Risk Management Amid Economic Uncertainty

In times of economic uncertainty, the importance of processes in investment management cannot be overstated.

Our investment process revolves around a robust Three Layers of Risk Management framework that helps us navigate the complexities of the global financial markets. These layers include our strategic, long-term view, our tactical, near-term perspective, and our Cash Indicator methodology. In a world characterized by ever-changing economic conditions, trade policies, and global events, it is impossible to predict outcomes with certainty. By focusing on sound risk management through our framework, we can react quickly and effectively to changes in the market.

The strategic layer allows us to take a long-term view of the markets and adjust our expectations based on changing conditions. The significant fall in equity prices since late February has alleviated some of our concerns about stretched valuations in the stock market. As a result, our expectation for equity returns over the coming years are now more optimistic. This shift has prompted us to revise our strategic allocation to equities, although we are still underweight equities for the time being due to our tactical outlook.

Although fixed income investments remain an important part of our allocations, we now anticipate somewhat more modest returns from this asset class in the years ahead. In addition to generating current income, we look to our fixed income allocation to act as a ballast for the portfolio, providing stability against equity volatility. We are looking forward to adding to our equity positions once we gain more clarity on the global trade situation.

We focus on managing near-term risk and look for opportunities by responding to market shifts as they occur within our tactical layer. Given the heightened risks associated with the abrupt changes in policy, particularly around tariffs, our allocations are underweight equities and overweight cash and fixed income.

Within our equity and fixed income allocations, we are tilted towards quality assets, especially those in the U.S. market. We maintain a preference for high-quality businesses that show consistent earnings and low financial leverage, as these companies are better equipped to weather difficulties. The U.S. equity market continues to dominate and the robust corporate earnings growth, despite recent challenges from tariffs, provides opportunities in sectors less exposed to trade disruptions. Recently, overall earnings growth expectations for 2025 have weakened somewhat but the consensus still projects an 11.3% earnings growth for 2025 compared to 2024. Regardless of the rate, earnings growth should eventually lead to higher equity prices as prices track earnings over time.

While the market’s immediate reaction to the tariff news has been negative with a pronounced drop in equity prices, a weakening dollar, and falling commodity prices due to concerns over global economic growth, the long-term outlook remains more nuanced. The U.S. private sector continues to show strength with income growth outpacing inflation and steady jobs growth leading to higher personal disposable income.

For example, the March employment report came in well above expectations following soft data from January and February. The 3-month average jobs gain is now closer to long-term trends despite a reduction in the federal workforce, though many of those job losses are yet to be reflected in the data. Additionally, personal income is at an all-time high even after accounting for inflation and excluding government transfers, such as Social Security and Medicare.

The ongoing debate over tariffs and the potential for retaliation remains one of the key uncertainties facing the market. While we cannot predict how the situation will evolve, we consider three possible scenarios:

• Best Case Scenario: A successful resolution of trade disputes, with countries like China and the U.S. reaching favorable agreements. Such a resolution could mirror the 1971 trade negotiations under President Nixon, which resulted in a revaluation of currencies and greater competitiveness for U.S. exports.

• Base Case Scenario: Several important trade deals are made, particularly with countries like India, Japan, and Vietnam. While tariffs remain in place, their levels would be lower than initially anticipated and mitigate some of the negative economic effects.

• Worst Case Scenario: A failure to reach any significant trade agreements results in an escalation of tariffs akin to the Smoot-Hawley tariffs of the 1930s. Such a scenario would likely lead to significant economic damage, both domestically and globally, and would be the least likely outcome given the prevailing desire for economic stability.

Overall, we expect GDP growth in 2025 to slow compared to 2024, but the economic trajectory remains positive. For now, we remain cautious and plan to maintain this position until we gain more confidence in the direction of the trade issue scenarios listed above. Our current focus is on quality U.S. blue-chip companies, which also gives us a defensive posture in a volatile environment. For example, the potential impact of tariffs on industries, such as automobiles, is concerning but we see greater opportunities in other parts of the economy that are less vulnerable to trade disruptions. At this time, we favor the insurance industry as well as the telecommunications and consumer staples sectors. Within fixed income, we prefer high-quality asset-backed and mortgage-backed securities.

The third layer of our risk management framework, the Cash Indicator (CI), is a valuable tool designed to help differentiate between normal, or even the high levels of volatility that we have experienced recently, from systematic market breakdowns that would suggest increasing cash positions. We use it to gauge when markets are becoming excessively panicked or even overly optimistic, and it can guide us when to get aggressive or defensive within our Strategies.

By signaling those rare moments when fear and volatility simultaneously overwhelm both the equity and fixed income markets, the CI can also prompt increased cash levels.

In recent weeks, the CI spiked more than 70%, rising above 30 in a relatively short period of time. While certainly significant, this is below the level of 54 that would signal a 25% cash raise. In this case, these CI levels support our base case scenario, and we do not see a dislocation or systematic breakdown in the financial system, but rather an indication that the market is responding to the uncertainty surrounding tariff policies and their potential economic consequences. We consider this an event driven market correction. The situation remains fluid and, as we continue to relearn, things can change quickly.

We firmly believe in the behavioral benefits of including an indicator in investment management processes. The CI can be a great resource to help frame conversations with more volatility sensitive clients. It’s easy to fall victim to behavioral errors absent a tool and framework to provide perspective and a process for when to get defensive.

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Any forecasts, figures, opinions or investment techniques and strategies explained are Stringer Asset Management, LLC’s as of the date of publication. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect to error or omission is accepted. They are subject to change without reference or notification. The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested.

Past performance and yield may not be a reliable guide to future performance. Current performance may be higher or lower than the performance quoted.

The securities identified and described may not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.

Data is provided by various sources and prepared by Stringer Asset Management, LLC and has not been verified or audited by an independent accountant.

S&P 500 Index – This Index is a capitalization-weighted index of 500 stocks. The Index is designed to measure performance of a broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.