Market Update

The S&P 500 Index has declined approximately 20% from its February high to its most recent intra-day low, erasing all gains since the Presidential election. This sharp decline, often referred to as a correction or bear market, resembles a market crash due to the speed of its drop. Historically, steep market drawdowns like this tend to recover quickly—assuming fundamental reason for the selling is addressed, and a deep recession is not on the horizon.

The primary cause of this sharp drawdown is the escalating trade war. President Trump has advocated for a more level playing field in global trade, arguing that U.S. tariffs should match those imposed by foreign countries. For instance, the European Union currently levies a 10% tariff on U.S. cars sold in their markets, compared to the 2.5% tariff the U.S. imposes on European autos. While this example illustrates the imbalance, global trade is far more complex and nuanced.

On April 2nd, the announced tariff increases raised the average rate by around 25%, surpassing expectations and sparking widespread concern. Over 75 countries have since expressed a desire to negotiate, with predictions that final agreements will lower tariffs closer to 10%. The United States, as the world’s largest economy, is resilient enough to adapt to changes in trade policy. However, higher tariffs could dampen economic activity, raise import prices, and even lead to a recession. In the short term, these adjustments may slow growth over three quarters. Long-term impacts could reduce U.S. economic growth by up to 0.5% annually, according to a Neuberger Berman research note.

The uncertainty surrounding these tariffs—along with retaliatory actions from foreign countries—has unsettled investors, businesses, and consumers alike. The latest Conference Board Consumer Confidence survey fell to its lowest level in 12 years, a reading often associated with recessions. Federal Reserve Chair Jerome Powell acknowledged that the tariffs’ effects on consumer confidence, economic growth, and inflation remain unclear, adding to investor anxiety. Powell also emphasized that any potential negative impacts are likely to be temporary, as businesses and consumers adjust.

After two consecutive years of 25%+ total returns for the S&P 500, a 20% drawdown is not unusual. Markets now appear to have priced in slower growth but not a recession. If a recession does occur, the stock market could remain in a downtrend. Historically, non-recession bear markets have experienced median declines of 22%, based on Fidelity research.

The market’s current behavior suggests a recession is not imminent. This optimism partly stems from President Trump’s recent strategic adjustments, guided by his cabinet. Treasury Secretary Bessent and other advisers flagged warning signs of potential credit market turmoil, including widening yield spreads, spiking U.S. Treasury yields, and a declining dollar. To mitigate these risks, the administration postponed tariffs for 90 days, allowing time for negotiations. Concessions have since been made, including exemptions for critical goods and tariff reductions on items like auto parts. The USMCA Trade Agreement also exempts goods covered by the deal from tariffs. Recession risks remain high, but only if elevated tariffs persist.

So far, earnings season is meeting expectations. For Q1 2025, the S&P 500 has reported earnings growth of 7.3%, with estimates pointing to over 10%, according to FactSet. Historically, actual earnings growth has exceeded estimates in 37 of the past 40 quarters. For the full year, earnings growth is expected to be a respectable 8%, supported by narrowing credit spreads and the possibility of future tax cuts. In the event of a mild recession, earnings growth could decline by 10-20%.

S&P 500 valuations remain elevated. The forward 12-month P/E ratio stands at 19, above the 10-year average of 18.3, while the trailing P/E ratio is 23.6, compared to a 10-year average of 22.3. However, valuations have improved recently and certain sectors, such as those represented by the Invesco S&P 500® Equal Weight ETF, offer better value. The ETF trades at a forward P/E of 17, below its 10-year average. Still, valuation risks persist, especially if earnings estimates are revised downward.

Market Outlook

Technically, the market remains in a downturn, suggesting limited upside in the first half of the year. The S&P 500 has fallen close to 20% from its intraday high, with small-cap stocks entering deeper bear market territory. According to Fidelity, the probability of a 25% bear market is 20%, while a 50% bear market has a 2% likelihood. Positive technical indicators—such as a declining CBOE VIX (from 66 to 29), improving breadth, and a bottoming process—suggest the market may be stabilizing. Volatility could return as a re-test of the recent market low if often part of a bottoming process. With slower growth already priced in, a recovery will depend on sensible tariff policies and continued earnings growth.

History shows that extreme market bearishness often leads to strong subsequent returns. When bearish sentiment, as measured by the American Association of Individual Investors (AAII), surpasses 50% for consecutive weeks, the S&P 500 has historically delivered above-average 12-month returns, based on data from Motley Fool, LPL Financial, and AAII. However, forward returns can vary depending on broader economic conditions.

If the economy slows significantly, the Federal Reserve may implement rate cuts to stimulate growth. Historically, such monetary easing has supported stock market performance. Since 1950, 25% of S&P 500 corrections (defined as declines of 10% or more) have escalated into bear markets (declines of 20% or more). While most corrections do not lead to bear markets, they serve as signals for investor caution.

Risks Ahead

One significant concern is the rising U.S. Treasury yield, despite slowing economic activity. Typically, Treasury yields decline as investors seek safe-haven assets during periods of uncertainty. However, rising yields are increasing the cost of servicing government debt, which now constitutes over one-third of the federal budget. This dynamic could strain the government’s finances, reducing resources for other priorities. Additionally, government and private sector layoffs could rise, further elevating unemployment—a key recession indicator. Conversely, the positively sloped yield curve suggests a recession is not imminent.