Reefs to starboard!

As we ply the straits of the sirens, strapping ourselves to the mast of our over-weights to stocks while also staying overweight money markets may prove to have been an even better idea than we'd imagined. Several of the near-term risks we've been highlighting are cropping up all at once now, so the odds of things getting rockier from here are rising. Still, the intermediate-term picture remains so promising that we, and others, are unlikely to be steered out of our overweight stocks position, and we haven’t changed our 7,000 year-end target on the S&P 500 (see Strapped to the Mast). Pending a sudden shift in the news flow in either direction, a back-and-forth tug of war between the bulls and the bears is likely to keep stocks in a range for now. In the meantime, we are monitoring closely the following list from our Baker’s Dozen that could improve, or deteriorate, sufficiently to drive the market outside the trading range within which it has recently been stuck.

Soft patch emerging? Although the data is far from conclusive so far, the possibility of a soft patch emerging is rising. The “sausage making” process on policy is proving as volatile as we anticipated, with uncertainty arising on multiple fronts at once: tariffs, taxes, regulations and geopolitics. This kind of environment often makes sober-minded CFOs cautious near term, and right on cue this caution came up repeatedly during the recently completed Q4 earnings season. Indeed, many CFOs proved unwilling to issue more aggressive guidance in the recent earnings season, unsure of the rules of the road that will emerge from the tariff wars and the "One Beautiful Bill." All this near-term uncertainty alone could spark a slowdown.

Pressure building on consumers. Walmart’s weak guidance, along with the softening consumer confidence numbers last week, have raised the possibility that the ever-resilient US consumer finally may be reacting to the continued stress of inflation pressure and structural weakness in the housing market.

Government layoffs so far are small but coming all at once (i.e., "systemic") and uncertainty around future cuts could magnify the impact. Despite the headlines around the government buyouts, there have only been about 100,000 announced layoffs so far across a federal workforce that is well over 2 million employees. Given the relatively small numbers involved here, along with the relative strength of the private sector, the headlines are probably more of a modest economic drag than the start of a full-blown recession. Still, more cuts are coming, and when layoffs like this happen nearly simultaneously, they can pack a bigger psychological punch than the straight numbers suggest they should. So, we need to start paying attention as Musk's chainsaw warms up. 

Chess matches in Ukraine and the Mideast are hard to watch. Between Ukrainian national war hero Zelensky being called a "Dictator" by the President of the United States and Israeli hostages being paraded around Gaza by masked thugs, watching Trump's "war chess" negotiations play out has been tough. We still think this will end well, but who knows.

Tariff wars are 'path dependent.' As Treasury Secretary Scott Bessent noted in an interview on Fox’s Sunday Morning Futures last weekend, the outcome of tariff chess will be "path dependent." In other words, things could go very well or very poorly from here. If target countries relent to Trump's threats, cuts, rather than hikes, in tariff surcharges around the world could be forthcoming. On the other hand, if someone makes a wrong move...

Here's the good news:

A 'Global Peace Dividend' may be in play sooner than thought. As hard as it is to watch the negotiations in Europe and in the Mideast, it is amazing that in four short weeks both conflicts are at least on hold and all sides are talking. This alone is encouraging. Now, what if the next moves are actual peace deals? The rebuilding effort in Ukraine could be as much as $500 billion, dwarfing the post-WWII Marshall Plan that sparked a huge recovery in the war-torn European economy.

The worker-starved private sector might absorb those DOGE casualties from the government. In some ways, President Trump's DOGE efforts are built around the idea that the private sector, forced to operate under the profit principle, has been "squeezed out" of the labor markets by the huge expansion of the government sector under President Biden. So, it's possible the private sector will readily scoop up whatever government workers emerge from DOGE's efforts. Our guess is this may take more time, and re-training, than some optimists think. We'll see.

Europe might be getting its act together. Last weekend's German elections signaled an emerging shift within Europe toward more conservative social and economic policy options, while keeping the far right and far left parties at bay. This is consistent with some of the early reactions to Trump's re-ascendance which we characterized at the time as "Trump goes global." Given the amount of dry economic tinder in Europe, any shift towards less regulation, lower taxes and more private sector could have a powerful multiplier effect. We'll see. Year-to-date, the long-underperforming European markets may be sifting this out.

Xi may be preparing to play his next move. Another big near-term upside potential for the global economy is China, so bad off that it may be good. With Trump threatening, Xi would seem to have no good move except domestic stimulus, including welcoming back the tech entrepreneurs who "Made China Great Previously." Such a move would be a boon globally. In this light, the reemergence of Jack Ma, Alibaba's founder who had been "canceled" by Xi, warmed many capitalist hearts in China this weekend. Again, too early to tell, but encouraging.

A rate cut might be coming sooner than expected. The backward-looking Fed has certainly not been guiding to this, and some strategists out there are even—incredibly—talking about a rate hike. But if a soft patch emerges as we anticipate, the Fed is sure to react by accelerating its rate cutting program. This possibility is another reason to not get too bearish.

All in all, things are getting rocky as we sail the straits toward our 7,000 year-end S&P target. Hang on! With valuations at best "fair," more optimistic company guidance mostly on hold, and near-term economic risks rising, a short-term pullback in stocks could be coming before Trump’s supply-side reforms begin to crystalize. Good thing we have a little extra cash stashed away in case we hit a rock.