Investing Like “The Great One”

Investment Memo, March 2025

Among his myriad career achievements as arguably the greatest player in the sport’s history, Wayne Gretzky, “The Great One”, is almost as well known for a quote on hockey tactics that is still used in the business world today: “Skate to where the puck is going to be, not where it’s been”.

At Southeastern Trust, we often apply this principle to investing and the management of your wealth. Amidst rapid change, it is more important than ever to follow an investment policy grounded in principles that have proven to be successful in all types of market environments.   

We believe that our value in managing client investments is usually most evident during extraordinary moments. Many of our advisors guided clients during the technology and internet bubble mania of the late 1990’s, and the depths of the global financial crisis during the late 2000’s.  Today, investors and market participants are debating the future direction of stocks as many U.S. companies began the year at some of the most expensive valuations in history before an unsettling correction starting in late February.

Rather than use this memo primarily to recap the past, we will attempt to update you on our 2025 forecast and use 2024 as a comparison to discuss the many changes that have already occurred in markets this year and why they are likely to continue.

Diversification Matters Again

We believe that diversification is entering a period where it will become more critical to return and risk outcomes than at any time since the global financial crisis in 2007-09.  The U.S. stock market has exhibited very narrow leadership over the last two years, particularly in 2024 when the largest “Magnificent 7” stocks contributed over half of the return of the S&P 500 Index.  This is likely a sign of a late cycle bull market where investors are exclusively piling into the biggest, best performing companies while largely avoiding other sectors that have not kept pace.  

Equity Concentration Risks

Since the S&P 500 Index peaked on February 19, many of these biggest stocks have been some of the weakest performers in the correction period.  The market began to exhibit a subtle shift from growth to value stocks last summer, somewhat coinciding with the peak performance of Nvidia relative to other tech stocks and the index.

Within the U.S., we believe value stocks, particularly in small and mid-sized companies, are best positioned for future returns.  With growth stocks still trading at very rich valuations, even after the correction, we believe they are not priced for an economic slowdown which now seems likely.  They are also widely owned and will likely be a source of liquidity and selling pressure in continued market drawdowns. 

International stocks are poised to benefit from these forces.  They have outperformed so far in 2025 from a weaker dollar and comparatively easier hurdles in earnings growth expectations and fundamentals.  While the U.S. market has been trading in its top 10% of many historical valuations, international and emerging market stocks are much closer to their long-term averages.  While you could have made a case on valuation for these stocks for several years, we do see two differences right now.  First, the valuation dispersions are at such extremes, it requires an almost implausible scenario for U.S. growth to exceed the rest of the world by such a margin to maintain this peak premium.  Second, there is evidence of increased growth and inflationary forces in major international markets such as Germany and Japan.  During the U.S. market selloff in February and March, flows went into foreign stocks, leading to year-to-date outperformance of about 13% and 8% between international developed (MSCI EAFE) and emerging market (MSCI EM) stocks against the S&P 500 Index as of March 15.  When valuations reach an extreme, the snapback to norms can be often be rapid and dramatic.

Fixed Income Tradeoffs – Stability Reward, Inflation and Currency Risks

Bonds have stabilized in performance following a volatile 2024.  A surge of optimism for “risk-on” trades surrounded the presidential election, which included themes of higher growth expectations, inflation and interest rates.  That trend has largely been reversed this year by more sobering rhetoric from the new administration about spending cuts and tariffs.  The new Secretary of the Treasury has pointedly commented about his focus on the 10 Year Treasury yield as a key benchmark that the government wants to keep down to manage borrowing costs on the $36 trillion national debt.  As yields have pulled back, we will look to selectively add to bonds on lower prices / higher yields.  However, with the uncertainty of tariffs and future inflation, we continue to recommend Treasury Inflation Protected Securities (TIPS).  We also recommend allocations to foreign bonds due to the currency diversification and attractive yields in many emerging markets.  With the administration focus on keeping U.S. rates down, this is likely to put pressure on the dollar relative to other currencies.  On the positive side, bonds have begun to exhibit traditional behavior in “risk-off” markets, as they rise in value due to expectations of falling growth and interest rates.  Unlike in 2022, this year has seen bonds provide stability and uncorrelated returns to stocks in portfolios.

