From February 19 to April 7, the stock market rapidly dropped approximately 21%, primarily due to investors discounting significant bad news, particularly import duties on products entering the US. According to Trading Economics, inflation is not a problem in Europe, except for Turkey, Ukraine, and Russia. Inflation is also not a problem in the Americas, except Venezuela, Bolivia, and Argentina. The leading economies in Asia do not show signs of inflation either. For many years, most of these countries, if not all, have imposed import tariffs to protect their markets without encountering inflation.
Import duties may be perceived as a tax on consumers; however, they are not inherently inflationary. In December 2024 and January 2025, some of our quantitative indicators began to signal a weakening stock market in anticipation of a declining US economy. This rationale supported our defensive positioning (about 55% T-Bills + cash) to safeguard the value of our portfolios as we entered Q1 2025. Thus, the tariff issue served merely as a catalyst for a stock market correction that would have taken place anyway, due to the economic cycle. The economic cycle, driven by GDP growth, inflation, interest rates, and monetary policy, is what influences the direction of the stock market.
The question is, where does the stock market go from here? In the technology sector, semiconductors began to sell off in July 2024. Leading companies such as Microsoft, Apple, Amazon, Nvidia, Google, Tesla, and Meta started to weaken in December 2024 and January 2025. Except for Microsoft, the rest of the group is in a downtrend. However, their accumulation has never weakened, which is not a sign of a secular (long-term) bear market.
In my last article, I noted that the issue driving financial markets is the US economy, influenced by inflation, GDP, interest rates, and the monetary policy enacted by the Federal Reserve (Fed). This remains true today. While the economy is not yet in a recession, GDP is slowing down, and inflation does not seem to be a concern for bond investors, despite Wednesday’s report. Even if investors perceive progress in trade negotiations and the reciprocity sought by the US, uncertainty regarding a weakening economy will persistently limit stock market performance. Conversely, a strong employment number reported on Friday sent bond yields higher, with the understanding that the Fed will be prudent when considering cutting interest rates.
The first quarter (Q1) GDP and Personal Consumption Expenditures (PCE/inflation) were reported on Wednesday. We learned that GDP is contracting by 0.3%, while PCE has risen to 3.6%. This creates a troubling combination for the stock market, as it indicates that, from the Fed’s perspective, inflation is likely to remain a concern amid slowing economic growth. Once again, the Fed has shown caution regarding further rate cuts, and given the PCE reading, I doubt policymakers will choose to ease monetary policy.
The chart below illustrates the performance of the one-month T-Bill (solid orange line), which has the maturity closest to the Fed Fund Rate controlled by the Fed. After declining over the last four months of 2024, signaling a lack of concern about inflation, the line remains below the 50-day moving average (blue line) and the 20-day exponential moving average (dotted line). This suggests that bond investors, who have a solid understanding of monetary policy, are not anxious about inflation. Additionally, on Wednesday, the spread between the 2-year and 10-year yields steepened by six basis points, indicating no fear of an economic recession.
The stock market opened significantly lower after Wednesday’s GDP and PCE reports. However, investors seem to recognize some favorable outcomes, as all losses in the Dow Jones, S&P 500, and Nasdaq 100 were recovered by the end of the day. All three indices closed in the green on Wednesday and continued to rise on Thursday and Friday.
Over the past month and a half, I have noticed that when the stock market gaps down at the opening bell, it is quietly bought later in the last three or four hours of trading. Gapping down at the opening, followed by intraday buying, does not sound very bearish. On the contrary, I would suggest it may be quite bullish. I would be very concerned if the morning sell-off were followed by heavy selling in the afternoon. This was the case during the bear markets triggered by the internet bubble and the mortgage crisis.
Momentum, while improving, is still slightly negative (first indicator window below the chart) and entering the resistance area, which may suggest that investors are nearing a profit-taking decision. The second indicator window shows that the S&P 500 Index is outperforming the Nasdaq 100, indicating that investors are reluctant to take on excessive risk. On Wednesday, both indices successfully tested their respective support areas established by the 20-day EMA (dotted green line). On Thursday, both broke through their respective 50-day SMA (blue line) and are poised to test their 200-day SMA (5750 in the chart below). This is a significant test in an overbought stock market. From a technical standpoint, the index must remain above 5440 if investors opt to take profits and a pullback occurs. Should it fall below this level, a test of the April lows could transpire.
On Friday, the Volatility Index ($VIX) closed at 22.68. In our quantitative process, we consider readings above 20 to be too high and indicative of price instability. The higher the number, the greater the instability. However, the accumulation of stocks within the index continues (bottom indicator).
Conclusion: While I expect volatility to persist, we may have seen the bottom of this correction in April. If so, this doesn’t mean we can’t test support at that level again. I understand the optimism and uncertainty surrounding us; perhaps investors are beginning to assume that international trade activity will continue. The rules of the game will be different, but global trade activity will not cease. Most importantly, if the Federal Reserve doesn’t effectively manage the current economic cycle, it could pose more danger to the economy and investors than tariffs. The economy may return to Phase III in the economic cycle, where GDP slows and inflation accelerates. In this environment, volatility remains high, but the stock market does not collapse.
With best wishes,
