Elevated Uncertainty and An Overdue Reset
It’s safe to say that the honeymoon was short, as the feel-good equity rally fostered by the Trump win in November has already come to a screeching halt. The Trump administration’s pro-business plans of tax cuts, deregulation, and a friendlier M&A climate were expected to lead to a great backdrop for equities to continue to rally in 2025. Indeed, the S&P 500 reached a new all-time high on Feb 19th. From the election in early November to Feb 19th, the S&P 500 was up 8%, the Magnificent Seven, 17.6%, and the Nasdaq-100 by 11.3%. But since Feb 19th the Trump administration’s policies on trade seems to have negated all of the potential pro-business policies. All of the rally since the election has been given back and then some. The S&P is down by 8.1% since Feb 19th, the Mag 7 by 14.1% and the Nasdaq-100 by 11%. The aggressive tariff policies and their potential implications increased volatility and led the markets to recalibrate earnings estimates for 2025.
The elevated uncertainty around trade with our closest and biggest trade partners raised concerns for an economic slowdown and prompted what now feels like a risk-off environment, as markets and investors adjust to a new set of economic and geopolitical policies. In addition to the non-stop tariff headlines impacting markets, US consumers continue to be impacted by persistent food inflation. It seems that we are reminded by the media on a daily basis of the high food prices, eggs in particular. If you shop for groceries, you’re quite aware of the higher food prices without the media’s help. President Trump spoke of the cost of eggs himself in his recent joint address to Congress. Now, even the DOJ is investigating egg prices. This just demonstrates how frustrating the current situation is for food prices in general. These two issues, tariffs and the cost of food, seem to be central to markets and consumers at the moment.
The recent decline in equities has been particularly acute in growth stocks. The Russell 1000 Growth Index is down 11.3% since Dec 24th compared to the S&P 500, down 6.4%, and the Russell 1000 Value’s -0.7% in the same time period. Perhaps this leads to a longer-term market rotation to value from growth; time will tell. We’ve seen this type of price movement in the growth vs. value styles many times over the years. And cyclically sensitive industries like banks, travel, and retailers are all down mid-teens to twenty percent since the election. This may indicate more than a “normal” correction which is often led by investors’ taking some chips off of the high-tech growth parts of the market.
But all of this being said, does the decline in the market and the somewhat gloomy consumer outlook really portend a recession just around the corner? For the most direct answer to that question, I would point you to read our CIO’s recent commentary on the subject. Our economy remains resilient, as evidenced by our relatively low unemployment rate of 4.1%, a very modest widening of credit spreads (which are still fairly tight historically), and consumers, who continue to spend. So, is a recession imminent? Or, could you also say that the equity selloff since Feb 19th is a market correction that was overdue and was going to happen at some point?
Valuation for the S&P 500 suggests a correction was coming, regardless. From early August to the election, the S&P 500 rallied 10.5%. It then continued to go up sharply to Feb 19th. In total, from early August to the high on Feb 19th, the market rallied by 19.3%. 19.3% in six months! The market multiple in early August was 21.5 times forward earnings, but by Feb 19th it had climbed to 26.6x. As with market’s appreciation, that’s a rapid expansion of the market multiple in a very short period of time. In particular, the aforementioned high-tech growth stocks (Mag 7) rallied by 36.6% (!) from early August last year to Feb 19th. Accordingly, the Mag 7’s multiple went from 30x in early August to 38.3x in December when growth stocks started to weaken. Equities rallied hard and fast and the tariffs and Trump rhetoric were likely the catalyst to start an (overdue) reset to the market. This isn’t to belittle the threat to the economy from the tariffs. But rather, that the market had gotten expensive and had priced in a lot of good news. These adjustments come along from time to time; indeed, most years see a market drop sometime within the year of at least 5% and many years see declines around 10%.
The investing environment looking forward does include some positives. Already, the 10yr Treasury has moved lower, oil prices have dropped, and the US dollar has also declined. A lower 10yr Treasury has led to lower mortgage rates, helping out the housing market and first-time home buyers, in particular. Lower oil prices should mean that we see gasoline and power prices ease somewhat, helping out consumers’ wallets. The weaker US dollar is a positive for US multinationals. And the market multiple today is now at 20.8x. Still not cheap, but it isn’t expensive and it is a lot more attractive than 26.6x. Investors should also note that we are likely at, or at least, very close to peak-tariff uncertainty. The point being that the equity market was expensive and due for a reset. They’re never fun and they always feel terrible. But the overall economy remains healthy and the uncertainty surrounding tariffs should dissipate over the next several months.
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