The overall technical picture seems to be changing by the day, if not the minute, following alongside overall tariff expectations media tweets. Like a game of tennis sending a ball back and forth across the court, recent action has sent markets up and down… complicating the overall technical picture as we move just two weeks into the month of April. While markets may be changing, one thing is for certain- a reliance on protecting assets instead of growing them has become paramount. With that said, remembering the importance of building (and sticking to) a process can help provide context and clarity when the going gets tough. After all, your journey is not a straight line like it often seems like when times are good. There are several peaks, valleys and other obstacles along the way. So, before I get into the meat of the newsletter for the week, I thought I would show a graphic of what our plan is and how the plan plays out. Please feel free to use this for anything in life!
This week I felt that it was important to give a clear idea of what major issues I consider in evaluating the next course of action for the financial markets. Every cycle has a different set of hot points, but at present, these are what I have top of mind. In evaluating the markets for the next expected action, four major components come to my mind:
- The current turmoil that exists in the political arena. This seems to be focused on the tariffs, but also the Ukraine / Russia conflict, nuclear weapons in Iran, DOGE and immigration.
- Historically I look at what we could expect the markets to do based on an analysis historically of what has been happening to see if there have been previous examples of market action like we are seeing and what has happened subsequently.
- There have been 20 “bear cycles” since 1950. In examining how the markets have acted after a major decline might give us guidance on what we could expect this time.
- Given that we have hit extremes in the market in the most recent pullback, how does this one look verses previous, and can we glean anything from it.
Current turmoil:
I will take just a moment and talk about the tariff issue. It appears that every media pundit has their own interpretation of what is really going on with the tariffs, but almost all seem to be bashing the Trump administration saying that the action is either wrong or has been handled all wrong. I believe that due to the negotiation tactics the president employs, this could be a lot of noise about countries that have very little effect on US trade and that he is almost entirely focused on China and how to equalize trade imbalances with them. Due to this being a very unconventional style of negotiation and an almost impossible variable for market strategists to quantify, it is creating an overly large level of stress on the markets. In looking at the goods imports from China, NDR Research provided a great graphic on total goods imported up to the 2018 tariff in Trump’s first administration, and how they have progressed to today:
I believe that this is another reason for the severity of the pullback that was experienced since late February. I believe it needs to be understood that this pullback due to tariffs was not the expected economic effects- since these really can’t be measured, but more importantly that the markets don’t like what they can’t understand or quantify.
President Trump, his style and tariffs in general, collectively, are far from quantifiable! So, in classic Trump style, he pulls a rabbit out of a hat last Wednesday and says that he is going to allow the negotiations to happen for the next 90 days before imposing the trade jarring tariffs. Then, over the weekend, he says that he is going to reverse the tariffs on certain technological goods like phones, computers, semiconductors, and other electronics. This is again, another quasi rabbit out of the hat. This is also a set of good signs for the economy if companies don’t need to completely redirect their momentum at this moment.
U.S. consumer sentiment continues to drop. The Reuters/University of Michigan Consumer Sentiment Index slumped in the April survey. It was the fourth decline in a row, taking the index to its lowest level since June 2022, which was a record low. To put this in another perspective, by this measure, consumer sentiment is now worse than during the Covid shutdown and the Global Financial Crisis. Its steep decline from a year ago implies a downside risk to consumer spending and overall economic growth in the near-term. But if there should be any settling in the tariff negotiation, this consumption could heat back up to make up for lost time.
We are also noticing a lot of traction in moving to a cease fire in the Ukraine, and talks opening up between the US and Iran concerning their nuclear arsenal. These two major international issues if solved could ease international tensions, but probably not do a lot to change the overall equity markets.
Historical similarities:
Historical perspective is the concrete evidence of what has happened before. The most recent one is what happens in the first quarter of the first year of a new president’s tenure. As I have shown, this tends to be quite a bad time. I believe that “this time” is even worse due to the fact that it comes on the tail end of a 2 1/2 year up move in the markets. Also, on a valuation basis many parts of the market are considered overvalued. This has been said to be a reason for far greater decline to possibly be in the future. And the overconcentration in a select few companies that make up an inordinately large percentage of the indexes and mutual funds probably needed a reason to let off some steam. The statistics that I have placed in recent newsletters that I feel are very important to consider are:
Another set of historical statistics were presented in the last two weeks where I showed what happens when there are two back-to-back days of over 5% down and what happens subsequently a year later. This high probability outcome has been impervious to the reasons why this time the market has declined.
The next one is the history of the starts of new presidential terms going all the way back to 1928. This is what the first year looks like with an emphasis on the first quarter (circled in yellow):
The last one is the one that shows what tends to happen since 1950 when the correction is very fast. 6 out of 6 times the market has been higher:
“Bear cycles” since 1950:
The next thing that I evaluate is where the market is in the current progression. This is when we try and overlay the current market decline with past market declines and try and consider the economic backdrop as well. It should be noted that this decline has happened during an economic expansion. We have full employment and rising wages. We also have inflation, but not accelerating inflation. Also, we are in an interest rate loosening cycle from the Fed.
