If you had chosen to spend April detoxing without screens or the internet, you might return this weekend and wonder what all the fuss was about.
Certainly, looking at our portfolios this morning I can see our fixed income investments are within a whisker of all-time highs and up around 2.5% year to date, our alternative funds up c6%, and only our equity funds showing any losses – down about 3.5% on average. By tomorrow, our largest Balanced Multi Asset portfolio will be showing flat, if not slightly up, for 2025. All quiet then!
Of course, it all looked a bit different on 10th April when we recorded our last webinar in the teeth of the Trump tariff debacle. Everything was down, although markets were rallying with the news the previous evening that Trump was suspending his reciprocal tariffs for 90 days. The Heard and McDonald Island penguins were off the hook (for now), although China (who dared to retaliate) were to be crucified. It’s been a steady recovery across the board ever since.
- So, was it all self-induced by the actions of one man?
- Are we back to normal with nothing to worry about?
- Are we panicking that, having sold our holding in the S&P 500, we no longer have any exposure to Tesla? Its shares are up 24% since April 10th, aren’t we missing out?
Our roving reporter Stephen O’ Sullivan takes a deep dive into the first 100 days of Trump’s presidency in his piece this week. Stephen is enroute to pay homage to the great Warren Buffet in Omaha at the Berkshire Hathaway shareholders meeting. I look forward to a full report for the next update. Warren’s business partner Charlie Munger left us at the end of 2023; we must hope Warren will be watching Ethel Caterham on how to enjoy life for the next 20 years!
Charlie and Warren are investing legends and inspire us on a daily basis. Their investment insight gives us the confidence to say No to all three questions above. Let me explain.
US Exceptionalism
Firstly, US equity markets were vulnerable (and remain vulnerable) to a correction.
So, Trump’s tariff capers were certainly a catalyst, but markets were already falling, having peaked in February. The euphoria over AI and US exceptionalism (that it’s the only place to invest) had driven share prices irrationally high towards the end of 2024 and this has to be worked out somehow – a correction downwards in share prices is one way to do that. The other way is that share prices just don’t go up very much in the future, whilst increasing company profitability and inflation allow the overvaluation to unwind.
This chart below shows this clearly. It takes a minute to grasp, but simply put, it is showing the next decade returns on the S&P 500 cross referenced with the relative price-to-profits of the shares in the S&P 500 at the start of the investment period
The green line shows the CAPE ratio, or relative price of the S&P 500 at the start of April, which was 33. For context, it peaked at 44 in 1999, before the dot com bubble burst. For those who don’t remember, the post-Millennium hangover was really bad. It took three years for global equities to find a bottom 50% lower than at the end of 1999 and another three years after that to recover.
There will be those who argue that US economist Robert Shiller’s CAPE ratio is not the best measure of relative value, and others who will still argue that US exceptionalism means US equities should be and always will be highly priced. But history suggests otherwise.
We have written extensively here about the concentration risks in the S&P 500 centred on the magnificent seven – Apple, Microsoft, Meta, Nvidia, Amazon, Google and Tesla. Ominously for US market fans, Warren Buffet’s Berkshire Hathaway sold half its Apple stock in 2024 along with shares in Bank of America and in the last quarter of 2024 all of its S&P 500 index holding. No doubt Stephen will be able to give us more insight on this in the next update, but on face value it looks like Warren took some note of history and shared our views on US market risks. He will be banking on being able to reinvest the capital and profits from these sales in better return opportunities.
If the US stock market was the only place we could invest and the index tracker was our only way to invest in it then things might be different, but neither is true. We have fixed income funds offering us 6-8% on a much more certain basis and with significantly less downside risk. Plus, we have active managers who can invest in the US economy but without getting overly exposed to the Magnificent Seven. Like Warren, we think it is both prudent and likely to generate better returns investing elsewhere. We might well be wrong on the last point, but we will certainly have reduced risk.
It is worth reminding ourselves that our job is to make positive real returns at the lowest risk possible. As we know, we are mostly investing irreplaceable capital and avoiding large permanent losses is one of our key missions. That markets have bounced back this time is great, but that just means the overvaluation risk in the S&P 500 remains.
UK investors in US indices were down 20% peak-to-trough by the 9th of April, with markets seemingly in free fall – that can’t have been comfortable for them. Thanks to the depreciation of the Dollar, those investors are still off 10% year to date. I wrote a short paper on all this last week which you can read here, that name checks some of the biggest UK retail investor funds and highlights their exposure. If you have colleagues expressing concerns as to the gyrations of their pension funds, it would be a great piece to send them.
Q1 2025 Earnings
Courtesy of FactSet, here are some key data points for Q1 earnings as of 25th April when just over 1/3rd of earnings had been announced:
- 73% of S&P 500 companies have reported a positive EPS surprise and 64% of S&P 500 companies have reported a positive revenue surprise.
- Earnings Growth: For Q1 2025, the blended (year-over-year) earnings growth rate for the S&P 500 is 10.1%.
- Earnings Revisions: On March 31, the estimated (year-over-year) earnings growth rate for the S&P 500 for Q1 2024 was also 7.2%.
The key numbers to watch are the revised estimates (7.2%) and blended earnings growth (10.1%). These are good numbers, but the chart below from Bloomberg analysts shows how consensus earnings growth estimates, which were 17% at the end of 2024, have tumbled since the start of the year. We highlighted this as a big risk in January this year, faced with bullish consensus estimates of where the S&P 500 would end 2025.
The Q1 earnings so far suggest analysts may now be over pessimistic, but companies are yet to see and are really only guessing what the final impact of tariffs will be.
As to the Magnificent Seven and Tesla, 6 out of 7 have reported (Nvidia always reports late) and the grouping of these companies as market leaders is certainly looking less clear. Only Microsoft (+1% YTD) and Meta (-2% YTD) are adding to S&P 500 index returns so far year this year. Microsoft is well insulated from both tariffs and recessionary risks, Meta less so if advertisement spending turns down. The others are all dragging the index down with returns between -13% and -17% year to date after their earnings releases, which have been unable to send them back to their previous index leading roles. Noting all these returns are all in US Dollars, you need to take off 6% to see returns in Sterling.
Tesla is the outlier – down 30% in US Dollars 36% in Sterling, even after a 24% recovery. We don’t understand the current valuation of the company after Tesla reported a 70% drop in earnings, nor the investment case for Tesla’s anticipated dominance of driverless taxis or humanoid robots. We are very happy to be able to watch Tesla’s future from the sidelines. As Charlie Munger famously said when asked about Tesla and Elon Musk at a Berkshire Hathaway (BH) shareholders meeting (BH have never invested in Tesla):
“My thoughts are two, I would never buy [Tesla], and I would never sell it short,”
And
“I have a third comment,” the billionaire investor continued: “Never underestimate the man who overestimates himself. I think Elon Musk is peculiar, and he may overestimate himself, but he may not be wrong all the time.”
