Investment Insights

 — Steve Orr 

At a Glance:

• Uncertainty running markets
• Tariff tantrum turning to torment
• Growth scare adding to Wall of Worry
• Are we there yet?

About that rally

The S&P 500 hit its most recent all-time high of 6,144 on February 19. That close marked its third record this year after posting 57 new highs last year. That February high marked the third time the big index had tried to break out of a post-election trading range. Each of the three new highs were struggles by the index met with quick reversals. Imagine pushing up a manhole cover on Wall Street to peer out momentarily, only to have it slam shut on your head…

Tariffs and geopolitical noise are getting the blame for the ensuing correction. The S&P 500 closed Monday 9% below its recent high. Small cap and the NASDAQ indices had already slid past the 10% correction level. Regular readers of these missives recall that we judge markets on more that just price action. Valuation, trend and sentiment all play roles in moving prices in magnitude and time. Valuations play out over decades and trends usually two to five years (a market cycle) — and sentiment turns on a dime.

Each of the indices dropping below their 200-day moving averages has stalled the current Bull cycle that began in October 2022. A big driver in this rally has been buy-the-dip momentum. Traders were comfortable buying in any downturn because the Federal government was continuing to spend, and the Fed’s bias was to lower short-term rates before raising them again.

Peaking 

Valuations have run above their 15-year average, for, well, almost 15 years. Thanks to the easy money policies of the Federal Reserve and other central banks, money could easily flow into stocks. The momentum of tech stocks and the Magnificent 7 in particular drove the median P/E ratio of the S&P 500 to 26 times at the end of February. That is about 1.5 standard deviations above its 61-year average of 17.8x, according to Ned Davis Research.

The rally took a trend pause starting in December, grinding back and forth in about a 6% range. Again, the tariff tantrum takes the blame for dropping the S&P out of its range. On Monday the 10th the big index closed decisively below its 200-day moving average for the third time in seven months.

Trading and retail sentiment peaked in early December and stayed elevated until tariff tantrums started late last month. The last time we saw sentiment fall this far this fast was five years ago, when the economy was ordered to shut down. At this writing, sentiment is so bad that it’s “good” — at these levels, stocks generally post double-digit gains over the next year.

Taxing

Once the tariff talk began in earnest in February, traders finally took notice. Most were content to ride another 10% gain in earnings as projected by Wall Street. Tariff talk made them a bit nervous, but they did not take the administration as seriously as they should have. Once tariffs were turned on, then off, then delayed, stir, rinse, repeat, buyers have turned to selling as the path highest certainty. Wall Street values certainty above all else.

Known tax rates, tariffs and stable currencies give executives confidence to plan and invest. The current environment encourages them to sit on their hands. Consumers put off big ticket items and reign in spending. Tariffs act like a tax in that they do push some prices higher. Generally, an importer tries to bear some of the increase. A good portion of the change in prices happens in the foreign exchange markets. The value of our dollar has already fallen about 6% against the Euro and Japanese Yen in anticipation. Sorry if you are headed overseas for Spring Break.

R word again

Job growth has been steadying the past several months, notching out the winter storms and Cal fires. Underneath the headlines, there is some movement toward slower growth. The underemployment rate U-6 spiked last month, and the number of multiple job holders continues to rise. We expect next month’s data to show the effects of D.C. layoffs.

So, is a recession just around the corner? No, not anytime soon. But we believe our forecast of a weaker economy in the second half of the year is being pulled forward by the administration layoffs and spending cuts. The R word today is Risk-Off for traders. For longer-term investors it’s wait and see as to how deep the correction goes.

How about the S word? Stagflation is another word clients are throwing at us. There were three big bouts of stag in our (my) lifetime: 1974, 1979 and 2022. All three were started by oil prices spiking.

Happier admin 

One theme the Trump administration has harped on is cheaper energy prices. President Trump revived Sarah Palin’s “drill, baby, drill” slogan during his campaign. The global oil markets are some of the most efficient and “textbook” in their operation. Supply and demand changes are reflected very quickly in prices. OPEC announced last Monday that it would begin increasing production in April. The increases will be slowly rolled out over 18 months and will just replace falling output from a few countries. In short, no big inventory change. 

But the administration is happy because crude prices have dropped around 12% since tantrums began in January. Lower crude helps headline inflation, consumer wallets and the trade deficit. It does not help our Permian and Eagle Ford producers, however.