Navigating Choppy Waters, Makes for Resilient Sailors
U.S. economic policies under Trump have seen a significant change in focus from his first to second term. Early within his first term, the primary emphasis was on tax cuts and deregulation, aimed at stimulating business investment and economic growth. However, now within the first 100 days of his second term, the focus has pivoted towards trade policy, with an increasing reliance on tariffs, especially targeting the US immediate trading neighbors i.e. Canada and Mexico and globally China and the EU.
This "tariffs rollercoaster" has caused concern amongst market participants regarding inflation and economic growth, leading to calls for caution due to policy uncertainty. A reflection of this uncertainty is seen in the Atlanta Fed GDPNow estimate for Q1 2025, which as of March 18, 2025, stands at -1.76%, which is up from -2.1% the prior day (See Exhibit 1).
The resulting drop in US long-term interest rates to 4.33% (as at 03/24/25) signals a shift in bond market expectations towards an economic slowdown compared to the 4.79% peak before Trump's inauguration.
Scott Bessent, the US Treasury Secretary, supports lower long-term rates, possibly to reduce borrowing costs and ultimately stimulate growth. However, his belief that the recent weakness in the stock market could be healthy implies that the Trump administration might accept market volatility in exchange for longer-term stability.
On the other hand, Wall Street is concerned about the impact of tariff uncertainty, slowing economic growth, and the administration's potential responses. There's a real fear that a prolonged stock market decline could erode business and investor confidence, potentially leading to a recession. If companies start taking actions to protect shareholder value, such as cutting costs or reducing investments, it could further slowdown economic activity and create a negative cycle.
April 2nd, regarding Canada/Mexico tariffs implementation will be important in terms of providing a framework from which the market could navigate through the tariff dilemma.
Presently, the fed futures (as at 3-24-25) are discounting that we will get 2.5 fed cuts for this year (See Exhibit 2). This is up from the 1.75 cuts that the market was discounting at the beginning of this year. This may prove too optimistic given inflation risks continue to remain to the upside at 2.8% and even though both CPI and PPI prints for February were lower than expected, core PCE is expected to be higher at the end of the month and this is before the full effects of tariffs are felt.
Notwithstanding the above, both prices paid and supplier deliveries for ISM Manufacturing PMI have recently been trending higher which also increases inflation risks (See Exhibit 3). This could put any near-term Fed Put which would be a welcome relief for equities further back into the year (unless the labour market which is still in reasonable shape rapidly deteriorates). The Fed expects unemployment to rise to 4.4% for 2025. A rate above this level would probably be met with concern.
To wit, the US Exceptionalism narrative that was the market consensus at the beginning of the year is now being challenged. Slower growth coupled with stubborn inflation and policy uncertainty is not a recipe for broad based equity out-performance.
The SPX Index is down -1.94% on a YTD basis (as at 3-24-25) and recently briefly entered official correction territory from 52-week highs (i.e. down more than -10%) in addition to underperforming both Europe and China. We see this as an opportunity for investors seeking some diversification away from the US.
Exhibit 4 highlights that even with the current out-performance as undertaken by these markets that they are still trading at attractive levels relative to the US. For comparative purposes, the SPX Index currently is trading at around a 4.73% earnings yield i.e. a $100 investment can be expected to yield a profit of $4.73 relative for example to the UKX Index (FTSE 100), where the same level of investment would generate a $8.06 profit.
With the exception of the 2021 to 2022 drawdown (led by rising inflation further complicated through supply chain disruptions, geo-political tensions as well as Mag 7 valuations under pressure from the market discounting higher interest rates), the previous four material market downturns have all been between -8% to -10%. With the most recent pullback the SPX briefly hit -10% from its 52-week high and since has recovered to just around -5.72% and once again is above the 200-day moving average (See Exhibit 5). This can be viewed as positive and may be indicative of an interim bottom being put in place.
From a technical analysis point of view the 5,500 level of the SPX Index is seen as the near-term downside target.
Given the market's focus on the upcoming April 2nd tariffs deadline, Exhibit 6 highlights those sectors (excluding Utilities, Financials, Real Estate and Energy) from which their underlying companies have more than 50% their revenues within the US and thus will be less susceptible to reciprocal tariffs.
From the chart, Technology as a sector is most susceptible to reciprocal tariffs while Telecommunications is the least.
As previously mentioned, slower growth coupled with policy uncertainty and upside inflation risks is not a recipe for equity broad based out-performance. According to FactSet (as of March 20th, 2025), the S&P 500 is expected to report year over year earnings growth of 7.1% for Q1 2025, compared to the estimated earnings growth rate of 11.6% on December 31st, 2024. If 7.1% is the actual growth rate for the quarter, it will mark the seventh consecutive quarter of year-over-year earnings growth for the index. To put this into context, while earnings growth has been revised lower, overall corporate earnings are still in reasonably good shape.
While the market looks for guidance as to what will be the next clear catalyst to drive the index towards higher highs, earnings growth remains the order of the day and those sectors/companies that can surprise to the upside should still be rewarding to investors.
Exhibit 7 highlights that Healthcare (which was the 2nd worst performing sector for 2024) looks very compelling trading at a -15.96% forward P/E valuation discount and a 90.02% higher forecasted EPS growth rate relative to the SPX Index consensus. Telecommunications at -12.23% and 28.15% respectively is the 2nd most favourable where these two metrics are concerned. Given these sectors' role as being traditionally more defensive and now being less susceptible to reciprocal tariffs, this makes for an even more compelling case for an allocation given the current macro environment.
What about the Mag 7?
The BM7T Index (Exhibit 8), a proxy for the "Mag 7" stocks, has experienced a significant pullback in its forward P/E ratio, dropping by approximately -27.17% from its peak in 2024 to current levels. Given these stocks have already fallen 25–30% from their 52-week highs, putting them firmly in oversold territory, and with the expectation that the Fed will ease later this year (which could support valuations), these stocks are starting to look more appealing.
The relative strength Index for the BM7T Index relative to the SPW Index (S&P 500 Equal Weighted Index) indicates that a bottom may have formed with RSI having recently crossed through the oversold line from below (See Exhibit 9, highlighted circled area).
Therefore, investors may want to consider initiating a position in some of these high revenue growth names. Given the continuing role of AI (and its anticipated downstream impact of AI innovations in other sectors), now may be the right time strategically for investors with a longer-term outlook.
Conclusion
With GDP downgraded and upside inflation risks due to the lack of clarity on the Trump administration's tariffs and economic impacts, volatility is expected to remain high. However, consensus GDP forecasted to be 2.6% for Q1 2025 is still positive (above Q4 2024 actual) and the labour market still presents in good condition with unemployment at 4.1% and wage growth (while slowed) still in line with its intermediate trend.
As the market seeks direction on what the next catalyst will be to push the index to higher levels, earnings growth remains a top priority. Sectors and companies that manage to exceed expectations should continue to drive returns for investors.
Possible catalysts may come from Fed cuts, a diluted version of tariffs, geopolitical conflicts resolution i.e. ceasefires and the stimulative effects of deregulation/tax cuts which have yet to be implemented.
While the current pullback in stocks undoubtedly will have some investors on edge, there are opportunities for investors (especially those with a longer-term investment horizon).
