In the last two weeks the euphoria has been completely sucked out of the market. That is the kind of thing that happens, when positioning gets too one sided and over- exaggerates on a catalyst to the upside. I know when major US equity indexes get close to correction territory (defined by a pullback greater than 10%) or exceeds that threshold like in the case of the Nasdaq or small cap index, it doesn’t feel comfortable, especially when that happens at a precipitous pace. But it’s completely normal and healthy for that froth to come out of the market to keep the bull-market sustainable. In fact, the average intra-year drawdown dating back to 1980 is about 14%. As we know just because that is a drawdown from a peak, that doesn’t mean that’s where the market finishes at year end. It obviously depends on the reason for the selloff and whether it’s justified to the extent that it has, but historically this type of oversold landscape have been good buying opportunities especially for investors with longer time horizons. Now it is important to know that media outlets get higher viewership when people are talking about alarming doom and gloom stories. Whenever the stock market pulls back 10% you’ll likely hear many investment experts talking about this time it will lead to a 20% or 30% pullback because of this or that. Yes, bear markets do occur, but most pullbacks or corrections do not lead to a decline of that magnitude.
Whenever there are selloffs it’s important to keep your composure and look at it from a calm and rationale viewpoint. Ask yourself what is the catalyst, what is the state of the economy/where is it headed, how are corporate earnings doing, what multiple are you paying for them, how do the charts look? So let’s take these one at a time. The main reason the US stock market sold off was Tariffs on our trading partners starting to be announced. I’m a little surprised that it caused this kind of reaction since it’s been the promise of the entire campaign but…that’s what we are currently dealing with.
So now that we know the catalyst what impact will that have on the economy and does that justify the current or even deeper selloff to come? Obviously, no one knows what will actually play out, how could they? We don’t know the ultimate degree of the tariffs, what goods or regions will be exempt, the retaliation by trading partners, the reaction by companies buying and selling globally. So with many unknowns that increases the range of potential outcomes, but what I have found is markets like to overreact to things in the short-term and then reverse whenever there is some clarity. It is my opinion that although tariffs will likely be implemented to certain countries and goods, they will be more of a negotiating tool than something that will turn into a global trade war. There is the potential for slower growth and/or higher inflation, but we are starting from a pretty healthy economy where consumer spending is still decent, and inflation is still a little elevated but consistent with the historical landscape.
Now there were certainly some reading in this past month that warrant some caution about the overall health of the economy, but that is all it is at this point. The US economy added 151,000 jobs in the month with wage growth that continues to outpace the rate of inflation, which is certainly consistent with a healthy economy. However, there are certain components like hours worked being at a four year low, and the number of workers that are taking part time rolls that don’t match their skill level being the highest since covid, that warrant some concern. Retail sales also showed weakness for the January reading, however weather likely played a big roll in that. ISM manufacturing and services were both expansionary in the lates reading, however manufacturing saw some weaknesses in new orders. Tariffs will likely cause companies to pause projects and hiring until they get more clarity on what they will look like. President Trump said he’s not looking at the stock market as a gauge, but based on his last time in office I really believe that the market being down will lead to quicker negotiations with our trading partners. There are also many proposed policies that will likely lead to faster economic growth such as de-regulation and tax cuts.
On the corporate front, earnings were very strong for the fourth quarter. Estimates are coming down for Q1 more than the average due to tariff uncertainty, but that could just as quickly get reversed with more clarity. The lower bar also sets companies up for better earnings announcements when they actually come out. Valuations are still elevated for stocks, but they have pulled back to more attractive levels. Looking at the chart of the S&P 500 after the decline over the past two weeks, the index has crossed below the 200-day moving average and is currently dipping below the trend line from the 2022 bear market. That is certainly not welcomed news but it is not abnormal for these levels to be temporarily breached before continuing in the existing trend. The indexes have entered very oversold levels on the daily charts characterized by the RSI indicator, so I would expect at least a bounce in the near term. At that point we will assess the landscape and decide whether new highs are likely or whether it is time to take further risk off the table. But for the time being, we are still more in a buy the dip mindset.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Economic forecasts set forth may not develop as predicted