February twenty-third, twenty twenty-five (250217-250223)
First, Europe’s expectation gap
Discussion of Europe continues to focus on a Russia-Ukraine ceasefire, reconstruction, and increased fiscal spending. As Europe’s peace dividend comes to an end, a structural increase in the EU’s fiscal deficit from 0.5% to 1% of GDP seems the most likely change. This would bring total defense spending to 2.5% and 3%, respectively, as a share of GDP.
The process will not happen all at once, because defense spending is highly capital-intensive. This gradual process will differ from country to country, and the trading cycle will also be long; it will be a process of buying pullbacks amid a choppy upward trend.
For interest rate markets, Europe’s urgency to increase defense spending shifts the focus to the long end of the curve and to how much additional supply may be needed in the future. Limited fiscal space, along with political and practical constraints on rapidly increasing regional defense capabilities, adds further uncertainty due to the German election. In the near term, the policy outlook may remain unclear.
This is also why expectations of a sharp increase in spending in the near term are unlikely to materialize, especially spending that could change the outlook for Europe’s economic cycle.Therefore, we prefer trading strategies aligned with the broader macro outlook, and curve steepening fits this approach relatively well.
At the short end, the latest wave of cyclical optimism, starting from a low level, has led to a pullback in expectations for European Central Bank rate cuts. However, as noted above, there is no near-term change in the economic cycle, and the market has clearly overestimated the strength of growth and inflation.This is another expectation gap.
Second, the Magnificent Seven
The Magnificent Seven’s leadership has ended, there is little sidelined cash, and sentiment indicators are poor. In this difficult market environment, do not rush to “buy the dip” against the trend.
1/ Mutual funds are 790 bp underweight the Mag 7
2/ The Mag 7 have lagged YTD
3/ Mutual fund cash balances stand at a record low
4/ Sentiment Indicator below "stretched" levels
5/ Retirement yearly flows are running out of juice
For U.S. equities, January and February are the strongest months each year for asset-allocation inflows. As February ends, that support from flows will diminish, and the market may become harder to navigate. Be prepared.
With the weekend coming to a close, I wish everyone reading this a happy life and all the best for the week ahead!
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Note: All content in this article is for reference only. It does not constitute investment advice or serve as the basis for any laws, regulations, or regulatory policies. Investors should not use or rely on this information as a basis for their decisions.