it is reliable.
Still, Bitcoin as a modern day invention that is aspiring to be hard money in an easy money era has certainly earned its place on the menu for some, in my opinion.
Different Players on the Same Team
But why choose between gold and bitcoin when you can have both? I see them as different players on the same team. How much of each? Ha, that is of course a question that will have different answers for different investors everyone depending on your risk appetite. But from my perspective, a 4-1 ratio (gold-Bitcoin) seems like  could be a good starting point for some. Why? Goldâs volatility is one quarter of Bitcoinâs, even though they have similar Sharpe Ratios.
If we compare the historic price of Bitcoin to gold on a 1:1 basis we see that Bitcoin has dominated. But if we compare Bitcoin to gold on a 1:4 basis, we see that the two assets are more alike (above). This is how I think about normalizing a unit of gold to be on the same playing field as a unit of Bitcoin.
Taking Turns
Ironically, gold and Bitcoin are negatively correlated to each other. As the chart below shows, both assets have been taking turns lately, as measured by their Sharpe Ratios.
From the looks of it, it may well be Bitcoinâs turn to take the lead, given that its Sharpe Ratio is -0.40 while goldâs is 1.33. So perhaps we are due for a baton-pass from gold to Bitcoin.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
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