HOLT
HOLT: Economic and tariff uncertainty – Numerous headwinds remain
Economic uncertainty and high Treasury yields signal further downside risk to equity valuations and may be a pre-cursor to a wave of CFROI downgrades.
Economic and tariff uncertainty; large scale CFROI downgrades next?
Economic and tariff uncertainty; large scale CFROI downgrades next?
Despite the significant market derating over the last three months—a 3.5 standard deviation event on a HOLT P/B basis compared to the last 40 years – numerous headwinds remain, indicating further downside risk to equity valuations.
Record economic uncertainty and the growing risk of a US recession have prompted downward adjustments in share prices. The risk now is that the changing macro backdrop causes a wave of consensus CFROI downgrades, and a further market derating, particularly as median consensus expectations remain near peak levels in the US, Europe ex UK and GEM ex China.
High Treasury yields point to other strains in the system
High Treasury yields point to other strains in the system
There are additional strains in the system. High US real treasury yields in a slowing economic cycle signal bond market concerns over inflation and/or in the US’ unpredictable trade policy. At the very least, this highlights the disconnect between the persistent gap in risk appetite in equities and more bearish bond markets, reflected in the US equity risk premium which is still 100bps below its long-term median.
High interest rates also risk flushing out businesses with weaker balance-sheets (and those who finance them). Consistent with the rise in High Yield bond indices, we have seen the HOLT Probability of Default (PoD) of low Quality Value stocks spike to 2022 levels. We screen for stocks with weak balance-sheets and a high HOLT PoD.
Where should one position in this context
Where should one position in this context
The underperformance of risk-on stocks since US markets peaked in mid-February, despite their undemanding valuations, suggests this sell-off is different to the 2022 episode.
Given the prevailing uncertainty and the risks of being whipsawed on the wrong end of a trade, it has paid to be in stocks with a balanced attribute of Quality, Momentum and Value (HOLT Best in Class) rather than being overly exposed to stocks with an attractive single factor attribute. Low Volatility strategies have also, predictably, performed strongly in the last few months.
Of note as well, the high share price correlation of Quality and Value stocks highlights that in some cases, the baby may have been thrown out with the bath water. On this basis, we screen for resilient stocks (high quality, low vol and low growth stocks) trading on an attractive HOLT P/B vs. history.