Transcript
Amada Agati:
Hey Friends! It’s hard to believe it’s already time for the March edition of Adding Alpha, but here we are. So, let’s take stock of where markets are two months into the new year and gauge what comes next!
We’re only about 60 days into the new year so a lot can change, but for now, a change in the calendar has translated into some very different themes for investors relative to the past few years.
For starters we’re finally seeing some expanding market breadth again. While we finished 2024 at a 12-month low of just 55%, breadth is climbing back up in the 60-65% range. The equally weighted version of the S&P 500 is also keeping pace with its market cap weighted equivalent.
From a technical analysis perspective, this all suggests market internals are both positive and strengthening, which should help support markets at current valuation levels. While we are seeing broader market participation from sectors and industries beyond the Magnificent 7, it’s a bit too soon to claim a full-on rotation yet, as the market is still being led by large caps and quality growth-oriented exposures.
International equities are outperforming on a year-to-date basis, but is this performance truly sustainable? Because in four of the past five years, international has outperformed domestic equities to start the year, only to then fade quickly. 2022 was the exception to that rule. So far in 2025, the key drivers appear to be a bounce and relief rally from the sharp Q4 selloff in the hopes of 1) less aggressive tariff policies being implemented, 2) an end to the Russia-Ukraine war, and 3) the recentelections in Germany which might help catalyze a reacceleration in economic growth across both Germany and the Eurozone.
In the meantime, the rubber is meeting the road on developed international earnings results, which are coming in below expectations for Q4 and revisions for Q1 have fallen into negative territory to the tune of -4.6%. 2025 does not appear to be rhyming with 2022 so far for developed international equities, so investors beware!
Let’s turn to the debt ceiling for a moment. In "normal" times, investors would be concerned about the debt ceiling drama that occurred in late December/early January and knowing we're about to face it yet again in mid-March. That concern usually shows up in the form of heightened market volatility, but it really hasn’t to-date. The 20-year average for the VIX is 19 (we’re currently at about 15) and the MOVE Index has a 20-year average of 85 (we’re currently at about 96 and falling). The difference this time around is an $800 billion liquidity tailwind from the Treasury’s “extraordinary measures” that is helping to lubricate financial markets and keep market volatility low.
Final thought on S&P 500 earnings: Q4 results came in strong, but what’s changed is we’re seeing Q1 revisions fall more than usual, with the biggest drivers of the decline concentrated in the Industrials and Consumer Discretionary sectors, and the autos and machinery categories, in particular. It’s anticipation of tariff policies being implemented in short order aka Q1. If tariffs don’t ultimately go into effect or they are more limited in terms of their scope of impact, that could set the stage for at least some positive upside surprises. The ISM Manufacturing Index is back in expansion mode for the first time in two years, and that’s traditionally been a reliable leading indicator for earnings growth reacceleration.
Net-net, consensus still expects S&P 500 earnings to grow a solid 13% in 2025. While it may be tempting to extrapolate this as an indicator of strong expected price performance, it’s worth remembering returns last year were primarily driven by multiple expansion, a dynamic we view as unlikely to repeat in 2025, particularly with the S&P 500 still trading in excess of 20x.
As the S&P 500 hit a new all-time high recently, investor angst has started to build with these valuation levels – not “burning down the house” sentiment – but 2025 clearly feels different. One thing that hasn’t changed though, is investors are still seeking catalysts to keep this rally going.