Economic Outlook Murky

The new administration has undertaken very different tactics in handling fiscal policy, while the Federal Reserve is on hold for now with additional interest rate cuts given sticky inflation and uncertain effects from tariffs.  The Department of Government Efficiency (DOGE) has been tasked with reducing government spending and the current annualized deficit, which sits at over $2 trillion.  While these aims may be beneficial to the economy in the long term, a significant cut to government spending is almost certain to reduce Gross Domestic Product, earnings growth and stock valuations in the near term.

At their most recent meeting, the Federal Reserve increased their outlook for inflation and unemployment.  The U.S. economy is experiencing classic late cycle behavior with slow but steadily rising unemployment, fewer job openings, slowing growth in services activity and contraction in government spending following stimulus in the early and middle stages of the cycle.  The economic expansion, and arguably the bull market, has likely been extended much longer than customary by the extraordinary levels of deficit spending, usually only seen during wars and recessions.

Current Playbook

*Focus equity exposure on areas shunned by the momentum and “Mag 7” driven market of 2024, such as mid and small U.S. companies with reasonable valuations, and international developed and emerging markets.  Small cap international stocks look particularly compelling.

*Maintain equity allocation target for now, as the market correction has been limited primarily to U.S. growth stocks.  We would look to reduce equities if a broader set of stocks and sectors entered downtrends.  

*Focus bond exposure on high quality U.S. taxable and municipal issues, but hold satellite exposure to local currency sovereign debt and inflation protected securities.  Bond yields have been range-bound for some time.  We would become more constructive adding fixed income allocations and increasing duration when longer term Treasury yields approach 5%.

*Rebalance portfolios if asset allocation has drifted from targets.  Alternative investments such as managed futures and market neutral or long-short strategies appear to be attractive to add risk protection in the event of a recession.

*Private investment returns in many sectors, particularly in diversified private equity, have not kept pace with U.S. or even global stock markets over the past two years.  These appear to be attractive entry points for investors seeking to add to long term positions and who don’t require the full liquidity features of public markets.

Investment Outlook

We expect that the market action and economic data of recent periods is more likely to lead to a longer correction or bear market in the U.S. than a resumption of the bull market uptrend (as we saw last August).  When the S&P 500 reached its all-time high on February 19, very few underlying sectors were participating at highs as well.  This is a common signal of a topping pattern late in a bull market cycle.  The U.S. market was priced at some of its most expensive valuations and multiples at its peak.  Given the expected impact on growth from reduced government spending, tariffs and rising unemployment, along with the lofty earnings estimates expected in 2025, it is difficult to imagine a scenario where the market will revisit those levels soon. 

Fortunately, diversified investors have seen little effect from the damage in U.S. growth stocks as of mid-March.  Value and international stocks and fixed income have all had solid returns so far this quarter.  However, if the U.S. economy does trend toward recession, we do expect some contagion to other stocks and sectors.  We are being vigilant to determine when to take more defensive measures to protect capital.

At Southeastern Trust, our process is built around identifying the best investments for your portfolio based on a multitude of factors.  We look closely at valuation but realize that by itself is not a catalyst for performance right away.  We also examine the economy and market trends closely to identify clues they provide about the health of one another.  For example, many stocks have been expensive on paper for some time but continued to perform while economic data was mixed and market momentum was strong.  This led us to maintain our equity exposure and positioning despite valuation appearing to be quite negative.  

However, the shift in markets this quarter, combined with increased underlying weakness in the economy, is causing us to pivot to a more cautious stance.  As cycles end, there is often muscle memory to go back to the favored sectors and companies that led the past growth and outperformance.  There are often fits and starts to this process; it took two and a half years for the tech bubble to fully unwind from March 2000 to October 2002!  As investors, it is usually best to look forward, not backward, to achieve competitive results that meet your financial goals.  We are here to be your investment eyes to skate to where the puck is going next.