Markets in limbo - the week ahead

Important information -  the value of investments and the income from them can go down as well as up, so you may get back less than you invest. 

Investors are stuck in an uneasy place between optimism about the so-called Trump put and anxiety about what looks like an increasingly likely economic slowdown or recession. 

The Trump put refers to the idea that there is a point at which a belligerent US President will respond to market weakness and reverse damaging trade and tariff measures. Sharp rallies in both bond and equity markets in the past couple of weeks suggest that this put exists and that it will kick in at close to the recent market lows.

So, when bond yields hit 5% and an auction of US government bonds was poorly supported, the President launched one tariff U-turn. When a 10% stock market correction turned into a 20% technical bear market, he did another. Investors are increasingly hopeful that a floor is in place.

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That’s the optimistic argument. It is supported by still reasonable earnings growth expectations (albeit slowing in future quarters) and valuations which have fallen from their recent highs. 

The earnings picture will become clearer this week as a swathe of results emerge across a range of key sectors. Most important of all will be tech stock results from Meta, Microsoft and Amazon. At the same time, valuations of those Magnificent Seven shares have come back from nosebleed levels to more reasonable multiples. The Mag Seven as a whole is now priced at 25 times expected profits, compared with 40 only a few months ago.

The final part of the bullish case for shares at today’s levels between the February highs and the March lows lies in the different but related market for corporate bonds. Here the spread between the yield on bonds issued by companies and those sold by governments has narrowed after spiking in response to the early Trump tariff bombshells. That suggests that credit analysts don’t envisage too much pain ahead for companies.

• Read: Tariff turmoil: what is the right exposure to the US?

The counter argument

That is the optimistic view. It is what the big investment banks are holding onto when they predict a return to 6,000 for the S&P 500 by the end of the year. That would imply a flat performance for 2025 after 20%+ returns in both 2023 and 2024. But it would be a result that many investors would have happily accepted a few weeks ago when the market bottomed out below 5,000.

The less optimistic view has three legs. First, the economic one. Goldman Sachs recently upped its view of the likelihood of recession to 45%. That seems plausible with tariffs likely to settle between 10 and 20%, way above the 2.5% at which they started the year.

That leads to the second leg of the bearish argument. That company earnings will inevitably fall back in such a difficult economic environment. The market is currently pricing in high single-digit earnings growth for 2025, but history shows that earnings tend to fall in even a mild recession. 

The final leg is around valuations. The US market, after its recent correction, trades on a valuation multiple of 19. That’s lower than it has been, but it is higher than the 17 average for the five years leading up to the pandemic or the 10 it has reached in recessions since 1980.

A 3% earnings growth rate and the pre-pandemic average valuation multiple implies 4,500 for the S&P 500, down from today’s 5,500.

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The search for safe havens  

So, with shares sitting in an uncomfortable limbo land, investors are looking hard for ports in the storm. And one that they have alighted on with enthusiasm is gold, which last week hit a new all time high of more than $3,500 an ounce. 

• Read: Should I invest in gold - and how?

It has fallen back a bit since the latest capitulation by the President, but the precious metal will continue to look like a safe haven, especially in a world where shares and bonds are moving together in a more correlated fashion than for many years.

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