David Picton explains why markets are taking a rosy view of the US, why that could change, and what concentration in digital sectors could mean for investors
David Picton sees four equity market categories in the world today. Emerging markets and developed markets outside of the US comprise two of the four. The other two categories are listed on exchanges in the United States. The President & CEO at PICTON Investments sees the so-called ‘magnificent seven’ or ‘magnificent ten’ mega-cap technology companies as one of those four categories, and the remainder of US markets as another. He makes that distinction because those giant companies tied to the rise of AI are far less exposed to the underlying state of the US economy, while the rest of US equities are still tethered to GDP in some form.
Picton explained why that distinction between US market categories matters in the context of a US economy clouded by uncertainty. He explained that the underlying US economy is being treated kindly by markets, which are currently operating under something of a ‘goldilocks’ consensus. He noted, however, that this consensus rests on a lot going right for the US and the policy aims of President Trump, if things turn there could be broader problems for the US economy which may be less ideal for those US equities more tied to their underlying economy.
“While the Fed is supposedly a little bit on the tight side, the economy continues to have fairly strong resilience, especially in the face of the amount of uncertainty it's seen,” Picton says, “Some of that could be a pull forward as tariffs are coming. On top of that, you have the big beautiful bill, which increased tax cuts and allowed business owners to write off all of their capital spend in a year on machinery, equipment, etc. That's pretty big as that's occurring. It appeared, as well, that given the TACO trade the final tariffs were going to be much more reasonable, and yet they would still encourage people to build plants and equipment in the US. At least, that's what the market's thinking.”
So far, Picton notes, tariff-related cost increases have not been directly passed through to consumers at the rate some analysts had predicted, resulting in more benign inflation numbers out of the US. At the same time, the Fed is expected to cut rates and many Fed spokespeople have said they might be cutting already if not for the uncertainty around tariffs and inflation.
There are even positive tailwinds for the whole global economy in this environment. The onset of a full-blown trade war has prompted many developed markets to reflect on ways they can boost their own productivity. such as Canada’s dismantling of interprovincial trade barriers and Europe's new willingness to deficit spend for capital projects, infrastructure, and defense.
Market consensus is resting on a scenario for the US economy that looks pretty idyllic at the moment. The trouble is, Picton notes, a lot has to go right for the US to stick its proverbial landing. He notes that the long-term economic uncertainty introduced by US policy could produce a degree of economic overhang as delayed decisions and withheld investment begin to have a latent slowing impact on the economy.
There may already be signs of an economic slowdown in the US housing market, which is seeing a significant rise in new listings along with limited activity due, in part, to higher mortgage rates, resulting in falling house prices. The excess savings built up during the pandemic, too, are almost completely exhausted. Moreover, while the big beautiful bill introduced tax cuts it actually increased the tax burden and broad costs for lower income Americans, when factoring in cuts to benefits like Medicaid. That cohort of US consumers, Picton says, may already be retrenching. While hard data currently supports the goldilocks scenario, softer survey data points to a growing sentiment that leans towards stagflation. The US economy, therefore, might be facing worse risks than it would appear to on the surface.
For those who see these risks to the US economy, Picton notes that the mega-cap quality growth names in that ‘magnificent seven +’ category could be a source of ballast given their relative disconnection from broad economic risks. That said, these companies come with their own risks related to technological developments, the pathways to profitability for AI software, and a textbook degree of concentration risk. While the two sides of US equity markets might look like they could balance one another out in this environment, Picton stresses that portfolio construction needs to account for a wider array of variables.
“Our whole mantra here is that portfolio construction absolutely matters more so than it's done in a very long time,” Picton says. “The simplest way of thinking about it as a set of return streams…what you’d like to try to do, ideally, is have these different return streams that rise in the long-run but over shorter time periods are not correlated to each other.”
