The first quarter of 2025 definitely had its highs and lows. The S&P 500 hit an all-time high on February 19 but then fell into correction territory over the course of the next several weeks.
The stock market’s thinking heading into 2025 was that the outlook for the future was positive. Specifically, investors anticipated that economic activity would be improving under the new Trump administration as it pushed for tax cuts and deregulation. The problem is that the administration needs to work with Congress (an arduous process) on tax cuts but can act independently to impose tariffs and cut wasteful government spending. This caused tax cuts to be placed on the back burner while tariffs and spending cuts have been pulled forward on the list of policy priorities.
The sudden reversal in the market was precipitated by Trump’s announcement that tariffs would go into place against Canada, Mexico and China in March. This led to a “risk-off” move that included the unwinding of the AI trade and a stark sell-off in the “Magnificent 7.” This occurred at a time when US Treasury yields were falling, which was a reflection of the market’s fear that a tariff war could spark a recession.
The market pullback has led to a compression in P/E multiples as stock prices plummeted while a bit surprisingly the earnings estimate for 2025 stayed remarkably stable. How to interpret this? This incongruence could mean that the correction in prices is due to a stock market that had been overvalued state or perhaps in a bubble (AI?). A more pessimistic interpretation is that the market is moving ahead of a weakening economy that will eventually bring down earnings estimates.
Meanwhile, European and Asian equity markets are posting robust gains, but is this logical? If the world’s premiere economy falls into recession due to a trade war with other leading economies, wouldn’t this affect the global economy?
Consider that Fed Chairman Jerome Powell observed recently that the “hard data” is still indicative of a healthy economy and and is not reflecting the weakening levels of consumer and business confidence that have been apparent in “soft” survey data. In other words, what consumers and businesses are saying isn’t matching up with what they are doing. They have been more negative with their thinking than with their spending.
Could this mean that earnings results over the next couple of quarters are likely to be better than feared? If so, this market can recover its losses and possibly move to new highs.
Date of report: March 31st 2025