January’s strong equity market performance carried over into the first few weeks of February. Since then, we have seen a strong pullback in U.S. equities, despite some modestly good inflation news. One factor is the uncertainty created by the Trump administration’s tariff policies. It is no surprise that Trump would use the threat of tariffs as a negotiating tool (weapon?). However, his on-again/off-again tactics have created problems for businesses, large and small. It’s difficult to invest in growth initiatives when you have no idea what future costs will be. More worrisome is the increasing sense that he favors tariffs as a long-term revenue generator and a means to encourage domestic production by increasing the cost of imports. There is an argument for wanting to level the playing field: other countries impose tariffs on goods imported from the U.S. while they export to the U.S. without penalty. Nonetheless, history has shown that tariffs are not a good idea in the long run as they can be recessionary.
Amid the above uncertainty, GDP growth is slowing. The Atlanta Fed’s GDPNow model pegs the GDP growth rate at -2.1% based on current data. However, the GDPNow model figure is not a prediction of expected Q1 GDP. Certainly, the real (after inflation) GDP growth is expected to be negative. One significant factor in GDP expectations is the impact of imports. The government arrives at the GDP number by adding up all the things we buy—whether by consumers, governments or businesses—and then subtracts out imports. January’s advance report on international trade reported a huge surge in imports for the month, led by industrial supplies. Many importers were presumably trying to get ahead of Trump’s tariff increases. This advance buying could reduce imports in February and lead to better Q2 GDP numbers.
A slowing economy, weakening consumer confidence, some cracks showing in the labor market, the Fed’s continuing higher-for-longer posture and tariff wars are rekindling talk of a recession, perhaps as early as Q4, but more likely, if at all, next year. If Trump’s earlier tax cuts are not extended by Congress, the economic impact on businesses and individual taxpayers would likely increase the possibility of a recession. It would be the largest tax increase ever.
While this uncertainty has added to the current pull back in U.S. stocks, it is not, in my view, the driving factor. The reality is that the market has been overbought for some time, led by the 10 largest tech companies which make up about one-third of the value of the S&P 500. A pullback at some level was inevitable. The tech stocks were trading at earnings multiples driven by unrealistic earnings expectations. One result was that other stocks experienced value increases due to multiple expansion as well. When big tech earnings no longer supported their lofty P/E ratios they, and the market generally, were ready for a fall. The first trigger was China’s DeepSeek AI software bombshell, followed by the tariff war set off by Trump’s tariff threats.
Some of the market sell-off is also driven by massive trading triggered by algorithms that respond to technical market metrics.
There have been two bright spots for investors during this downturn. First, as interest rates have fallen, bond prices have moved up. It’s refreshing to see bond prices not moving in sync with stock prices, which hasn’t been the case in recent years. Secondly, international stocks have done well. Most client portfolios have had modest positive returns for the year, the pull back in the U.S. equity markets, notwithstanding. This highlights the benefits of diversification.
There has been a modest rally since the sharpest drop in the U.S. markets. Some have suggested that this may be a sign that we’re at or near the bottom. That said, further declines are possible given the uncertainty discussed above. Only time will tell.
A planning thought: If you are taking regular income distributions from your portfolio or have mandatory RMD’s, you may want to consider accelerating the distributions for the year. This would secure the income assets at today’s values. The funds can be invested in a money market fund from which you would make withdrawals as needed. If this is of interest, let us know and we’ll work on how to raise the funds.
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