Investing alongside change

April's Incredible and Historic Moves:

Risk-assets struggled amidst extremely volatile price action as investors weighed the probabilities of tariffs hitting profits and valuations.

1. Already down 7.7% from its highs on April 2^nd, the S&P suffered its 6^th largest 4-day drawdown since 1950 (-12.1%) * ¹
   • The S&P has seen exceptional intraday volatility since April 2nd, with April 10th marking a remarkable 5 days in a row with a >6% intraday range. Since the 1920s, the only stretches of >6% intraday volatility longer than this were at the peak of the GFC in October 2008 and during the early pandemic turmoil in March 2020. ²
   • Amidst this volatility, the S&P 500 Index had its 3rd best day since 1950 (+9.5%) and the NASDAQ had its biggest daily advance since 2001 (+12.2%). ¹
2. US High Yield Spreads widened by 147 bps in the 2 weeks ending April 8th, the second largest 2 week spread widening this century outside of COVID, the GFC and the European Debt Crisis. The spread of 453 bps reached on April 8th was nearly 200 higher than the February 19th tights. ¹
3. Leveraged Loans saw no capital market activity for the first time in a non-holiday week since March 2020, which was illustrative of the cautious tone in the market. ³

*Looking at independent 4-day periods

This drawdown in risk-assets happened alongside a weaker USD and sharply higher US Rates, a sign of de-dollarization trades going through the market, which have likely been exasperated by levered position unwinds & positioning reversals.

4. With the S&P registering a -15% move over 3 month, we have also seen the Bloomberg US Dollar Index register a nearly -9% reading over 3 month. Looking back at -15% 3 month S&P moves, we have not seen a corresponding weakening in the Bloomberg US Dollar Index since the Tech bubble popped over 20 years ago. ¹
5. On Thursday, with the S&P down -4.9%, the EUR posted the largest gain against the USD (+2.3%) since 2015. ¹
6. The correlation of EUR moves to the US vs Germany 10Y Rate Differential has been -0.64 over the last year; this week, that correlation flipped to +0.68. ¹
7. Meanwhile, US Rates are moving sharply higher. The 30Y Treasury yield saw its largest weekly move higher since at least 1982. The yield differential between the US 2Y and US 30Y had its 5th largest weekly move steeper since 1977. ¹
8. Looking cross-market, last week saw the largest weekly move higher in the US vs Germany 10Y & 30Y Yield Differentials since at least 1995, and this move was ~1.7x larger than the prior largest. ¹
9. Looking at the top 25 largest reporting risk-parity funds, we saw the largest deleveraging of >7y duration assets since March 2020. ⁴

Top 10 Things to Consider Today:

1. Tariffs can continue to drive market volatility. While we don’t like to over-emphasize survey data, there has undoubtedly been a genuine evolution in the regime that is impacting corporate and consumer sentiment and spending today. CEO confidence, measured by the Chief Executive Magazine's survey, has dropped to the lowest levels since 2013, and we have seen metrics for worse financial conditions and economic policy uncertainty reach highest levels since the 1990s and 2000s respectively. With the effective tariff rate rising to an unprecedented 22.0%, global markets can continue to be reactive to aggressive tariff strategy and headlines amidst ongoing uncertainty.

2. A focus on lower rates is understandable with the growing uncertainty of where the debt is going. The administration will want to ensure rates do not move higher in reaction to tariff policy. After some of the largest moves higher in US Rates of the last 50 years, they will likely move forward with this front-of mind. Net interest expense is on track to outpace nondefense discretionary spending for the first time in decade. Furthermore, on average the US is issuing debt as large as entire countries – weekly! The US average weekly issuance is $573 billion in comparison to Mexico’s total debt of $743 billion, Australia’s $614 billion, and Saudi Arabia’s $400 billion. While foreign demand for treasuries was once palpable, the demand has waned meaningfully. At its peak, China held $1.3 trillion in US treasuries. That figure has decreased 58%, currently at levels last seen pre-GFC. Taken together, these factors compounding over time poses a real risk.
3. The US is a largely domestic, services-oriented economy. Although tariffs are still a risk, the US is the world’s biggest importer and much less reliant on trade for growth. It has also transformed into a service-oriented economy: the largest contributor to the economy’s GDP is spending on services, which are far less cyclical and volatile than goods. This taken together has helped the US economy outperform even the most optimistic of expectations the last two years. Although we have cut our forecast for Q4/Q4 2025 real GDP growth to 0.0%, following the recent tariff news, the evolution of the US into a more independent economy is critical to keep in mind.

