By Pete Biebel, Senior Vice President, Senior Investment Strategist
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That mighty vessel, the U.S.S. Stock Market, has been steaming steadily northward for most of the past 15 years. Much of the market’s progress during that stretch was fueled by essentially free money. Artificially low interest rates and generous federal handouts during the pandemic were tailwinds that kept the voyage afloat and greatly increased corporate earnings generally and the valuations of tech stocks in particular. Those tailwinds also increased the valuations of real estate, fine art, collector cars, precious metals and many other asset categories. But following a couple years of especially smooth sailing in 2023 and 2024, the market has encountered a bit of a squall as it sets sail in the first months of 2025.
That pleasant voyage might have ended several months ago, but November’s election results put new wind in her sails. The new administration brought promises of reduced regulatory burdens, fairer trade policies, lower taxes and reduced government. Investors drank up those promises like pina coladas on a Hawaiian booze cruise. The major averages climbed to very near or above their previous record highs early in the year. But just like on a booze cruise, the free cocktail of easy money feels great while it lasts, but at some point, it must end, and there may be a hangover that follows.
The market has suffered a shot across the bow in recent weeks. The averages began taking on water in mid-February and seem to have run aground through the first half of March. SPX and the NASDAQ Composite Index (COMP) have had four consecutive losing weeks. All the major averages are now below their 200-day moving averages. Last week, SPX fell 2.27%; it has lost more than 6% over the past five weeks and is now more than 4% in the red year-to-date (YTD). COMP is now down a bit more than 8% YTD after losing a bit more than 9% over the past five weeks including a 2.43% loss last week. The Dow Jones Industrial Average (DJIA) has done a better job of treading water, and though it fell about 3% last week, its YTD loss is a mere 2.48%. At the other end of the spectrum, the small-cap Russell 2000 Index (RUT) has been keel-hauled. RUT has lost more than 10% in the past five weeks, and despite only sinking 1.49% last week, RUT has lost more than 8% in 2025.
Two of the S&P industrial sectors that had buoyed the market during its 2023/2024 pleasure cruise, technology and consumer discretionary, have been anchors YTD. Tech is down about 8% YTD, all of which was lost in the past five weeks. The consumer discretionary sector is now more than 12% under water in 2025; all of the loss has come in the past five weeks. So far, only two other sectors are in the red for the year: communication services (-0.24%) and industrials (-0.48%). The YTD leaders among those sectors that are still afloat are healthcare (+5.35% YTD), energy (+4.79%) and utilities (+4.11%). Meanwhile, non-U.S. equity sectors, especially dollar-sensitive sectors, have had a great year in the past two and a half months. International equites, both developed and emerging, along with some commodities, are at the top of the list.
Many commentators are quick to blame the new administration for rocking the boat. There’s no doubt that the on-again, off-again policy pronouncements have business leaders and investors confused. But those policies weren’t the market’s iceberg. They were mere catalysts that made investors realize that, in a very richly valued market, any economic or political developments that might cause reductions in future earnings estimates could pull the plug on stocks. Investors looked toward the horizon and saw a heightened potential for slower growth and/or increased inflation and/or higher interest rates.
If you’re looking for someone to blame, take a look at hedge funds. Early last week, Goldman Sachs reported that the recent flight from risk by hedge funds was the largest they had recorded in four years. As you might expect, much of the hedge fund selling was concentrated in some of the more widely held stocks. That would explain the large losses in many of the mega-cap tech and chip stocks. Per the Goldman report, “We have started to see large and broad-based risk unwinds… Our best guess is that we are currently in the middle innings of this episode.”
Some of the recent economic data might also be blamed for muddying the waters. Jobs growth has been uninspiring. The Purchasing Managers’ Index (PMI) indicated that recent growth in manufacturing has been fueled by prices spiking to the highest level since 2022. Last week’s Consumer Price Index (CPI) and Producer Price Index (PPI) reports showed a slight softening of inflation, but the bond market didn’t care. Even with the more favorable data, bond prices fell, and yields increased. The University of Michigan’s survey disclosed that consumer sentiment in the past month sank the index from 64.7 to 57.9. And the National Federation of Independent Business (NFIB) survey of small-business optimism indicated that uncertainty among small business owners reached its second-highest level in more than 50 years.
