Transcript
Amada Agati:
It’s time for the July edition of Adding Alpha! Given the long, strange trip that has characterized just the first half of 2025, it feels like a good time to do a status check on what we outlined as our Top 10 investor themes for the year.
10. Is…. Normalizing Price Correlations
The correlation between stocks and bonds is still elevated, and after three months of moving lower, it jumped up again in June – which isn’t necessarily a bad thing in an up-market.
There were a few weeks in March and April when both stocks and bonds were down, but if you zoom out to the monthly return level, bonds have been doing their job on the diversification front this year.
9. A Rebound in Private Markets Activity
M&A activity has been starting to pick up – deal volume has grown by more than 20% year-over-year; and we’re also seeing signs that dry powder is being put to work again after a bit of a dry spell.
The IPO market is still far from showing frothiness, which may indicate some structural shifts afoot in private markets.
8. Cash
YTD, the only time cash has outperformed both the S&P 500 and the Agg was a one-week stretch during May; now, it’s lagging both by more than 150 bps each.
Investment Company Institute fund flows indicate cash allocations are building, but that may be more a function of aging demographics, and improved pension funded status due to a strong rebound in equity market returns, rather than a tactical or defensive move.
7. Expanding artificial intelligence Use Cases
From large language models passing school exams, to life-like audio/visual content created in seconds, AI is still in the early innings of its adoption cycle.
Given the pace of innovation, a few key themes stand out to us, such as: generative AI and content creation, power demand and infrastructure, and autonomous systems and robotics. It’s not just about $NVDA anymore!
6. Much Broader Earnings Growth
The 2025 growth estimate for the S&P 500 is tracking at about 9%: ex-Magnificent-7, it’s still ~7%, including a big projected decline in Energy. The “bottom 493” have rebounded!
Profit margins are approximately 50 bps from their all-time high. Even if markets continue to grapple with tariffs and higher inflation in the short run, companies will have a little more margin or room to deal with higher costs.
5. Valuation Headwinds
The S&P 500 is at all-time high, S&P 500 NTM EPS at all-time high, but S&P 500 NTM P/E…is not even at a YTD high!
Earnings growth didn’t move much despite the volatility in March-May, which translated into some healthier valuation multiple compression, but mid- and small caps have not fared as well.
4. Secondary Wave of Inflation Concerns
The latest reading for CPI was 2.4%, meanwhile the 2-year breakeven yield is 2.55%, and the Cleveland Fed’s inflation forecast is 2.65%.
The popular University of Michigan survey of consumers expectations for inflation showed that they expect a whopping 5.0%, and the NFIB small business survey is at the highest level in more than a year. Inflation concerns remain elevated, despite there not being much hard evidence of actual inflation!
3. A Less Accommodative Fed
At the start of the year, the market was priced for 3-4, 25 bps rate cuts. Today, it expects just 2. Our PNC Economics team expects just 1 by year end.
While monetary policy itself is less accommodative than in prior years, forward guidance remains dovish for markets. Financial conditions have been easing and are at their most accommodative level in three years.
2. Deficits & Debt Levels
The “twin deficits” have been a bothersome theme for markets this year with the budget deficit tracking -6.7% of GDP and the current account deficit at -4.6%. Historically speaking, both are sitting at outsized levels.
The 30-Yr U.S. Treasury yield is hovering near a 15-year high, while the rest of the yield curve has been largely range-bound in the last few months. Translation: the curve is bear steepening, an unfortunate reflection of the bond market worrying more about growing deficits and debt levels over the long run than it expects potential acceleration in economic growth.
Drum roll please…. And the #1 most important investor theme for 2025 has been and will continue to be…the Purple Haze of Fiscal Policy Uncertainty
From foreign trade and tariff policies to tax reform and the fate of the debt ceiling, we expected the potential for policy changes to create uncertainty that could have a material impact on global markets – that feels like an understatement looking back on the last 6+ months.
The political news cycle continues to change by the hour, making it very difficult for investors to separate the news from the noise, and markets to assign an appropriate valuation amid all the policy moving parts.
We are hopeful the haze will eventually clear for the market and that it can look past most of the policy noise in the second half of the year and focus on the continued fundamental strength of the hard data, ultimately finishing the year in positive return territory. So, what does this mean for investors? We continue to stress the importance of staying invested and maintaining a well-diversified portfolio.
