Stocks dropped last week, but that was mostly in response to Fed Chair Powell’s warning on tariffs. But ignoring that, the actual news last week was positive. First, there was more backdown on tariffs, as the tariff exemptions on electronics from China is a de-escalation and will reduce the negative impact on the economy.
Second, the Q1 earnings season has started well (and much better than feared). Numerous companies from differing industries (AXP, BAC, UAL, TSM) posted solid results and largely held guidance intact, showing us activity didn’t collapse in Q1 despite the policy volatility.
Third, economic data remained solid, also pushing back against slowdown fears. Retail sales were fine, while jobless claims remained historically low. Bottom line, news over the past two weeks has been positive and given still deeply skeptical sentiment and investor nervousness (something we highlighted in recent sentiment readings), the ingredients are in place for another near-term rally (if we get additional good news).
However, despite that positive set up, I still think the S&P 500 will be unable to sustain a rally to (and beyond) 5,500-ish. Conversely, unless we have a material negative surprise, the S&P 500 shouldn’t trade far below 5,000-ish, and here’s why. First, cutting through the tariff noise, the reality is that tariffs are much higher than they were at the start of the year (at a minimum, there are 10% blanket tariffs on imports). That will boost inflation, complicate the Fed’s strategy, pressure earnings and possibly restrain consumer spending. The only question is how much.
Second, policy chaos hasn’t slowed down. Sure, the chaos has tilted a bit more positively in the last two weeks, but it’s still chaotic. Third, the longer tariffs and policy chaos remain in place, the worse it will be for growth and the markets (so we are just in the beginning innings of the impacts). Finally, there is a new risk to worry about: A conflict between Fed Chair Powell and President Trump. If Trump tries to remove Powell and Powell refuses, a Constitutional debate will erupt and that will further erode market confidence.
Bottom line, these factors limit the upside in this market, in my opinion. The past few weeks has showed us that if the market starts to come apart, Trump will back off of tariffs. That implies a backstop of sorts in the markets (at least for now). Second, corporate America and the U.S. economy has earned the benefit of the doubt. This will be the third time in the last five years that analysts have issued dire warnings on growth and earnings (Covid and when the Fed hiked rates). Both times, they underestimated the strength of corporate America and the U.S. economy. Perhaps the third time will be the charm, but so far, data and earnings are proving resilient in the face of unprecedented uncertainty.
Bottom line, I believe this rangebound market between 5,000-5,500-ish continues to favor maintaining defensive long positions. That is why we are 50% value/fixed income. Given this environment, I think they can continue to outperform or create a backstop for further moves down. I don’t expect to maintain these positions for long but probably until mid year. The markets are still biased to the upside for the year, we just have to get beyond the uncertainty to realize the growth potential for the markets.
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