Throughout the second half of 2024, we repeatedly expressed concern about the market’s very rich valuation. We pointed to metrics like the “Buffet Indicator,” which is the ratio of market capitalization to gross domestic product. That indicator topped out in 1999 and 2008; it has been hovering above those peaks and at its highest level ever. The Shiller CAPE ratio is a price-to-earnings ratio of current valuations to a 10-year average of earnings. It too has been signaling an overvalued market. And we explained how the market’s prevailing equity risk premium (the stock market’s earnings yield versus the safe harbor, risk-free rates available in government notes and bonds) implied poorer expected future returns in stocks relative to bonds. Those indicators implied that we should expect substandard returns in the stock market in the years ahead, not necessarily a major pullback, but probably less upside.
Back in mid-October, we quoted a Goldman Sachs report that projected the S&P 500 Index (SPX) would have an average total return (with dividends) of about 3% on a nominal basis, or just 1% adjusted for expected inflation. That report went on to suggest that SPX had a 72% probability of underperforming bonds over the next 10 years, and a 33% probability of lagging inflation.
The voyage forward may be less rewarding than the last couple years has been, but that doesn’t mean it has to be excessively painful. Despite the recent setback, most investors are still ahead of where they were a year ago. The last two times that the market was so richly valued (1999 and 2008) came at the end of the dot-com bubble and the housing bubble. The bear markets that followed those bubbles had to work off the extreme excesses that had built up. That doesn’t seem to be the case this time.
Currently, the biggest potential risk is the federal debt bubble. For months I have cautioned investors to keep an eye on the 10-year Treasury note yield. If any combination of increased long-maturity Treasury issuance and increasing inflation cause the 10-year Treasury note yield to increase much beyond the recent highs, that would be an added negative for equities. In fact, if market pressures force that yield above 5%, then things could get worse in several respects. Inflation would likely increase; economic growth would likely decrease; and estimates for future corporate earnings would likely decrease.
Many investors may be feeling that they missed their big opportunity to “buy the dip” following the big rebound rally on Friday. I suspect the odds are that they’ll have at least a couple more chances. The technical condition of the market is very weak. The Friday bounce reduced but didn’t eliminate the negative momentum. Given the steepness of the decline, any retracement rally through the vacuum left over the past couple weeks will look impressive but will probably be followed by a lower low.
In my most recent commentary, Fourth and Goal, I wrote that for SPX, “Falling below the 50-day would shift momentum to the bears. Below that, the critical level is 5924, last Monday’s low. Sustained trading below that level would strongly indicate that the market had seen a significant intermediate-term high.” SPX dropped below that level in late February, then fell below the more critical 5800 level early this month. Last week the index hit a low of just above 5500 before the big Friday rebound. SPX ended last week at 5639, about 100 points or about 2% below its 200-day moving average (5740ish). A further rebound rally should easily climb into the 5750 – 5800 range. SPX is unlikely to get back to the 5900 level anytime soon. If the index takes out last week’s low in the weeks ahead, then the next likely downside target would be in the 5300 area.
It will be all hands on deck for the Federal Open Market Committee (FOMC) policy statement and Chairman Powell’s press conference on Wednesday afternoon. The market’s past hypersensitivity to these pronouncements will likely be more subdued this time around due to the more immediate influences of the market’s technical condition. Note also that the first quadruple expiration of futures and options on stocks and indices will cause a big spike in volume on Friday.
Happy St. Patrick’s Day!
| Economic Calendar (3/17/25 – 3/21/25) |
Previous |
Consensus |
|
| Monday 3/17/2025 | U.S. Retail Sales, February, M/M | -0.9% | +0.6% |
| Retail Sales less Autos, February, M/M | -0.4% | +0.3% | |
| Empire State Manufacturing Survey, March | 5.7 | -1.8 | |
| Business Inventories, January, M/M | -0.2% | +.03% | |
| Home Builder Confidence Index, March | 42 | 42 | |
| Tuesday 3/18/2025 | Housing Starts, February, SAAR | 1.37mm | 1.38mm |
| Building Permits, February, SAAR | 1.48mm | 1.45mm | |
| Import Price Index, February, M/M | +0.3% | -0.2% | |
| Industrial Production, February, M/M | +0.5% | +0.3% | |
| Wednesday 3/19/2025 | FOMC Policy Announcement | ||
| Fed Chair Powell Press Conference | |||
| Thursday 3/20/2025 | Initial Jobless Claims | 220K | 222K |
| Continuing Claims | 1,870K | 1,888K | |
| Philadelphia Fed Manufacturing Index, March | 18.1 | 12.0 | |
| Existing Home Sales, February, SAAR | 4.08mm | 3.97mm | |
| U.S. Leading Economic Indicators, February, M/M | +0.3% | -0.2% | |
| Friday 3/21/2025 | No Reports Scheduled | ||
| First Quadruple Expiration of 2025, Options & Futures on Stocks and Indices Expire | |||
Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Market Commentary/Market