Cross-Asset Views: US correction or cyclical bear market?

This 1st quarter undermined many of certainties built up at the end of last year. 1/ US exceptionalism, cracked by the DeepSeek episode, which calls into question American AI supremacy and the accumulation of capex (vs. ROI). 2/ Trump trades and the rosy “Trump bump” scenario next... political uncertainty is now at historical highs and tariffs will probably prove larger and more global than anticipated, pushing forward the pricing of a stagflationary US scenario. 3/ MAGA vs MEGA: in the face of the new Trump administration, the German fiscal and European military revolution suggest an unprecedented fiscal impulse that could realign European growth with that of the US... while China is also turning on the fiscal lever. Could the correction in US risky assets continue? We think so. In the short term, the equity correction and bond gains should certainly generate pro-equity portfolio rebalancing effects (late March/early April). Although US equity sentiment sank, our indicators do not show any sense of panic nor any capitulation at this stage on US equities with resilient ETF flows, VIX curves resilient and CTA positioning not yet extreme. Fundamentally then, the peak of political uncertainty is probably still ahead of us, and in our view macro news flow still has room to deteriorate (particularly on the hard data side). While our economists do not anticipate an US recession (we see US growth at 1,8% this year), we do believe that recession pricing could increase in the short term, particularly with a cautious Fed; the recent repricing of credit spreads points in this direction.At this stage, US interest-rate dynamics will be key to equity momentum, as is traditionally the case at the end of a cycle characterised by high equity valuations, decelerating macroeconomic activity, low unemployment, a strong dollar and restrictive monetary policy (see “Lessons from the past show the Fed’s put is key”). A fall in US rates would therefore support US equities and credit markets, while stable or even rising rates could trigger a 2nd wave of correction and plunge the market into a cyclical bear market. With this in mind, US tariffs-induced inflation and fiscal risks are key. Can European equities continue to outperform? In the medium run we do not buy the possibility for a strong decoupling Europe vs US. But, tactically, the validation of German and European (defense) budget plans and a ceasefire agreement in Ukraine are wildcards. Even if potential European growth remains lower than in the US, as well as the potential for corporate profits/margins (the US premium will continue to prevail), the dynamics will remain favorable to Europe in the short/medium term, with a fiscal impulse that should more than offset the negative effects of tariffs. In terms of valuation, European indices also remain cheaper, with potential for rerating (the DAX is expensive, however). In our view, the same argument also applies to China, although the Chinese market is less “investible” given political risks.All in all, we believe that the pro-Value, pro-Europe and pro-China momentum still has potential in the short run... especially until some of the US uncertainty dissipates and/or US asset valuations adjust further. This should probably happen by the end of Q2. We prefer defensive vs. cyclical sectors in the US, and SPW vs. SPX. S&P500 Dividends futures are also a nice non-recession play for long only investors. The US dollar could continue to lose its stress-hedging power, and we prefer gold. On the Fixed income side, short duration offers the best carry-to-risk along with USD cash, as we see a higher floor to EUR and USD 10y tenors (resp. 3% and 4,5% for Dec.). On the alternative side, stock/bond correlation will remain noisy around zero. We still like FX Value (JPY and EUR are undervalued vs USD) and continue to recommend a steady allocation to CTAs, whose performance has been disappointing YTD but remain a good hedge vs inflation/recession risks.