Focus on a Single Story

24 April 2025

From a behavioural perspective, a key feature of major market episodes is that investors tend to focus on a single story. That is a key reason for the “magazine cover” effect. Once a single story is on the front cover of the Economist or another major publication it has probably become the prevailing bias among investors. As we noted last week, tariffs are a “known risk.” To be fair, what is not known is how long the Administration will take to negotiate a deal and the potential impact on growth and profits. While investors are focused on the single story, the critical reason for the magnitude of the correction in equities was more likely due to the valuation and positioning (risk-reward) starting point, which was ironically a reflection of the consensus belief in American Exceptionalism at the start of this episode and the disappointment in AI relative to euphoric expectations.

As we noted last week, the United States and China are in the ultimate game of chicken. Either something breaks and we plunge a lot lower in risk assets or shorts get steamrolled by the US Administration and China capitulating. From our vantage point, the key in this episode was the poor-risk reward starting point. The S&P500 (global risk proxy) traded at 23 times forward earnings compared to the long-run average of 16.7 times. Even after the recent correction, the valuation is still 19.9 times and consensus EPS growth remains +8.2% over the next 12 months.

The poor risk-reward and valuation starting point was also a reflection of the consensus belief in American exceptionalism. Ironically that prevailing bias was evident in extreme concentration in mega-cap tech, AI expectations and demand for the US dollar (“Envy of the World”). The prevailing bias was also echoed in the Economist Cover late last year (first image) and in the Bank of America Fund Manager Survey. The focus of single story earlier this year was the complete antithesis of the prevailing bias, positioning and Economist Cover this week (second image).

Economist Cover Image, October 19th, 2024, and April 19th, 2025.

To be fair to investors, April 2nd was worse than the worst expectations. From a macro perspective, as best we can tell, there has likely been a genuine sudden stop in activity, new investment, hiring and trade. That is evident in manufacturing surveys like the Philadelphia Fed manufacturing index (chart 1) and Korean exports over the first 20 days of April (-14% year-on-year to the United States). There also appears to be legitimate disruption in trade and shipping. In that context, earnings expectations and credit risk premiums appear under-priced for a probable contraction.

Chart 1

Source: Bloomberg

In contrast to the sudden stop in 2020 that was also policy driven, the Federal Reserve appears to be in “wait and see” mode. From our perch, The Fed Chair ought to share blame with Trump. As our Italian friend put it, this is not the first time Powell has shown his autistic latency. He did it in 2018 during the first tariff episode. He did it with the infamous “transitory” view of inflation post COVID and he appears to be doing it again today as the recession odds rise. Powell also contributed to the feud with the emergency rate cut in September 2024. Clearly politicising it on social media lies squarely on the Donald. It is also probably unnecessary given the markets have priced meaningful rate cuts.

The good news from a tactical perspective is that both the Treasury Secretary and the President appear more conciliatory toward China and the Fed overnight. From a behavioural perspective, the single story has become the consensus belief. Moreover, market stress indicators like SOFR, repo and the bond markets remain relatively calm. There is no dislocation or systemic bleed, yet. Implied equity volatility has also collapsed from the high and might contribute to a reflexive (self-reinforcing) recovery in equities and risk assets more broadly. On the negative side, there has likely been a genuine impairment to growth, trade, and profits. That is not adequately reflected in consensus earnings expectations or equity and credit risk premiums.

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