4. Federal spending has been a large contributor to overall economic activity over recent years. The magnitude of cuts here will be important to watch. This massive public sector deficit has created a massive private sector surplus and wealth-effect. The very large Federal spending adjustments represent a risk to this at the margin. While we have seen this start to come through with data points, with about 86% of all spending going to programs like Social Security, Medicare, and defense, it will be a challenge to produce material cuts in those areas.

5. Employment growth has largely been driven by healthcare, education, and immigration – these three areas are under pressure today and represent a risk to the data to watch closely going forward. Out of the 7mm private payroll gains over the past 3 years, 3.1mm (44%) came from Education & Health Services sector. Cuts to Medicaid would force states to downsize the program pushing costs to health care providers. Furthermore, last year most of the rise in unemployment was driven by an increasing supply of new entrants (rather than increasing job losses). So, job gains are likely to slow as we reduce the supply of workers; however, we could ironically now see the labor market tighten with a smaller labor pool. These employment dynamics are hugely important for coming labor reports and will require careful interpretation.

6. Higher interest rates have contributed to the housing affordability crisis, particularly for the lower 50% of income earners. This group faces significant stress from higher non-mortgage debt costs, without benefiting from higher asset prices or returns on cash. Real wage growth is insufficient to address the low-income struggle, as expenditures for lower-income households are significantly higher than their incomes. This is all the more reason the administration will be focused on avoiding higher rates.

7. Despite significant progress in reducing post-pandemic inflation, inflation remains persistently high above the Fed's target, creating challenges for the Fed. 3 month & 6 month run rates are sticky high above the Fed target. Rising inflation expectations pose a challenge, and the Fed aims to keep these expectations anchored to prevent further inflationary pressures. Although the most recent inflation print came in weaker than expected, tariffs can cause a significant price level shock higher. Most recently, we raised our tariff inflation contribution up to 1.5pp from 0.55 pp previously. Our Q4/Q4 2025 forecasts increased to 3.8% for core PCE and 4.2% for Core CPI.

8. The range of growth outcomes is increasingly uncertain, with stagflation becoming a more significant risk. The Fed's assessment indicates that risks to growth are tilting downward, while risks to inflation are tilting upward, highlighting the challenges they face in balancing these factors. The liquidity regime, however, is set to become more favorable. The Fed's balance sheet runoff will decrease significantly (drops to less than $20bn from currently averaging $61bn), and the Treasury's cash outlay ahead of the debt ceiling deadline will act as a liquidity injection into the private sector.

9. We like being a lender in Europe. Euro credit performed terrifically well on the back of the German fiscal announcement. The rally in European Credit spreads, despite widening US Credit spreads and a 10% S&P sell-off, highlights the power of diversification in portfolios. Today, we also like owning European peripherals, which offer attractive carry when swapped back to USD. In sum, an Income-oriented portfolio in Europe today can provide ~4% Real Yields. These yields are significantly higher than those available in the past decade, presenting a compelling opportunity for investors.
10. Today asset allocation in portfolios should look to optimize return, balance, and risk. Income still wins. While credit clearly must be evaluated alongside of a slowing economy, good quality credit is arguably coming into this recent growth-shock concern in a uniquely strong fundamental position. The overall rate of defaults and distress is historically low, and on the technical side, credit assets are increasingly scarce relative to “risk free” assets. The treasury market grows by the size of the HY market every nine months and the US HY market is only ~73% the size of one year’s Federal deficit. In Fixed Income, attractive real income can be constructed with tangible diversification, high-quality holdings, and strong relative stability amidst a world of largely unpredictable regional growth and inflation dynamics. The breakeven yield changes required to see losses over one year in fixed income today have become amazingly attractive, particularly if the Fed cuts interest rates from here. In all, we still like optimizing portfolios to create a high-quality, volatility-resistant ballast that offers yield well above the rate of inflation. On the equity side, valuations have contracted significantly, and while we believe there is a potential for volatility to continue, today’s environment represents a good opportunity to invest long term in good cash flowing businesses though the timing of the recovery remains uncertain.