Some Worries We Have
The S&P 500 is less than 0.1% away from new highs and up 4% on the year, on the heels of gaining 25% last year and in 2023. Yes, things have been very good for investors and fortunately we’ve been in the camp for more than two years now that we are in a new bull market and that being invested in stocks made a lot of sense.
But that doesn’t mean we don’t see some potential worries out there. Of course, like everyone else, tariffs are indeed a big worry (with a huge amount of uncertainty), but more on that below. First, here are some market indicators we’re watching.
Year Three of a Bull Market
As we noted in our 2025 Outlook: Animal Spirits, stocks usually see huge gains the first two years of a bull market (just like they did this time) and the third year can be more choppy and frustrating. Although we expect stocks to do much better than the average third year gain of 2.1%, this is still something to consider a potential issue. End of the day, after the huge gains we saw two years off of the October 2022 lows, it would be perfectly normal to see some consolidation at some point in 2025.
Lagging Advance/Decline Ratios
An advance/decline (A/D) line is simply a cumulative tally of how many stocks go up or down each day on a specific exchange. The way many of us learned it, breadth leads price. When A/D lines make new highs, it suggests the indexes will likely continue a bullish phase. We saw A/D lines break down well ahead of the tech bubble bursting 25 years ago and again before the Great Financial Crisis, suggesting there indeed was deterioration under the surface.
Yes, we have many stocks doing well this year (even international and emerging markets are joining the party), but one worry we have is various A/D lines have yet to breakout to new highs. There is still time here, but we’d classify this as a yellow flag for the bulls right now. Should these improve and eventually break out (like we expect), then the bull would be back in a big way. Here’s a nice chart showing various A/D lines lagging.
The December Low Indicator
Last and certainly not least, here’s one of our favorite indicators. This is called the December Low Indicator, and it is fairly straightforward. When the S&P 500 doesn’t close beneath the December low in the first quarter, good things have tended to happen the rest of the year. The opposite, of course, is when the December lows are violated in the first quarter, which often has not been good news. To refresh your memory, the past two years the S&P 500 didn’t break the December low and those were great years, while a breakdown in early 2022 was one subtle clue that the odds had risen that the rest of the year could be dicey. Well, sorry to be the bearer of bad news, but stocks indeed broke their December low about a month ago.
Interestingly, since 1950, stocks held above the December lows 38 times while they broke the lows 37 times. Talk about even-steven. Those are some pretty big sample sizes, and sure enough, the takeaway from the historical results is very clear.
Those 38 times the December lows held? The full year was up an incredible 36 times and up an average of 18.9%. The times it failed? The full year was down 0.2% on average and higher less than a coin flip.
If you want to investigate things more closely, here are all 38 times the S&P 500 held above the December lows. Hard to look at this any other way than in the years this has happened, it was a major clue the bull was alive and well.
Here’s the other side to things and unfortunately where things stand in 2025. What happened when the December low was violated? Once again, the full year returns were plain and simple much weaker. Just a quick glance and some of the worst years ever saw the December lows broken in Q1. This infamous list includes years like ’73, ’74, the tech bubble, ’08, and ’22. This doesn’t mean 2025 will be like those years. Still, this is one thing that undoubtedly is in our worry column.
Now for Some Good News
Let’s get to some good news now. Stocks are off to another great start in 2025, and that could be a clue this bull market is alive and well. The S&P 500 is up just under 4% year-to-date as of Valentine’s Day (+3.97%) and it turns out that when stocks are up more than 3% as of this red-themed day, it suggests more green is in the future.
A total of 32 other times since 1950 saw the S&P 500 up more than 3% as of Valentine’s Day, and incredibly the rest of the year was higher 30 times and up nearly 14% on average, well above the average year of 7.7% post-Valentine’s Day.
DC, We Have a Problem
Over the last two years, markets have been able to tune out a pretty dour national mood. Even with all the negative sentiment, the S&P 500 gained more than 25% in both 2023 and 2024. In fact, real GDP growth clocked in at 2.9% annualized over the last two years, above the pre-pandemic trend. Sentiment was downbeat, but this didn’t really crimp consumer spending.
In our 2025 Outlook, we wrote that we expected this momentum to continue into 2025, with a potential boost coming from a turn in the national mood and a rise in “animal spirits.” We weren’t saying this would necessarily come about or was even absolutely needed, but we did see an opportunity for a rise in animal spirits to materialize.
