As of Friday, the S&P had declined 7% over a two-week period. I went into detail last week talking about how many times a year markets tend to have these kinds of drawdowns going back in history. In a positive year in the markets, the average max drawdown has been 11% over a nine-week period. We continue to navigate the crosscurrents, of which there are many, based on this time horizon. Tactically, we’re encouraged that our indicators are moving towards attractive levels. While thinking the stage is set for some type of relief rally, based on the sharpness and depth of the current pullback, we are now considering the extent of the bounce given breakdowns in other areas.
In this week’s note I wanted to go over where we are the cycle vs. the secular (longer-term) picture, as well as addressing the international markets and how they have been acting. This will not give a clear picture of when the “coast is clear” but in the absence of a major economic decline, the stage is still set for further advances and a resumption of an uptrend.
US Markets Verses International
Ironically, since the beginning of the year, foreign markets around the world and particularly in Europe are outperforming the US equity markets as the world frets over the potential effects of tariffs should they be broadly deployed by the Trump Administration. We see some irony in the recent outperformance by foreign markets over the US markets. In our view, foreign companies in Europe, Asia, and Latin America are likely to suffer even more from deployment of tariffs than companies in the US. Looking around the world, the capacity to produce goods destined for export to the US has increased to such an extent over the last two decades to suggest that not only China but much if not most of the rest of the exporting world is currently suffering from overcapacity of goods destined for US consumption. China’s domestic economy has not yet grown enough to replace US demand already lost in the recent worldwide diversification away from a one country global supply chain to a more diversified supply chain across the globe. Tariffs would likely only exacerbate the situation for China as well as for other countries suffering from over capacity of export-driven production. We expect more is likely to be revealed over the course of the next few weeks as to the effect of tariffs by the US as well as from any retaliatory tariffs that are levied. We would expect that cooler heads could prevail as all sides consider the effects on both producers and consumers. Beyond tariffs, there’s a long list of budget related items for Congress and the Administration to address, such as some kind of resolution to the war in Ukraine and more to consider. At times like these, we recall that in hindsight challenging times are often the best for identifying investment opportunities as well as recognizing risks that lie close at hand. Prudent diversification, patience, and an eye for “babies that get tossed out with the bathwater” in market pullbacks remain central to our thinking. Stay tuned.
Over the prior 20 years, such instances as today when the all-world, ex-US has shown a level of relative strength tends to be short lived. Only between 2003 and 2007, when the ratio was trading as it is today did the international markets temporarily outperform the US markets. Without an extended period of base building, our hunch is that this recent action should again be short lived. In looking at periods when the S&P was in a decline, the all-world only outperformed the US markets 17% of the time since 1988. If the US markets should continue to drop, this would necessarily correlate with a negative economic environment. Should we experience a negative economic environment, the foreign markets would be devastated much worse due to a decline in our consumption of their goods and services, whether it be catalyzed by the tariffs (which tend to be very short-term) or some other event.
Where Are US Markets Right Now
In looking at the US markets, it has been since the end of 2023 that we have experienced a decline as we are currently. It should be remembered that quite possibly people are bearish because we are on the heels of two 20% plus back-to-back years. So here is the pictures of the S&P 500. Please note that this move, at this point, is a reversion to the mean of the moving average.
A point that I find interesting is that even though the index itself is on a steady decline, the internals of the market are reversing and showing less strong selling pressure.
Another point to consider is that in the first quarter of a new administration, the equity markets tend to really have a tough time. As can be seen in the chart below, I have overlayed the 2025 market on top of the average market for every first year going all the way back to 1928. January seems to be a bit of a honeymoon, February is when the new president tends to shake things up, March is a settling of the shake up, and the first half tends to then be quite strong.
Is The Bond Market Saying Anything
When fears hit their highest levels, money flows into the bond market, namely shorter-term US Government bonds. They are soverign, pay good interest and show very little fluctuation. But I am bringing up bonds for a different reason. I am always paying attention to the economy. Is it growing or is it slowing? Are we in a continued steady progression, or are we entering a recession? One the best ways to see what the money is saying about the answers to these two questions is the price changes that are going on between Hi-yield bonds and 10-Year US Treasuries. If money scared about the strength of the economy, the interest rate on Hi-yield bonds will go up as money will flee for the safety of US Government bonds. The reason is that if people are going to take on greater risk they should be paid to do so. At present this IS NOT THE CASE. See below:
Until this changes and we begin to get reports of economic softness, I continue to believe that what we are experiencing is a digestion / pullback rather than something more daunting.
In Conclusion
I would be wrong to say that this pullback is not painful. It is! On the surface, given the growth concerns now rapidly rising to the surface, the current market action might be what one would expect with a growth scare. But beneath the surface and the headlines uncertainty, this doesn’t look much like a growth scare at all. Rather, these reeks of a momentum unwind of the big winners of the last few years.
Uncertainty is the hottest word in town right now. It’s no surprise that many are pinning the blame on the dampening effects of uncertainty. But to pin the recent turmoil on slowing growth as a result of dented confidence from elevated uncertainty is a bit of a stretch. I will leave you with a picture of Larry Williams cycle work. Based on Larry’s cycles, a cycle low is expected on March 14th. This just so happens to be the same day as the possible US Government shutdown. Clearly this is but one more point to dent current confidence.
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