The S&P 500 pulled back roughly another 4% in March, just as it did in February. It is sitting just above “correction” territory - the term we use for a 10% drawdown from the peak. Volatility returned in a big way in the first quarter as there were more up or down days of at least 1% than we experience in full years on average. The narrative driving this volatility is of course tariffs, but also concerning is persistent inflation and weakness in the labor market and slowing economic growth. With inflation already hovering around 2.9% (which is about 50% higher than the Fed target) the fear is that tariffs will throw gasoline on the problem and ignite another bout of soaring inflation like we saw a few years ago. If inflation spikes at the same time as the economy cools and unemployment increases, the Fed will be in a very difficult position since the cure for one illness is the cause of another.
When investors get nervous, they start to make mental notes of levels they are comfortable buying and selling at. It’s a psychological phenomenon and something that has been studied in behavioral economics. We have tools that give us approximations of where these levels are, and they can be helpful for investing and planning. One level (and we noted this here a few months ago) was 4,200 on the Dow. This was the pivot point of the July highs and the November lows. It also happened to be the exact level the Dow bounced off in January. Months ago, we said as long as the Dow is above this level there was very good reason to believe the bull market was still on. It all comes down to supply and demand. Very simply, the data has shown that the demand for stocks is greater than the supply above that level. As I write this, we are just above 4,200 after dipping below several times over the last 3 weeks. Does this mean sell everything and hoard cash? No. But it does mean proceed with caution in the near-term.
The backdrop of macroeconomic insecurity along with indices dipping below key levels of demand has us more discerning of when and where to deploy cash. This is true even with the long-term outlook unchanged. The US economy is still poised to grow at roughly 2% and stocks still offer a better risk-adjusted return over the medium and long-term to bonds and cash. However, we’d like to see volatility subside and risk appetite pick up before we really dive back in. The markets are searching for direction, and many investors are in a wait-and-see mode.
The reasons for worry and pessimism are always well documented in the media. But let’s also look at reasons to be optimistic. Credit it abundant and global growth is gaining steam. Credit spreads are tight, meaning that companies are well capitalized and banks are eager to lend. Markets get into big trouble when lending dries up and money movement freezes. Every economic crisis is really a credit crisis. Secondly, we are seeing actual and predicted growth picking up across the globe. Copper is flashing positive signals and is a major leading indicator of economic growth. It is a vital component in construction, defense industries, cars, wind turbines, power grids, and so on. Copper often sniffs-out growth before it shows up in economies and stocks - and it just hit a new 52-week high. It’s going largely unnoticed because the growth is not being driven by the usual suspects of the US or Europe. It’s the emerging and developing economies doing the heavy lifting, growing at 4.2%. This is more than double the pace of developed countries. The take-away is that if we were really headed for a prolonged economic slowdown, it would be unlikely that global industry would be ramping up and the credit and lending markets would be so healthy.
The US markets, and the tech industry specifically, were due for a period of digestion after the gains we have seen over the past several years. The volatility is warranted and so far we do not see this turning into a crisis. Drawdowns of this magnitude are seen routinely during bull markets.