Lacking confidence, investors have remained in a risk-off mood. The shift from complacency to pessimism started in December. As market optimism has been replaced by pessimism, consumer confidence has given way to mounting economic gloom. The overall takeaway from reports on the markets and composite itself is that the market fears are out of proportion with market performance. Considering the negative sentiment, it’s not surprising that in a Google Trends evaluation of search terms, “recession” and “bear market” have been heading toward their highest levels since 2022. If the economic and market worries are justified, much more market weakness and contraction evidence may lie ahead. But the weight of the evidence says something different. We’re more likely to see widespread recognition that the fears have not been justified, in which case equities will start recovering from the extreme pessimism. That would be the message of a buy signal from the sentiment indicator. Below is a graphic of the level of extreme pessimism that we are seeing at the moment as well as where is has been going back to 2021.
At the moment, I believe I am seeing similarities to the scenario back in late October 2023. The S&P 500 was hitting extremely oversold levels while coming into an area that I expected to be major support. The index would go on to fall a little lower than I expected back in 2023, but ultimately it did find a low soon after and begin a large rally. The backdrop is different this time, but the technical setup is largely the same. The S&P is under its 50-WEEK moving average again for the first time since October 2023. It has also exceeded the lower end of what I thought probable but is still within the general realm of the support. Equity markets remain hesitant because of the tariff headlines causing uncertainty among CEOs, consumers and markets. This lack of visibility naturally makes it difficult for markets to find equilibrium. Hence, the recent volatility. But, at the same time, the 4% decline in Nasdaq 100 on Monday was a clear over-reaction. And as we pointed out Wednesday, these “high velocity declines” often mark important market turning points (higher). Rarely is it the start of a bear market, or a major downturn. Remember, we were at a 52-week high just a month ago. And as we noted, the only decline of that speed that portended a bigger drop was COVID 2020. So, if one believes the tariff wars have the same downside risk as a global pandemic, then 2025 decline is not an opportunity. I would tend to not see it as an event of the magnitude of COVID. Here is the comparison that I see at present. Please note that I have highlighted the periods that I feel are similar. The first one is the decline in October of 2023, and the other is today:
To me, the next logical question is, “What is the probability that the decline exceeds 10%?”
I believe that the probability of recession has to go above 50% and there has to be a belief that the Fed has no way to help the economy by lowering interest rates. Both of these are wrong. There is a very low probability that the ecnomy goes into a recession and the Fed is now poised to make somewhere between 1 and 4 rate cuts this year. This is the current measure of probability of rate cuts that are currently expected by market prognosticators:
If this should be the case, this is tremendous firepower for a market bounce / recovery. Bottom line: the 10% decline from February 18th is the 5th fastest in the past 75 years. In 6 of 6 times the market is higher 3m, 6m, and 12m later, EVERY TIME. It has only been under 20 trading days. This is very short and very sharp. Hence the reason for the extensive pain felt. So, what happens next, if this is going to act like the previous times? Needless to say, if this current market were to act as the previous did, this could be just another shaking of the leaves on the tree prior to further benefit from a strong US economy. Here is what has happened in the past as well as exactly what made the markets uncomfortable prior to previous sharp setbacks:
Nobody will be able to say exactly what causes a sharp market action to reverse. Often times the sharp move just simply gets tired. “This time” will it be a cease fire in the Russia / Ukraine conflict? Or will it be a settling of the Tariff Tantrum? I don’t really know. But I do know that we are at extremes, and the extremes tend to end quickly if they are just short-term in nature. If the reasons for this market pullback are more deeply rooted, then the economy should reflect this. If the economy weakens, the Fed should speed up their easing process and we should be able to avert a recession. Time will tell, but we will be here steering the ship in the storm.
- Ken South, Tower 68 Financial Advisors, Newport Beach
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