How to think about the ongoing correction – part 2
we're not out of the woods yet
US stock markets are back up last 2 days, are we not happy? Well, it’s better than 2 days down. The price action of Friday-Monday show one big positive: S&P and Nasdaq did not break down below their 300-day moving average. We have a support level here.
But it’s not conclusive yet, as I show in charts below. We still have a bad setup in charts with multiple resistance levels.
OECD has cut down its economic growth forecasts and increased inflation forecasts. Especially for North America where the impact of US tariffs is far larger than in the rest of the world. As such, expectations of a Fed put are pretty weird in the face of higher inflation expectations. US Consumer inflation expectations are even worse.
We mostly have a problem of “no upside”, which means that stock analysts growth expectations are very high and “only have downside risk”. If OECD is right, while valuations are high based on high expectations and we’ll get hit by that double whammy.
I’ve heard someone smart on Bloomberg Surveillance (can’t remember who) saying: post Trump election, the market went up on expectations of measures positive to economic growth, in this order:
large tax cuts first
followed by significant de-regulation / change in policy
and finally little tariffs here and there but mostly on China
And we got the exact opposite. Hence, large swings in stock markets:
S&P500
5 Nov 5,783
11 Dec 6,084 +5.2% from 5 Nov
17 Mar 5,675 -6.7% from 16 Dec
Nasdaq Comp
5 Nov 18,439
16 Dec 20,174 +9.4% from 5 Nov
17 Mar 17,808 -11.7% from 16 Dec
The result of the bounce last Friday is mixed (see charts below) and we have 3 complicated conversations (below the charts).
Why is it mixed? Because it is not conclusive
The good part is that the correction in both S&P500 and Nasdaq Comp stopped on the 300-day moving average. We have a support level here. As you can see in both charts below, looking back at Feb-Mar 2022: when markets breakdown below the 200- and 300-day moving averages, you’re stuck there for some time.
These charts also show that the bounce off the 300-day mva that we have seen last Friday does not tell us that it is over (that markets will go up from here). You see an example of that just 2 months before the 1st rectangle in the charts above. Zooming into that:
the S&P breaks down below the 200-day moving average
bounces up on the 300-day mva
the S&P goes up ~5%
after a 1-month bounce, the S&P then breaks down below the 300-day mva and stays below that level for 1 year
it often takes 2 or 3 attempts on a critical resistance or support level to confirm if the market is moving above or below that level. We have to wait.
The other not-so-good element is that the break-down of Feb-Mar 2025 has created 3 big resistance levels (the black lines). In terms of a positive scenario, I would expect that the S&P remains stuck around the lower black line for a while and that it takes a long time (6-12 months) to break above the higher black resistance line.
The negative scenario is that the S&P breaks down lower, as shown above (Apr 2022).
3 complicated conversations
Weakening growth? Yes but the Fed will cut rates aka the Fed put
There is a wide agreement that Mr. Trump’s higher tariffs will lead to higher inflation and lower growth. The latest OECD forecasts published yesterday 17 March show just that. It’s quite straightforward:
“Global GDP growth is expected to moderate from 3.2% in 2024 to 3.1% in 2025 and 3.0% in 2026, with higher trade barriers in several G20 economies and increased policy uncertainty weighing on investment and household spending.”
According to OECD, the US putting tariffs on imports from everywhere will mostly hurt US growth. 10% higher tariff implies:
US growth 0.72% lower
Canada growth 0.64% lower
EU growth 0.17% lower
China growth 0.10% lower
“Over 2025-26 inflation is projected to be higher than previously expected, although still moderating as economic growth softens. Headline inflation is projected to fall from 3.8% in 2025 to 3.2% in 2026 in the G20 economies. Underlying inflation is now projected to remain above central bank targets in many countries in 2026.”
This is the 1st area of risk to expectations: there is a growing expectation of a “Fed put”. If growth slows, the Fed will have to cut rates and that will save us. That’s a convenient view but the Fed’s mandate is price stability and maximum employment – not growth per se and not asset prices. We’re anxiously awaiting for the Fed’s next meeting March 19-20 and how the “dot plot” will change: how many cuts, how big? Lower growth but higher inflation is not a setup where the Feds will cut rates. Unemployment increasing rapidly and inflation not increasing is probably the best case for a rate cut.
You can say of course that lower growth will lead to higher unemployment. But 1) it’s a matter of degree: will unemployment increase a lot more than inflation? 2) the Fed tend to see unemployment as a cyclical problem that will go away but inflation as a persistent problem that has nasty long-term consequences, especially lower Consumer spending. If you ask US Consumers (U Michigan does), inflation expectations are even higher:
Stock markets decoupling shows that we are not in a global slowdown
That’s the other popular argument: there is no global slowdown, it’s just US uncertainty. Certainly, year-to-date, the German stock market (DAX in red) is up 17%, Hong Kong (HSI in green) is up 23%. S&P in blue, -3.5%.
That’s a good argument but:
1) As the OECD shows in the “GDP effects” chart and the “inflation projection” chart, the biggest impact of US tariffs is in North America (Canada, US, Mexico). In the rest of the world, it is mild to low. So there is a reason why US markets are correcting while others are ignoring the problem. It’s a US problem.
2) USD has weakened since Dec 2024, JPY and EUR have appreciated by ~5% and there are massive carry trades around these FX pairs, especially JPY/USD. It is not that the USD weakens because the S&P declines. It’s the opposite. The expectation of higher growth / inflation (especially wages) in JPY economy, increasing JPY rates leads someone to close its carry trade, i.e. sell US assets to payback its JPY borrowings.
The market is just too expensive
I showed that last week here: the S&P and Nasdaq are a bit expensive but relative to past 5-year averages, it’s not extravagant.
Where we have a bigger problem is consensus growth expectations.
I use I/B/E/S Refinitiv data which shows:
Expected net income growth in 2025
S&P150 11%
Nasdaq150 17%
Expected net income growth in 2026
S&P150 13%
Nasdaq150 16%
That means that expectations can decline significantly if and when the economy slows and that’s why we should really worry about signs of weakening consumer confidence – or large retailers or airlines cutting forecasts.
That’s all folks.