The Big Picture
Column Summary:
*Market Uncertainty: Tariffs and spending cuts have shifted market focus from tax cuts and deregulation.
*Economic Indicators: Mixed signals from jobless claims, copper prices, and yield curves complicate economic outlook.
*Investment Shifts: Defensive sectors outperform, and foreign markets gain as U.S. market volatility increases.
The stock market's thinking heading into 2025 was that the outlook glass is half full. Economic activity would be improving under a new administration pushing tax cuts and deregulation. That push hasn't changed. The problem is that tariff actions and government spending cuts have been pulled forward on the list of policy priorities.
Consequently, the stock market has been forced to consider the possibility that the outlook glass may be half empty, as the politics of the day have stirred concerns about an economic slowdown upending a previously full earnings growth outlook.
Corrections Among Us
The first quarter has had its highs and lows. The S&P 500 hit an all-time high on February 19, which left it up 4.5% for the year. By March 13, it had fallen as much as 10.5% from that high and was down 6.4% for the year.
The sudden reversal was precipitated by tariff and counter-tariff announcements, an unwinding of the momentum trade, and a stark sell-off in the "Magnificent 7" stocks. This all occurred at a time when Treasury yields were falling, which was a reflection of the market's burgeoning growth concerns, and European and Asian equity markets were posting robust gains, which was a reflection of rebalancing activity driven by a recalibration of the U.S. exceptionalism view.
The cumulative effect of the selling resulted in corrections for each of the major indices (a correction is typically defined as a pullback of 10-20% from a prior high).
Some Offsetting Positions
The pullback led to a compression in P/E multiples as stock prices fell faster than earnings estimates. Strikingly, the forward 12-month earnings estimate didn't fall at all. It stood at $274.47 on February 19 and today it sits at $277.54, according to FactSet.
It has been a peculiar divergence -- one that suggests this "correction" is either only a price correction from an overvalued state or a sign of worse things to come for earnings estimates on account of a weakening economy.
The latter narrative is not without its challenges.
- High yield credit spreads, which would widen rapidly on the specter of recession, or an actual recession, don't convey such concerns.
- The futures price for copper, which has extensive end uses in industrial applications, has surged 27% year-to-date as of this writing.
- Initial jobless claims -- a leading indicator -- are tracking at levels that are consistent with a solid labor market and an economy on a positive growth trajectory.
Still, worries about the growth outlook have been apparent in other ways:
- The spread between the 3-month T-bill yield (higher) and the 10-yr note yield (lower) has inverted.
- The counter-cyclical health care, utilities, and consumer staples sectors have exhibited relative strength over the last month.
- The futures price for oil, which has extensive end uses for consumer and industrial applications, has dropped 6.5% year-to-date as of this writing.
Are these the only discrepancies? No. These offsetting positions, though, speak to a market that can't determine if the outlook glass is half full or half empty. That indeterminate state has led to some fitful trading conditions for a market that had been priced only for good things happening.
Coming Months Are Integral
The mere idea that there could be an important economic shift afoot has been disruptive for the bull market. The linchpin right now are earnings estimates. They are holding up despite companies starting to sound a more cautious tone on the outlook because of the uncertainty generated by tariff policies and the strain consumers -- particularly low-end consumers -- are feeling from elevated price levels across a host of goods and services.
Fed Chair Powell observed, however, that the "hard data" is still pretty solid and has yet to fully reflect the weakening levels of consumer and business confidence that have been apparent in "soft" survey data. In other words, what consumers and businesses are saying isn't matching up with what they are doing. They have been more negative with their thinking than with their spending.
Mr. Powell added that the Fed is focused on the hard data and that, if the soft data is going to affect the hard data, we should know it very quickly.
The coming months, then, will be integral to the earnings estimate trend, not only because we are roughly three weeks away from the start of the first quarter reporting period, but also because we will know more about the impact of the tariff policies that have been put in place, more about government spending cuts, and more about the level and scope of reciprocal tariffs implemented by the U.S. come April 2.
A risk being run by the new administration is that the tariff policies overshadow its work to cut regulations and extend the 2017 tax cuts. That is the case now, but it will worsen if the economy rolls over on account of the tariffs and diminishes the influence of tax cuts, assuming the GOP can reach an agreement to extend the tax cuts without adding to the deficit. The former may ultimately be dependent on the latter. It is a delicate proposition amongst GOP members.
Briefing.com Insights
The investing environment has gotten more challenging -- quickly. The economy coming into the year was expected to pick up pace while inflation was expected to keep falling. Now, the market narrative features talk of stagflation with growth faltering and inflation rising, both of which could give way to a weakening labor market if they persist.
The price action has turned more defensive in the stock and bond markets, investor sentiment has been reined in appreciably, and the "Magnificent 7" has been anything but magnificent, which has applied a lot of downward pressure on the market cap-weighted indices.
Small-cap, mid-cap, large-cap, and mega-cap proxies are all down for the year; the low volatility factor has drastically outperformed the high-beta factor; value is outperforming growth; and foreign markets are outperforming the U.S.
That is all happening after a tremendous year in 2024 when everything seemed to go the market's way, and every dip was bought without question. Well, there are questions now because there are no clear answers about the economic outlook like there seemed to be after the election when investors were focused on less regulation, friendly tax policy, and a "Trump put" that has been talked down by the president himself.
The focus is now on tariffs and spending cuts, because the new administration has made it so. It is all politics, which we said the market would be playing in 2025 for better or worse. Things could get better, but they feel worse now because they have fostered a heightened sense of uncertainty about the economic outlook and, by association, the earnings growth outlook.
With that uncertainty festering, multiple expansion will be hard to come by since earnings prospects won't be fully trusted. A consequence of that mistrust is likely to be a market that continues to trade in a fitful manner where buy-the-dip tendencies are supplanted by an inclination to sell into strength that keeps this bull market under wraps.
