Almost there

Regular readers of this space know that since the beginning of this year, despite our longer-term bullishness on the equity market, we’ve been concerned about an emerging soft patch in the economy and with it, a stock market correction. With the longer-term bull case not only intact but reinforced by President Trump’s growth agenda, we’ve held to our modest equity overweights despite our near-term worries (see Strapped to the mast). At the same time, we’ve been holding back cash reserves for another add in a correction, should it come. That correction is now fully upon us, though for now, we’re holding our powder dry for a deeper pull back. Said differently, we don’t think we’re quite yet through the Straits of the Sirens. Call us “almost there.”

Uncertainty around tariff policies is impacting the real economy and investors alike. Both real economy businesses and stock market investors share one common trait: they like to know the rules of the road. When they don’t, they hesitate to commit major pools of capital. So, the present pull back in the economy and market is not surprising. The somewhat volatile Atlanta FedNOW model, an indicator of “real time” economic activity, recently plummeted to worse than -2% for the first quarter. While that is likely influenced by importers front-running tariffs, it is not the only economic indicator softening right now. Retail sales were quite weak for January, printing at -0.8% for the control group and existing home sales currently sit at their lowest level since the Global Financial Crisis. As we watch daily the “sausage making” of trade policy, the end game, as Treasury Secretary Scott Bessent put it recently, is “path dependent.” And as a result, businesses and investors for now don’t have a base case against which to calculate future returns on investment. This uncertainty is by definition creating a pause in activity, and we think for sure a slowdown—maybe even a negative quarter-over-quarter GDP print for Q1—is upon us.

Jobs market is softening. Even as businesses are hesitating to invest, the efforts of DOGE to attack government inefficiency may be roiling the jobs market. The government has announced close to 30,000 federal layoffs so far, with another 70,000 employees taking a buyout for later this fall. Private companies are also following this efficiency drive, and some, such as the consulting industry, are likely to magnify the impact of the federal-level cuts. Last week’s Challenger Jobs Cuts data for February saw over 172,000 involuntary separations announced—its highest non-recession reading since 2003—and a whopping 103% increase from last year. Nonfarm payrolls might still be holding strong, but last month’s reading of 151,000 jobs added was the slowest add in the last four months.

The Fed put is alive, but at lower levels. One positive of the current soft patch is that unlike previous economic pullbacks of recent memory, the Federal Reserve this time around has plenty of room to cut rates and stimulate the economy. Chairman Jerome Powell’s comments last Friday reminded the markets of this, and as ambiguously as he stated this, the hint alone was enough to spark a short-term rally. The Federated Hermes macro team has short rates over the next two years dropping to 3.0%, 50 basis points above our projected stable inflation rate. This implies 150 basis points of cuts ahead, and the markets last week moved quickly from a consensus of one cut in 2025 to three. Although the US economy is less interest-rate sensitive than it was 20 years ago, there are still sectors out there that would be disproportionately impacted in a positive way if and when the Fed restarts the cutting cycle: housing, small caps and financials. These are all areas of the market that have been hit hard since the euphoria over Trump’s election win began wearing off in mid-January.

Trump is more of a call than a put. Trump’s remarkable interview with Maria Bartiromo on Fox News over the weekend has the markets all in a tizzy. Of particular concern was his reply to her pointed question about the worries of stock investors over his tariff negotiations; in short, he told her, “No pain, no gain.” More specifically, the president calmly stated that some near-term market disruption was likely, and even necessary, to effect positive long-term changes in the structure of world trade, something we’ve been highlighting as a “sausage-making” risk for some time now. For better or worse, Trump’s statements over the weekend have reinforced our view that his policy agenda represents more of a long-term call option than a short-term put option for markets. Said differently, if Trump stays the course on his supply-side, growth-oriented policy agenda, despite short-term market disruptions, he’s likely counting on the forward potential value being created (the call option on growth) as itself drawing in stock market buyers at some point, particularly should the market plumb lower levels from here. Count us as in that camp of likely buyers.

Corrections are long-term healthy. The markets of late have been a one-way street, and in fact have not experienced as much as a 10% correction in 16 months now. As the most experienced market hands will tell you, these kinds of one-way markets are not healthy in the long term, as they inevitably lead to risks being mispriced and eventually to excess conditions that can only be corrected by a more severe downturn. So generally speaking, corrections of 10-15% are healthy for the longer-term bull to stay fresh, pushing out the weak hands and restoring value in equities. The current run of 16 months without a 10% correction is actually a bit shorter than the average such run (18 months), implying that a pullback of that size would be welcome and far from fatal. Internally, our target to add further to stocks has been 5,400 on the S&P 500, implying a fairly “normal” 12% pullback.

The banking system appears secure. One factor that can often turn a run-of-the-mill soft patch into a deeper recession is the banking system. It is the fuel that keeps the economy running, and when a soft patch happens within a weakened banking sector, banks don’t have the capacity to step in and extend credit to borrowers who find themselves in a temporary squeeze. Fortunately, in the present circumstances, the banking system appears sound and if anything, over-capitalized. All the key indicators we watch—capital ratios, loan default rates and loss reserves—are flashing green. Credit derivative markets and the diffusion indicators we track similarly suggest that credit remains readily available in the market and is far from freezing up.

Foreign economies are emerging from a multi-year slowdown. Another key positive of the current situation is the foreign markets. Until now, the US has been virtually the only locomotive pulling the global economic train, with China and Europe in particular stuck in prolonged periods of below-trend growth. One irony of Trump’s pro-America agenda has been that it seems to be spurring government leaders on both continents toward stimulating their moribund economies to offset the pressure coming from Washington. Last week, we had the announcement in Germany around lifting deficit-spending limits; and in China, the People’s Congress reiterated support for stimulating economic growth and added language around supporting the stock market itself. Should Europe and China begin to recover, this would be good overall and serve as a buffer to a broader economic pullback in the US.

Things just have to get ‘less worse’ from here. In our opinion, investing successfully through corrections like the present one is realizing that the best time to buy stocks is not once the situation has clearly improved, but simply when it stops getting worse. And though we don’t think we’re quite there yet we do think the “less worse” moment is approaching. For instance, in early April, when the President’s significant “reciprocal tariffs” are installed, we could well reach the point of peak uncertainty. From there on in, the back-and-forth of negotiations with our trade partners along with domestic manufacturers like our big auto companies, are likely to lead to something less than a full-blown re-creation of the entire world trading order. Other ”less worse” moments could come as the Fed shifts its rhetoric from “balanced and patient” to focused on keeping credit markets and the economy supported. Again, we are not there yet but seem to be getting close.

Overall, while big down days like we are experiencing now can be unnerving, they are more often buying opportunities than reasons to panic. We think this is the case today, and already many stocks in the cyclical and technology areas are “on sale.” Off our targeted new-money entry level of 5,400 on the S&P, assuming the positive longer term aspects of Trump’s agenda remain in place (the “call option”), stocks broadly would have significant upside in a two-year view, and substantially more than they were offering in the heady weeks following the election win. Still, we are being patient and sticking with our original plan of adding new money at somewhat lower levels, i.e., 5,400 on the S&P. Valuations become more attractive there, and with more tariff and tax sausage-making still forthcoming, the uncertainty plaguing the economy and markets is unlikely to dissipate and more likely to deepen. So, we welcome the current pullback and are hoping for a bit more of it, as we sail through the Straits of the Sirens. We’re almost there.