Data Determination vs. Headline ‘Hell’

SUMMARY

• We believe recent US stock weakness is related to a downturn in US economic data and headline shocks related to tariffs.
• We believe that concern over the economic data downturn is overblown.
• Extreme investor pessimism amid solid corporate earnings should help the market find a near-term bottom, in our view.

While February historically has been one of the worst months for stock market returns, the continuation of February’s selloff in US stocks here in March – juxtaposed against relative strength in some international markets - has our full attention. We believe this recent absolute and relative US weakness is related to the combination of overarching factors:

• A perceived dramatic downturn in US economic data;
• Headline shocks related to trade policy – aka ‘headline hell’;
• Large weighting to technology stocks in US indexes

We tend to view the US’ economic, geopolitical, and technological positioning as a strength (see recent Weekly View on this topic), but we recognize these are currently being called into question by investors. We are taking these concerns seriously, but believe we have not seen enough fundamental or technical deterioration to downgrade our constructive view on US stocks yet.

Downturn in US Economic Data is Likely Exaggerated

For those of us who follow the ‘GDPNow’ forecast- a model designed by the Atlanta Fed to give insight into how US economic growth is progressing ahead of the official GDP release date – the massive drop over the past week has been disconcerting (see blue line on Chart 1 below). Our view is that investors should take this downturn in the GDPNow forecast ‘seriously,’ but not ‘literally.’ Historical actual GDP growth, overlaid in red on Chart 1, suggests that GDPNow is often correct directionally, but not in magnitude.

Note: the GDPNow model has a history of over-extrapolating recession, as it did in mid-2022. The US economy did slow in the summer of 2022… but growth never went negative, as GDPNow predicted. Similarly, our current take is that the US economy is slowing some from a strong Q4, but is not recessionary.

We admit that the chaos of constant tariff rumors and announcements are injecting uncertainty into business and consumer behavior in the US, and we will continue to monitor data closely to see if this uncertainty is translating in concrete ways to an economic downturn that will jeopardize our Base Case. In our analysis, a sizable portion of the major downward revision in GDPNow over the last week stems from a record negative ‘net’ exports (US exports minus imports) reading, along with a drop in manufacturing new orders and a rise in inventories. The net exports and the inventory build are likely being driven by businesses and consumers ‘front-running’ the purchase of materials and goods to get ahead of potential tariffs. In particular, news outlets have reported a large number of investors swapping domiciles for holdings of gold from Europe to the US… a distortion caused more by political factors than by any fundamental change in underlying economics, in our opinion. We expect these negative impacts to reverse over time.

Another chunk of the downward revision to GDPNow was related to personal consumption, employment claims and construction data. Major inclement weather (as well as devastating wildfires in CA) occurred this year, so we suspect this impacted both consumption and employment in a way that is not necessarily indicative of a broader underlying trend…especially as these data points were particularly strong late last year. Alternative data points we track related to the consumer and the jobs market look healthier, in our view. In addition, recently released US manufacturing and services survey data broadly point to a continued mild economic expansion, in our view.

Bottom Line: In our 2025 Outlook, our highest probability ‘Base Case’ is that US economic growth will generally remain positive this year… powering corporate earnings growth and thus stock prices higher. We are not ready to abandon that view yet, especially as recent earnings results have corroborated this positive story, in our opinion.

Chart 2: Extreme Investor Pessimism Should Provide Near-Term Support

It is no secret that technology companies are a dominant force in US markets. With questions raised around global AI tech spending in light of China’s deteriorating trade relationship with the US (President Trump doubled tariffs on all Chinese imports to 20% last week, and China responded with retaliatory tariffs of their own) tech strength has become a weakness for US stocks this year. The S&P 500’s 30%+ weighting to tech and tech-adjacent sectors -including the ‘Magnificent 7’ - has contributed a significant share of the negative performance differential year-to-date between the US and international markets like Europe. However, when the dust settles, we continue to believe that tech companies’ continued positive earnings and cash flow will persist, providing a floor for tech shares…as we discussed last week in our Earnings Recap.

Notably, investor sentiment on the tech-heavy S&P 500 is now starting to hit the types of pessimistic extremes that have tended to mark near-term lows, in our opinion. For instance, the NDR Daily Trading Sentiment Composite (Chart 2, above) – one of the inputs into our ‘Beware the Crowd at Extremes’ indicator we wrote about here on February 4 - hit a reading of below 18 on Wednesday. This is among the lowest of all readings historically, going back to 1994, and represents a level similar to where the S&P 500 bottomed at the end of the last cyclical bear market in October 2022.

Risk Management Alert: Technical Support Levels We Are Watching

In terms of a technical ‘message of markets,’ we are viewing the recent weakness thus far as ‘noise’ and do not yet believe the US bull market is broken. The overall market trend (which we define as the direction of the slope of the S&P 500’s 200-day moving average – aka 200DMA - green dotted line, Chart 3, right) remains positive, though we note that the market has been flirting with falling below the 200DMA at around 5700. A definitive break below the 200DMA would be a potential sign that we may remain in choppy markets for the foreseeable future.

Healthy bull markets periodically experience pullbacks, which tend to moderate excessive optimism and can provide a solid foundation for future gains. Starting from the most recent uptrend that began after the last double-digit correction in 2023, we consider the 5650 level, a 23% retracement of the recent uptrend, as a minimum retracement level for a typical pullback, and would expect the market to find some support around or above this level. From a risk management perspective, secondary support in our view exists at the 38% retracement level around 5350. A significant breach of these levels would represent an official ‘correction’ (i.e., more than -10% drop from the peak) for the S&P 500 and a warning signal to us to expect further near-term weakness.

Risk Discussion: All investments in securities, including the strategies discussed above, include a risk of loss of principal (invested amount) and any profits that have not been realized. Markets fluctuate substantially over time, and have experienced increased volatility in recent years due to global and domestic economic events. Performance of any investment is not guaranteed. In a rising interest rate environment, the value of fixed-income securities generally declines. Diversification does not guarantee a profit or protect against a loss. Investments in international and emerging markets securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. Please see the end of this publication for more disclosures.