Playing With Fire, As A Correction Ensues

The major market indexes attempted to rebound after Friday’s dramatic selloff, but those hopes were dashed in the late afternoon when President Trump reiterated his intentions to go ahead with tariffs on Mexican and Canadian imports next month, despite efforts by both to meet his demands. Officials also asserted that reciprocal tariffs to be placed on all trading partners, including Mexico and Canada, were on schedule for April. Then we have 25% tariffs on pharmaceuticals, semiconductors, and autos scheduled for April, as well as an increase to 25% on steel and aluminum to begin March 12. Our trading partners around the world appear to be working in concert with a coordinated response in retaliation. Unless this is simply more theatrics from the Trump administration, it appears the trade war is on. No one wins a trade war, and the biggest losers are lower- and middle-income households.

The foundation of our economic expansion and the vitality of the American consumer is about to be tested mightily. Consumer and business sentiment has already cracked. We are starting to see disappointments in the high-frequency economic data, which is leading to lower estimates for GDP and corporate profits in the first quarter. The implementation of all the tariffs, as advertised, will only exacerbate the negative rates of change. Perhaps we were due for another pullback in the major market indexes after the S&P 500 reached a new all-time high last week and these developments are the convenient reason for it. Yet, I think the president is playing with fire at a time when a pullback could turn into a correction that could turn into something worse if he doesn’t rethink the timing of his fiscal policy implementation.

The S&P 500 has remained in a tight 4% range since the election with a brief breakout last week to a new all-time high that failed to hold for obvious reasons. Given the news flow, it seems almost certain that we will test the lower end of this range at approximately 5,800, which will come close to testing the 200-day moving average. That would be a 6-7% pullback from the all-time high and approximately 4% from yesterday’s close. It sounds relatively modest, especially compared to last summer’s nearly 10% decline in July. Still, it is concerning to me because of the reasons for the decline.

If the threat of punitive tariffs can damage consumer sentiment to the extent it already has, as well as impact consumer and business spending, the implementation of those tariffs would be far worse. If consumer spending stalls, then we will start to see deterioration in the labor market, compounding the efforts by DOGE to cut spending and reduce the size of the federal government’s workforce. If stock prices fall, that can also adversely impact consumer spending, as we know that the top 10% now account for approximately half of all spending, and they are the investor class.

This can have a snowball effect, which I don’t think Trump administration officials have had the courage to relay to the president. A meaningful downturn in the economy and market is a prescription for undermining the rest of the Trump administration’s agenda. Unfortunately, I think investors will have to suffer some near-term pain to get that message across.

Once it does, we are still likely to remain range bound, as sector rotation continues. As if the technology sector needed another headwind, earnings growth for the Magnificent 7 is decelerating sharply from 2024 to 2025, which has resulted in the sector falling from first in 2024 to last so far this year. That comes as no surprise, but the significant weighting these companies have in the S&P 500 will limit the upside for the index this year, as earnings catch up with what are still expensive stock prices. I still prefer the equal-weighted index.

Lastly, as concerning as my tone may be, I am still assuming that this is a pullback to the correction phase for the market and not an end to its bull run or economic expansion. Corrections of 10% or more have almost always been a function of the Federal Reserve tightening monetary policy or remaining too tight for too long. Today, we have a Fed that is poised to ease again as soon as we make more progress on inflation. That should be a meaningful counterbalance to the Trump administration’s policies if needed.

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