The past is the best roadmap we have for navigating what is in front of us. No situation is ever truly identical to the ones that preceded it, but the recent pullback in the stock market brings to mind some parallels to both the COVID Crash and "Tariff Tussle" sell-offs. Those were very much "news-driven" corrections, and, perhaps coincidentally, also took place around the same time of year. In all three cases, highs in the S&P 500 were made in February before a downside reaction continued. Like now, both of those previous drawdowns were also characterized by a heightened sense of uncertainty due to relatively unique circumstances. We had never experienced the entire world effectively being shut down like we did during COVID, and last year we had never really seen the world's leading economic power instigating a trade war with all its trading partners at once.
While shooting wars are obviously nothing new, this most recent conflict with Iran is somewhat uncharted territory given the risk to global oil markets and the fact that it has already expanded beyond Iran's borders. Regardless of how dismal the prospects for the future became during those previous sell-offs, however, the stock market eventually found its bottom. This time will be no different. A low will be made and likely at the point of maximum pain and capitulation. That is the way it usually works.
As I've said in my previous missives, all we can do during a pullback like this one is identify the most likely levels of importance, attempt to recognize the various factors that often coincide with lows, and then watch for evidence of heavy buying. If, at a time like this, you find yourself overly stressed or contemplating emotional financial decisions, it likely means too much risk is being taken and exposure should be reduced or hedged ("sell down to the sleeping point"). For others in the Warren Buffett camp, a time like this is excitedly viewed as a potential opportunity to put cash to work at lower levels.
When in the throws of a market decline- for whatever reason, we analyze the depth and severity of the “emotional” aspect of the decline. At lows, this is considered a level of “capitulation.” As can be seen in the chart below, we are currently in the capitulaiton range. Please take the time to see that the two previously seen and noted capitulation points were at the COVID low and at the Tarrif Tussle low. Clearly, this conflict is far from as severe that these two events, but I find it valuable to see where we stand. This can often provide some level of confidence as to whether the point we are at is truly a durable bottom, or if we have further negativity to absorb that tells us that more damage is in front of us.
In a bullish scenario, the war would end soon, the oil price would retreat, stagflation worries would abate, and the Fed and other central banks would be able to continue easing, supporting economic growth and earnings. In a bearish scenario, the war would drag on, Hormuz would remain closed, oil would hover around $100, gas prices would rise further, and stagflation would start to become more evident in the hard data, complicating central bank decisions. Market breadth and momentum would continue to worsen on the mounting media fanned worries and concerns with future earnings pessimism. In assessing whether either scenario is becoming more evident, we can watch the breadth (number of names that are rising), sentiment (the polled opinion of both individual and institutional investors) and volatility indicators (known as the VIX).
I think what makes it hardest at a time like this is the length of time that the weather has been just fine when all of the sudden it isn’t now. If we look at the positive periods since the Tariff Tussle, it is clear that this was an elevator down and then the stairs up. This one seems much the same way as we have only had 3 positive weeks in the markets in 2026 out of a total of 12! And the last 5 of these have not been in the positive column.
In the end, prices do what prices do, and when they are in a progression- both higher or lower, the media and virtually everyone looks for the “why” to pin the tail on the donkey. So far this year I have gone over the points that I believed could raise their ugly head in 2026 and make this year clearly not quite as much fun as the previous three. Actually, we can go back almost to October of 2022 to be exact. The issues this year, to reiterate are:
- Second year of Presidential term tend to be the worst year in the four-year cycle.
- Cycle Work from Larry Williams and Tom Newton of FundStrat Direct. Show a difficult period into third quarter. Note: difficult doesn’t mean down, could just be back and forth.
- New Fed Chairman. 10 out of 13 times a new Fed Chair markets have a decline, due to unknowns of a new person.
- Midterm elections could seriously impact the actions of the President. No way to handicap this.
- Inflation currently expanding due to spike in oil, increased productivity due to AI.
