The Cross-Asset Dilemma: US Dominance Fades, Volatility Reigns
In December, cross-asset traders seized the opportunity to capitalize on Donald Trump's economic promises. They purchased stocks, sold bonds, and invested in the dollar, anticipating a surge in the American economy.
However, over a month later, these strategies are facing challenges. US stocks have increased, but the S&P 500 lags behind international benchmarks. After an initial spike, yields on 10-year Treasuries have declined below 4.5%. The dollar has weakened against major currencies, marking its worst start to a year since 2018.
Compounding these issues is the heightened volatility observed at the daily level. While traders' instinctive reaction to buy the dip has provided support, it also contributes to extreme swings as bullish positioning leaves limited room for errors amidst trade-related headlines.
Analysts caution against "high-conviction bets in a low-conviction world." Tom Garretson of RBC Wealth Management advocates trading within this volatility without pursuing aggressive strategies.
This week exemplified the two-way turbulence: The S&P 500 initially declined by 2% over tariff concerns, then recovered after Trump agreed to postpone levies against Mexico. Currencies experienced drastic reversals, with the peso transitioning from the worst to best performer in minutes. Disappointing tech earnings were offset by positive moves in subsequent sessions, but the index retreated on Friday due to mixed jobs data and Trump's announcement of reciprocal tariffs.
Ironically, the subdued Trump trade is occurring despite underlying economic indicators remaining strong. Healthy labor market statistics and positive reports on personal consumption, manufacturing, and construction spending suggest a robust economy. However, volatility is primarily driven by trade-related tensions.
Investor positioning has become increasingly one-sided, potentially contributing to violent intraday movements. Equities, particularly US stocks, reached record allocations, while few anticipated lower bond yields. Some institutions even predicted a surge in 10-year Treasury yields to 6% by 2025.
Hedge funds anticipated a greenback rally, especially against the yen and euro. This has hindered managers seeking to profit from asset class trends. A Societe Generale index tracking commodity-trading advisors has dropped significantly, experiencing its second-worst start to a year since 2019.
Despite the volatility, risk appetite remains, as evidenced by inflows into exchange-traded funds. Retail traders invested near-record amounts in ETFs, and credit market investments surged in both investment-grade and high-yield funds.
Cayla Seder of State Street Global Markets remains optimistic about the America-First trade, citing the relative strength of the US economy. She anticipates diversification only if data suggests a narrowing gap in economic performance between the US and other regions.
Understanding the ultimate goal of Trump's trade policies poses a significant challenge for investors. Brad Conger of Hirtle Callaghan suggests that tariffs aim to reduce inflation by shifting production to the US. However, given the administration's prior emphasis on a strong dollar, which tends to weaken with lower inflation and interest rates, he anticipates a weaker dollar policy. His firm favors international stocks over US equities, betting on potential gains from a dollar depreciation.