Why Have Stocks Dropped?
Stocks started the new year the same way they ended 2024, with declines as the pullback reached a third week and the peak-to-trough decline in the S&P 500 from the highs near 6,100 reached nearly 5%.
While most of this selloff has been downplayed as just year-end rebalancing and positioning, and to a point that’s true, there are also legitimate reasons that stocks have declined since mid-December and I’d caution you against totally dismissing the uptick in volatility.
There are two main reasons this has occurred: First, the Fed. Second, politics. Starting with the Fed, the December FOMC meeting was important and the impacts of it are still being felt. Obviously, the FOMC reduced the number of expected rate cuts in 2025 to two from four. That’s clearly less dovish than what was expected.
But the bigger issue has been the language changes and Fed commentary that has, intentionally or not, birthed the idea in some investors’ minds that the Fed may be done with rate cuts and that they’ve “paused” and the rest of the market just doesn’t realize it yet. At a minimum, it’s made the markets very sensitive to any economic data that doesn’t warrant additional rate cuts (as we saw again this past week).
Put more plainly, until that December meeting, solid economic data was seen as reinforcing a soft landing (so positive for stocks). Now, solid data is seen as bolstering the case for a Fed pause (not a market positive).
Turning to politics, the S&P 500 had surrendered virtually all of the post-election gains at last week’s lows and the reason is simple: Unforced communication errors and typical Trump-related headline volatility have under-mined confidence that Republicans can actually execute on a pro-growth agenda of deregulation and tax cuts.
Starting with the Gaetz AG nomination, followed by predictable tweeted tariff threats against Mexico, Canada, China and the BRICs, which were then followed by threats about seizing the Panama Canal and, finally, the last-minute government shutdown drama have all combined to chip away at post-election enthusiasm.
Friday’s relatively easy election of Johnson as Speaker will reduce some of the policy anxiety but the coming month has a lot of early tests for Republican cohesiveness (including cabinet confirmation hearings) and it’s going to take more than quickly electing a Speaker before markets become more confident in the actual implementation of the pro-growth agenda.
Bottom line, part of this late-year/start-of-year market dip is due to positioning and rebalancing but it’s also due to negative events. To be clear, these are not the type of events that would derail the rally, but they are the type that make investors paying 22X forward earnings re-think those choices, as the near-term outlook has become legitimately less positive.
So, for this to stop, we need to see 1) The Fed reinstall confidence in the markets that it wants to cut rates (and isn’t about to pause) and 2) Republicans and Trump administration stop the distracting drama, act cohesively and give the market confidence they’ll actually be able to quickly execute on a pro-growth agenda. Until those two things happen, we should expect the road higher in stocks to be tougher climb than we saw in 2024…at least for the short term.
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