This is a really important set of circumstances as far as I see it. The decline should be a “cyclical decline in an overall secular bull market.” This is connotated as our equity markets are still in an upward progression, but that the current action is a temporary contraction within this upward progression. There can be many different cycles within a longer-term secular move. The current move from the February 19th all-time high in the index has now been followed by an extreme in the short-term decline as evidenced by the tables above. How much of a recovery after this decline is yet to be determined, but a recovery all the same should be expected given that the economy is still quite healthy. This is measured by economic statistics and individual corporate earnings. Last week we ended with the earnings for the first quarter from the money center banks of the US. They came in above expectations and guided higher.
Given that the markets have been on the defensive, banks could have easily played into this and presented a very guarded forecast for their future, but they did not. Instead, they forecasted above what the street expectations were. I find this a good sign. For this reason, I referenced the “V bottoms” of previous declines in last week’s note. For many, the next action that could be expected is another decline after the bounce we have seen over the last few days. This would infer a type of “W bottom.” W’s occur when the market experiences more selling and a decline down to or exceeding the previous decline. What could be really frustrating, is if this “W” is to take months or even sometimes years to happen!
We believe 2025 weakness is occurring within the context of a larger secular advance similar to the 1960’s and 1990’s. Remember, in the 1990’s, prior to the “Tech Wreck” of 2000, technology hit a bubble type of high. We have not seen this in the up move since October 2022. What I will be on the lookout for is fewer stocks falling if and when this takes place. This could imply that the velocity of the decline has waned. We are considering this pullback to be a form of a cyclical reset of sorts. This is when the leaders take a breather, but don’t break.
Current market hitting extremes
The research that I do every morning is one to measure where we are on a continuum and particularly when we hit an extreme. As seen below, my work shows extremes (highlighted in yellow) that have hit the same levels as the Great Financial Crisis, and COVID. I will not be able to tell you if the current tariff issues will have lasting effects as the Financial Crisis and COVID did, but I don’t think this will be the case. As a result, I further believe this to be a cyclical action that we are observing:
Beyond my work, and consistent with a widely followed statistic of market analysts, is the study of the VIX. The VIX is the broadest measure of volatility in the markets and when markets go down quickly, the VIX spikes. Here is the measure of the current market and past VIX spikes. I have noted the Great Financial Crisis and COVID as well for graphic comparison:
The next things that I look at are what other financial markets are doing. The first is the international stock markets. When we started the year, we were on the end of 16 years of outperformance to foreign markets. So, I don’t find it a shock that they would bounce when the air came out of the balloon of US markets in this first quarter. Next, I look at interest rates and the US Dollar. This last week we saw the fastest up move in 10-year US Treasury interest rates in a week in over 70 years. Did this happen due to a change in the perceived credit quality of US bonds? Did it come due to the expectation of greater inflation for many reasons? Or did it happen as a source of funds were needed to put back into US stocks when they could be considered short-term “on sale?” We really won’t know the answer to this for some time, but I think there could be another reason. This move in interest rates happened at the same time as the US Dollar exchange rate dropped very aggressively. It makes me wonder if due to the rest of the world not quite knowing how to evaluate the tariff effects if large amounts of US Dollar denominated debt and US Dollars in general were sold and repatriated into their local currencies as a safety measure. Again, this is very uncommon, difficult to quantify, and abrupt. In the end, I still believe that the US economy is the strongest one for a number of reasons and that foreign trade, although upset by tariffs, is still highly dependent on US consumption.
What I gather from this is that this short-term rally in foreign stock markets should be reversed. If the capital is then needing to be committed to stocks it should come back into US stocks. Also, given US Dollar weakness and higher interest rates, US Dollar denominated debt is now more attractive. Since our economy is not in a contraction, there is a large amount of money that could benefit from this short-term spike in interest rates. Technology has led this week after having found support, and it seems encouraging that many of the Mag 7 companies have reaffirmed their Cap-ex guidance for 2025. Thus, despite all the negative sentiment surrounding tariffs, some of the largest Technology companies in the US are not really "pulling in the reins". Financials are also rebounding sharply on good bank strength and given that this is the 2nd largest group within SPX, its strength is importantly contributing.
We just had one of the best weeks for US equities since 2023 in the face of tariffs and market decline. I think this is interesting in a lot of respects; a lot of strategists and pundits have turned negative on the economy and further economic strength saying the economy is going into recession. I find this interesting when major technology companies have reconfirmed their capex guidance for the year. This tends to be a very good testament for technology and the Mag 7 in general. This means that the top two most highly weighted sectors of the S&P; technology and financials not only came with good earnings but also good relative performance.
This all seems like quite a lot this week. It is a lot, but a lot has been going on. Please take the time to review this material and take a look at your own portfolios. This is a very interesting time and one to pay attention to.
-Ken South, Tower 68 Financial Advisors, Newport Beach
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