by Jurrien Timmer, Director of Global Macro for Fidelity Management & Research Company
Zoom out
It’s getting increasingly challenging to write my WAAR these past few Sundays, given how much the headlines keep lurching back and forth. Truce one day, threats of extinction the next, and back and forth we go. My inclination these days is to wait until Sunday evening when the futures open, but even then chances are that I wake up to a brand new set of headlines on Monday morning. At times like these, I find it helpful to take a step back and take inventory of my investment thesis and assumptions.
Another tumultuous week.
Equity markets gapped higher last week on hopes that the negotiations in Pakistan would lead to some sort of détente. The week closed with an S&P 500 index at 6816, a mere 2.6% below its all-time high set on January 28. More importantly, the forward P/E multiple closed the week down 13.4% from its high, after being down 19.1% two weeks earlier. Price is what you pay and valuation is what you get, so what investors are willing to pay for each dollar of earnings is a good indication of sentiment. On that front, the current drawdown is on par with the Tariff Tantrum exactly one year ago.
Equity indices never got to the kind of oversold levels that you want to swing a bat at, so we’ll see how these gains hold up as last week’s hopes are dashed (at least for the moment). Perhaps a better rebalancing point lies ahead. Stocks remain negatively correlated to oil prices and positively correlated to bond prices. The latter creates significant hedging challenge, as I will explore below.
Technicals
The weekly chart below shows that the S&P 500 index stopped short of an oversold extreme at its March 30 low of 6317. We never got that juicy entry point. We’ll see how the market reacts as the headlines continue to unfold in the weeks ahead. My sense is that we need to see the 50-day moving average number in the single digits and an index closer to the pre-tariff high of 6127.
AI
The AI juggernaut has continued to plow ahead at breathtaking speed, with most AI themes reaching new highs last week. Memory stocks were on top and software stocks were at the bottom and making new lows. This is not a “rising tide lifts all boats” trend.
1990 analog
The markets have been pricing for a quick end, much like what happened during the 1990 Gulf War. The analog below shows that the surge in oil prices to $100 (in today’s terms) was quickly reversed, and with it so was the 16% decline in the P/E ratio. The drawdown in the P/E ratio back in 1990 is similar to the 19% drawdown during this cycle (note that the chart shows a 10% drawdown because it measures close-vs-close instead of close-vs-high).
Source of funds, source of payment
One emerging narrative resulting from the Iran conflict is that Iran will more or less control the Strait of Hormuz with a “toll booth” approach and that countries might pay those tolls in Yuan or crypto. Meanwhile, the exporting countries might have to liquidate some of their gold reserves or Treasuries to offset their shortfalls. I don’t know if this thesis is true, but the easy way to test it is with the chart below. On the left is Bitcoin and the Polymarket odds of the Strait reopening, and on the right is gold and the number of crossings through the Strait. A new high frequency chart to add to the mix.
In search of diversifiers in a correlated world
With equities and bonds positively correlated again (a déjà vu to 2022), it’s good to see that the group of diversifiers that I have in my hypothetical 60/20/20 model have been doing their job. The chart below shows the “crawling” 50-day correlation of equity-like assets (near the top), bond-like assets (to the right), and diversifiers against both of them (in the yellow oval). Diversifiers can act as the places to hide when neither equities nor bonds are well behaved.
Gold is now trading back in line against global money supply growth.
Bitcoin continued to hold support at $65k.
The USD at resistance
The other side to the toll booth narrative in the SoH is that the dollar will continue to devolve as the dominant reserve currency, as more and more of the world’s trade takes place locally or regionally. With that in mind, it’s interesting that the DXY failed again at the “line in the sand” of 100.
Call/put ratio
One support behind the market’s surge last week was the reversal in sentiment from an oversold extreme, at least as judged by the call/put ratio. That ratio is still negative.
II survey
A longer term measure of sentiment (the Investors Intelligence survey below) shows that sentiment has not “crossed over” as it did a year ago. Maybe that will still happen now that the headlines have pivoted again.
Earnings
The saving grace for equities are strong fundamentals with a US economy firmly in mid-cycle, earnings estimates growing at double digits, and valuations not out of whack against metrics such as credit spreads and operating margins.
Q1 earnings season
Q1 earnings season begins this week and if the past few quarters are any guide we may be looking a 16-17% growth.
Valuation
With credit spreads still well-behaved and operating margins making new highs by the week, the valuation picture for US stocks remains justified, especially after the drawdown of the past few weeks. The chart below shows that the “fitted” equity risk premium based on spreads and margins is around 4%, which is very close to current levels.
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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