What’s New

We've spilled plenty of ink on this publication's pages over the last several months talking about the potential for an increase in market volatility. Our view has been straightforward – despite an underappreciated level of risk, markets have been largely priced to perfection. Risks included slowing growth, stubbornly high inflation, a new and potentially unpredictable administration, elevated earnings expectations, and severe market concentration. Aggressive positioning only augmented these risks. January provided a stark reminder of what can happen against these backdrops. From our perspective, investors should continue to expect a bumpy road ahead.

Let's start with policy. President Trump was inaugurated on January 20th and got right to work. Since taking office, we have seen a flurry of activity unlike anything we've seen in recent memory. In at least the last 50 years, no president has issued the number of executive orders the current president has in such a short period. However, this move-fast-and-break-things mentality has limits, as we saw with the decree to halt federal spending in certain areas. While potentially damaging from an economic viewpoint, it was quickly walked back. This type of uncertainty is likely to have consequences. Also adding to uncertainty at the moment is the threat of looming tariffs. Conversely, the focus on deregulation and support for artificial intelligence (AI) infrastructure are likely positives. The policy tug-of-war we expect to see in the coming months may create volatility-inducing headlines and pose a risk for a richly valued market.

Fortunately, this policy uncertainty is coming against a backdrop of a still-resilient economy. Our first estimate of fourth quarter GDP showed that the US economy continued to grow at an annualized rate of 2.3%. While inventories and non-residential investment were drags during the quarter, consumer activity remained incredibly robust. With labor markets still looking solid and household net worth near all-time highs, there's little reason to worry about a meaningful slowdown in consumption. Of course, the flip side is that inflation has remained sticky, and as a result, the market has dramatically cut back its expectations for cuts from the Federal Reserve this year. While the market has so far taken that well, it remains to be seen if the pricing out of rate cuts ultimately limits the capacity for multiple expansion through the year.

Potential drivers of volatility are not limited to policy and economics. In highly concentrated markets, headlines can cause meaningful dislocations. Such was the case in late January when a Chinese developer's rise of a far less expensive AI model rattled global markets. Nowhere was this more apparent than in the price action we saw from Nvidia. While the relative performance of the megacap giant peaked in June of last year, the name has rightly remained a focal point for investors. The reaction to the headline was dramatic, with Nvidia closing down roughly 17% that day on fears of reduced semiconductor demand. After all, valuations are only as reasonable as the earnings assumptions that are baked in. Investors are now left asking essential questions about the potential impacts on capital expenditures related to the buildout of AI capabilities. Ultimately, the answers to these questions will help shape the return profile of equity markets in the months and years ahead.

All of which brings us back to volatility. We continue to navigate richly valued financial markets despite elevated levels of uncertainty on multiple fronts. In such an environment, we believe that an active approach to investment management will allow investors to strike the appropriate balance between pursuing opportunities and managing risk.

Our Perspective

We have been concerned about the downside risks to the US economy for some time now. While we continue to see signs of softening in the US economy, growth has remained incredibly resilient due in large part to the massive fiscal transfers undertaken in the months and years following the pandemic. We believe that we are now nearing a critical juncture; fiscal stimulus has mostly moved through the system and policy uncertainty is rising. With the Federal Reserve having paused its cutting cycle, it remains to be seen how the economy will respond to a prolonged period of elevated rates. Given the varied risks we see in the market today, we are placing an emphasis on risk management and have adopted a modestly defensive position in our core portfolios.

Our View

Economic Cycle		The US economy has remained resilient despite the aggressive hiking cycle we saw from the Federal Reserve. However, growth is slowing from above-trend levels. Can the US consumer continue to remain resilient? Could policy change be disruptive, or might factors such as deregulation support investment?
Stock Market		The US stock market continues to trade near all-time highs. Earnings expectations reflect a rosy outlook. With the Fed looking more cautious on its rate cutting cycle, can earnings growth support higher prices in the potential absence of multiple expansion?
Bond Market		Risks to the economy and inflation look balanced. While elevated levels of inflation and resilient growth could push yields meaningfully higher, a sudden slowdown in growth could also see cuts priced back into the market and yields fall from their current levels. Corporate spreads remain near their lows.
Important Issues on the Radar		AI: Booming investment in semiconductors and AI infrastructure has been a feature of markets for years now. Will the release of lower-cost models lead to a reduction in investment or could increased efficiency super-charge these efforts? How may AI begin to have a real impact on businesses and the economy?
		China’s Economy: China has pivoted on key economic issues that acted as severe headwinds to growth over the last two years; however, economic growth appears to be stagnating and it will be critical to monitor the magnitude and the effectiveness of the policy response in the coming months. The imposition of tariffs may complicate the economic outlook.

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Source: Bloomberg.

All investments contain risk and may lose value. This material contains the opinions of Manning & Napier, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.