How to navigate the Trump Slump?

Financial markets are now, broadly measured, divided into two categories of people, as is in fact the global population, including those who do not actively invest:

-those who look at events unfolding from the perspective that nothing fundamentally has changed, waiting for 'old' dynamics to re-assert themselves in due course

-those who instinctively, or otherwise, sense things are changing, but there are no answers yet available as to what exactly the end outcome might be

The division between these two groups of people is nothing new. This happens every time financial markets change direction and composure. It's human nature to stick to the familiar script and view the world through an unchanged lens long after the facts have fundamentally changed.

It's one of the key reasons as to why bear markets, in particular in the early stages, experience strong relief rallies. Everyone who is pre-dispositioned to see a retreat as a buy-the-dip opportunity is today yet again ready to allocate more money into cheaper-priced equities.

Let's be honest about this; if we assume markets have been selling off merely out of fear and discomfort, because actions and tariffs by the US administration have made life in general more uncertain, then share prices that have fallen by -10% and more have become a lot more attractive, even if valuations might have looked somewhat bloated earlier in the year when sentiment was overly positive.

To the second group of people, such point of view ignores the fact things are shifting, and yesterday's set-up and general framework belong firmly in the past. If one assumes tomorrow might be a whole lot different from yesterday, buying-the-dip doesn't seem the smartest strategy around.

One mistake investors on Wall Street, and elsewhere, have made is to solely concentrate on the pro-business policies this freshly installed Trump 2.0 administration embodies. Less red tape and lower taxes equals higher share prices, right?

Within the space of a number of weeks only it has dawned upon many this new administration has in reality a much more radical transformation in mind; a plan to make the American economy more isolationist and inward-looking.

Even if one assumes everything will unfold according to plan, the imposed 'detox', as Secretary of the US Treasury, Scott Bessent, recently put it, still represents major disruption for the US economy, and elsewhere.

In macro terms, the key headwinds currently building can be identified as follows:

-The intention to shrink the federal government and its many institutions is leading to large redundancies and significant insecurity among those keeping their job. Those affected are all consumers.

-Indiscriminate import tariffs are wreaking havoc and significant supply-chain disruptions and uncertainty. Little surprise, US companies, big and small, are putting spending intentions on hold.

-Concentrating as much executive power as possible into the US Presidency, with constitutional checks and balances reduced to the absolute minimum, greatly upsets the 50% who did not vote for this administration, as well as a large proportion of those who did. Again, these are all consumers and business owners.

It should thus not surprise economic indicators such as consumer sentiment and capex intentions have deteriorated in recent weeks, upsetting financial markets. The key upset stems from the fact those 'soft' indicators are falling at an uncomfortably rapid pace, raising the prospect of significant slowing ahead for the world's most powerful economic engine.

All of a sudden, the US economy experiencing a recession this year doesn't seem out of the question.

Historically, while US recessions sometimes go hand in hand with prolonged bear markets for US equities, this is not always the case, but the starting point this time around has been above-average valuations (including in Australia) and a tremendous boom for AI, banks, technology stocks and crypto currencies.

An extended period of Risk Off sentiment can potentially pull valuations back to below average levels, which implies today's share prices can fall a whole lot further still, in particular for those stocks that fully participated in the bull market phase that started late in 2023.

Not making things any easier, it is equally possible none of the above applies. President Trump can reverse course or amend policies at will any time. The Federal Reserve has the ability to look through short-term inflation and announce further rate cuts, even re-introduce Quantitative Easing (QE) to prevent worst case scenarios from happening. US consumers and businesses can once again prove more resilient.

Back in 2020, things looked genuinely dire, at first, but worst-case scenarios were prevented and I am fairly confident most investors today would agree that, on balance, the share market trajectory post-covid has been more positive than negative, even including the Great Bond Markets Reset in 2022.

The counter-argument is bear markets always look like an angry kitten in hindsight, but when the proverbial hits the fan and average valuations shrink a lot further, depression tends to kick in when investors look at the damage done to their portfolios, even if it's only short-term.

To avoid any miscommunication: I do not have better foresight than others in these matters and there are times when simply ignoring all the risks and potential negatives is the better strategy in order to not sell at the wrong time or miss out on the recovery upswing altogether, but what if that does not include this time?

