In the first 12 weeks of 2026, the equity markets as measured by the S&P 500 were only up 3 of those weeks. Is this a function of the war? Is it a function of the polarization in the political aisles? Is it a function of President Trump’s style? Or is it the fact that the media is completely controlled by the liberal platform and no matter what the real reason is for the conflict, nothing is going to be said positive given that it is under the current president?
In the end, I pay attention to what the money is saying. I am totally incensed by the fact that there is almost zero mention of the fact that if we didn’t go in and deal with the nuclear arsenal that was being amassed in Iran that there was sure to be a nuclear disaster that could have affected the entire world due to religious beliefs. The fall out is clearly an issue of Middle East oil flows. Along with this oil flow are the associated goods like fertilizer being interrupted. In looking at oil flows, see the chart below that represents how vulnerable the US economy is to this current oil shock:
The war in the Middle East has stirred up worries over an energy-price shock tipping the economy into a downturn and undermining the equity markets. Besides the labor numbers last week and ISM numbers on Monday of this week refuting this, the media continues to espouse the disaster we are in the midst of. We believe the US economy is better positioned to contend with economic disruptions from war with Iran compared to past oil shocks due to mitigating factors that have not previously been present to this degree. Household energy spending as a percentage of after-tax income since 1970 is clearly on the decline as seen in the chart above.
Since the beginning of the year, I have been repeating the probabilities of a market digestion. I seldom state “why” as it is not so important other than during a cocktail conversation. What is most important, I believe, is that it was due, it is the worst year of a presidential term, and we have some other major stuff like a new Fed Head and a Mid-Term election going on. Both of these can’t really be handicapped, but statistically they both tend not to be friendly to the markets.
Since these are clear, concrete unknowns on the horizon, and since it has been since the Tariff Tussle last April that we have had a digestive phase of any consequence, it seemed right that there could be a first part of the year pullback. This is exactly what we have been experiencing since mid-February. That is up until last week. Here is the chart showing the action of the S&P 500 during this time. I am most happy about the measured pace of the pullback. As can be seen, it didn’t really suffer from any major drama type declines. Instead, it has been quite consistent. It has fallen, tried to recover, up to the red line showing resistance, then falling back down to a lower low. This all sort of happened up until last week as can be seen in the lower right of the chart:
My work has shown that since mid-January the number of sectors that were in a positive progression had started to fall even though the price of the index had not. This tells me that internally the strength of the market was diminishing and was “getting ready” to get negative. I say getting ready as it isn’t negative till its negative, so this must be monitored until it showed that things really were getting some momentum on the downside. This momentum showed signs of exhaustion and reversal back up based on the closing price data last Wednesday. Will this reversal continue? Again, until more data is given that supports this, caution should still be adhered to. Looking at longer term, going back a little over a year ago, the decline of the Tariff period can be seen, the rollover from the highs, and then the low that we have seen this last week:
I keep on coming back to the economic indicators. It must be remembered that these are all historical in nature as they reflect what has happened most recently. They do not reflect future expectations. To even attempt to do this one must look at the cost of money in the form of interest rates, the spread between the cost of hi-yield debt and US Treasury debt, and other economic components like commodities in general.
At present, aside from oil, there still appears to be relative stability and virtually no signs of a recessionary downtrend in the offing. As long as economic indicators remain positive, as they have been, and interest rates don’t spark inflation / stagflation, then this correction has been a pause to refresh and not a beginning of something much more destructive to equity prices.
Tax day is next week. Many are having to pay big tax bills for 2025. At the same time, the markets have hit extremes on the negativity front even though not at a time of economic slowdown or extreme overvaluations. Consumer confidence has reached an extreme on the downside. Could it be from the war or just the deluge of negative nabobs on the news channels. As can be seen below, the University of Michigan Consumer Sentiment Index has been bouncing at the lows since the period of COVID. I find this quite interesting as the markets and economies of the entire world seem to be at high points and continuing stronger. It really makes me wonder if these Sentiment Indexes really reflect a true cross section of the US economy or just a snapshot of carefully chosen few.
This week we will wait for more answers on companies, the economy, and hopefully a containment of the conflict with an ending in sight. Until a clearer picture develops, care should be exercised and selection with a focus on high quality both in equities and fixed income should be employed.
- Ken South, Tower 68 Financial Advisors, Newport Beach
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