Since the number one concern on investors’ minds is oil, lets dive into this a bit more. Here is the price of oil and what it has been doing since late last year. As can be seen, it was relatively quiet and then Boom!
The price of oil seems to be dictating things across risk assets at the moment. Gains in oil have generally coincided with losses in stocks recently, and that relationship might continue until we get some clarification on the future of the Iran conflict. I wish there was more technical help I could provide on oil, too, but really there isn’t much that jumps out other than the fact that the recent trading range has been quite large. It might look as if oil hasn’t done much over the past couple of weeks, but that sideways pause represents a range from $84 to $102. I think all we can really do here is wait for a break from that range to signal the direction of the next bigger move.
The next point I wanted to touch on is big technology companies. Since these represent a very large percentage of the overall market capitalization, I feel it prudent to single out how this group is acting since it has appeared to be a source of funds for other sectors to move higher due to a decline in the overall price of tech. If we really boil it down, we can use for sake of illustration the Magnificent 7 as a proxy for technology in general. As can be seen below, this group has actually corrected (digested gains) all the way back to its high point in the beginning of 2025! Note that not all of these 7 companies have gotten whacked, so it has been a certain few that have really absorbed the bulk of this digestion.
At the same time as these companies have been moving in price, their collective earnings, and consequently measured valuations have been going down. This means that they keep getting cheaper based on what they earn. This seems almost illogical, yet this is what has been happening. Thomas Lee of FundStrat Direct put out this illustration this past week showing the P/E ratio of the information technology sector relative to the entire S&P 500 index and as can be seen, they are now trading at the cheapest valuation that they have in ten years. It must be noted that during the Dot Com Bubble these technology companies had businesses that they “hoped” the world could benefit from, whereas today, they have businesses that the entire world can’t gobble up fast enough! Times, they are certainly a Changin’.
To go back to the effect of the rise in oil prices to the overall economy, it’s all about the length of time that oil prices remain elevated. If oil remains around current levels on a sustainable basis, our calculations suggest a 0.5-point reduction to global real GDP growth. This would likely identify as a sustained global slowdown and suggest that more downside needs to be priced into global equities. Short term, the market will be news driven. Global recession risk (which sees the worst bear markets) remains low considering the favorable starting point. The measure that the US Fed really focuses on is labor. And in looking at the labor reports from last week, even in the face of spiking oil and forced firing at many companies due to AI’s gobbling of jobs, labor is just fine. Unemployment claims really aren’t changing and the economy still stands on a firm footing.
This then logically brings me back to the number one trade off to stocks and bonds. As can be seen below, due to the inflationary effect of rising oil / gasoline prices, interest rates have been rising. This makes bonds more desirable, since they are paying incrementally more, and act as a further draw away from stocks. Since we are in a very important place in economic growth, I don’t believe that rates will go a lot higher, but if negative things continue that create inflationary pressures, rates could continue this escalation.
The issue of rates is what I feel is the most important fly in the ointment of the markets currently. The oil prices are the apparent culprit of the rise in rates to due the implied rise in consumer inflation created by gasoline prices and other petroleum related products. Besides this rise in the cost of money due to the higher rates, I am also paying particular attention to the spread between Hi-Yield debt and Hi-grade debt. Should this spread expand it could be making a statement about economic slowdown. At present this is not the case. See the chart below.
In the end, it really doesn’t matter what one thinks about things. We have markets declining across the board:
- US stock markets in a normal seasonal correction.
- US bond market in a decline due to higher interest rates, primarily driven by the oil spike.
- Foreign markets suffering the greatest due to dependency on Middle East Oil.
Currently large technology, industrials, and energy seems to be the best place to be hunting for opportunities, but when the markets are on the defensive, sitting on your hands tends to be the best policy. Our portfolios are stellar with nothing but leaders, but even leaders have a difficult time of it when the overall markets digest big gains.
- Ken South, Tower 68 Financial Advisors, Newport Beach
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