UBS strategist Richard Shellbach is advocating investors run a truly diversified portfolio to deal with the many risks and uncertainties in 2025.

After all, AI and other megatrends might well have much further to run, but portfolio rotation and PE multiples deflating further can keep downward pressure on share prices for longer while cheaply priced cyclicals and laggards might be at risk of earnings downgrades if economic momentum deteriorates significantly.

Adding US and reciprocal tariffs into the mix, and maybe higher inflation too, makes assessing companies and their operational outlook just a tad more complicated. Under all scenarios, unless one adopts a short-term trading strategy, keeping our focus firmly on the longer-term horizon seems but a necessity.

It is equally important to understand most investment experts, analysts and market strategists are living inside the 'everything is fine until it is not' world, meaning the probability of economic recession is not on their radar. Not yet. Hopefully it never will be, but 'hope' as an investment strategy has many flaws and weaknesses.

For example, analysts at RBC Capital have declared shares in accountancy software company Xero ((XRO)) an obvious Conviction Buy following a -15% weakening in the share price since mid-February.

As a long-standing supporter myself, I'd be inclined to welcome such calls as confirmation of my own positive view. Xero is categorised as a High Quality, Prime Growth story on the All-Weather Stocks section of the FNArena website.

But what if the US does experience a recession and financial markets move into Risk Off mode for a whole lot longer? It almost by default means Xero's share price can fall a lot deeper.

The counter-argument to RBC Capital's optimism came from Macquarie strategists on Monday.

Unless Trump blinks, Macquarie declared, share markets are destined for a bear market (-20% or more). Sectors including Technology, Discretionary Retail and Media are thus facing the double whammy of downward pressure on earnings and a de-rating in valuation multiples.

Macquarie's model portfolio is reducing exposure to last year's momentum winners and keeping the portfolio overall in a defensive positioning.

The idea is if one has exposure to some of the trusted outperformers from 2024, be they Goodman Group ((GMG)), or TechnologyOne ((TNE)), or Hub24 ((HUB)), or even SGH Ltd ((SGH)) and BlueScope Steel ((BSL)), to at least reduce such exposures in favour of cheaper priced alternatives.

For example; Macquarie has sold some shares in Coles Group ((COL)) and moved the proceeds into Woolworths Group ((WOW)) shares. Elsewhere, GPT Group ((GPT)) has been the recipient of reduced exposure to Charter Hall ((CHC)) and Goodman Group ((GMG)).

Equally noteworthy: Macquarie's portfolio has now added the beaten-down shares in IDP Education ((IEL)).

In Macquarie's world, Xero shares are not a genuine buy at current level. But investors should also note: both UBS and Macquarie, and probably RBC Capital too, don't hold high hopes for Australian banks either. It's a valuation consideration with both UBS and Macquarie preferring (cheaper priced) commodities instead (gold in particular).

Such are the dilemmas confronting investors in 2025. Under different circumstances, the focus would shift to solid, reliable, High-Quality growers with little debt and solid balance sheets, but import tariffs, concentrated positioning, FX, momentum trades and valuations are this time around having their say too.

This by no means implies companies like Aristocrat Leisure ((ALL)), Car Group ((CAR)), JB Hi-Fi ((JBH)), Netwealth Group ((NWL)), Pro Medicus ((PME)), ResMed ((RMD)) and Wesfarmers ((WES)) by definition cannot continue growing for many more years to come.

I'd be willing to put my head on the block and state: they most likely will continue growing for many years into the future.

Shorter-term, however, their valuation (and thus share prices) might be more dependent on what exactly is transpiring inside and from the US.

Common sense tells me reducing risk and hedging for whatever the end outcome seems but the most logical and appropriate thing to do. Whether this is best done through following in UBS's footsteps or by adopting Macquarie's view is probably determined by personal choice and preferences.

The FNArena-Vested Equities Model Portfolio has reduced some exposure to 2024 winners, increased the allocation to cash, but also added Xero shares into the mix. We remain fully aware that relief rallies are part of the script, and intend to remain vigilant, cautious and nimble.

As reported previously, the All-Weather Model Portfolio has 7% allocated to gold (ETF).

FNArena offers truly independent, impartial, ahead-of-the-curve share market commentary and analysis, on top of proprietary data and tools for self-managing and self-researching investors. The service can be trialed at (VIEW LINK)