We have been, and remain, policy optimists from a market perspective and it’s still very early, but at this point we are seeing higher levels of uncertainty and a less robust shift higher in sentiment than we expected. But keep in mind the new Congress has only been in place since January 3 and President Trump’s second term began less than a month ago. Still, to see such a marked increase in uncertainty following a fairly positive post-election response is concerning.
The University of Michigan Index of Consumer Sentiment pulled back over 3 points in February, falling to 67.8. That’s the lowest level since last August, and more than reverses the post-election bounce. The index is currently sitting well below the lows we saw during the height of the pandemic in April – May 2020. Another consumer confidence measure released by the Conference Board tells the same story. We have yet to get updated February numbers, but it fell 5.4 points in January to 104.1, the lowest level since last September.
Consumer expectations of their financial situation have risen significantly over the past year, but they’re still well below what we saw pre-pandemic and we haven’t seen a post-election surge in optimism about the future. Via a household survey from the New York Federal Reserve:
- 6% of respondents expect finances to be “somewhat better off” or “much better off” a year from now — higher than 34.2% a year ago, but below the 42.9% in February 2020.
- 21% expect finances to be “somewhat worse off” or “much worse off” a year from now — down from 23.5% a year ago, but well above the 10.5% in February 2020.
- The difference between the two was 15.6%-points — better than the 10.6%-point difference a year ago, but well off the 32.4%-point difference in February 2020.
Expectations appear to have plateaued, and simply put, that’s not great for animal spirits.
It looks like uncertainty over regulations and tariffs is hitting business confidence and is receiving a lot of attention in earnings reports. 146 out of 302 S&P 500 companies have referenced tariffs in their earnings calls so far, the most since Q2 2019. Most of them have yet to quantify its potential impact in their guidance, but that underlines the uncertainty, since we don’t have much clarity around tariffs. Half of the companies that reported also brought up currency issues in their earnings calls, saying that a strong dollar is putting pressure on overseas revenues (40% of S&P 500 company revenues originate outside the US). We highlighted in our Outlook that a strong dollar (on the back of elevated rates and tariffs) could be a threat to S&P 500 profits.
Tariff news (and whipsaws) have hit business leaders’ confidence. Priorities have shifted now to navigating tariffs and other policy issues, including settling new supply routes. Businesses have to decide whether or not to raise prices, and remember, all this is before we have any idea of the eventual policy that might be implemented.
Uh, Oh Inflation
The consumer price index (CPI) rose 0.5% in January, above expectations, partly driven by a massive 15% increase in egg prices in just one month. Egg prices are up a whopping 53% since last year, thanks to a worsening bird flu situation. Waffle House even went so far as to add an egg price surcharge of 50 cents on their menus. Energy prices have also crept higher, rising 1.1% in January. They’re still up just 1% since last year (gas prices are actually slightly lower), but households are never happy when energy and food prices go up.
Consumer expectations of inflation, as measured by the frequently cited University of Michigan survey, surged in February. One year ahead inflation expectations rose to 4.3%, the highest since November 2023 and only the fifth time in 14 years we’ve seen such a large 1-month increase. Five-year ahead expectations didn’t see a similar surge, rising from 3.2% to just 3.3%, but even that is well above levels we saw before the pandemic.
Now one big issue with this survey is that it’s “contaminated” by politics. If you separate 1-year ahead expectations of inflation by party affiliation, this is what it shows:
- Democrats: 5.1% (up from 1.5% in October)
- Republicans: 0.0% (down from 3.6% in October)
In short, Democrats are expecting a big surge in inflation, whereas Republicans appear to be expecting a deflationary recession, which would be the likely scenario if inflation were to hit 0% (though people who answer the survey probably don’t realize their response is an implied recession call).
Expectations for independents may hold a bit more signal here. They expect 1-year ahead inflation to be 3.7%, the highest level in a year. Usually, you see this kind of move only when gas prices surge, but nationwide average gas prices have risen just 10 cents to $3.14 since the beginning of the year. More likely, it’s the uncertainty about tariffs.
At the same time, a more robust survey from the New York Federal Reserve shows a more benign picture of inflation expectations. The sample size for this survey is larger, amongst other robust methodology choices. This survey showed that median 1-year and 3-year ahead inflation expectations were unchanged at 3%. That’s not too far above what we saw in 2019 (when it averaged about 2.5%). Still, things are on the upper edge of what would likely be comfortable for the Federal Reserve, which pays close attention to inflation expectations and sees it as a key potential driver of future inflation.
Market-implied short-term inflation expectations have also been rising recently, and markets are generally apolitical. 1-year ahead inflation expectations have moved up to 2.8%, the highest since March 2023. We also calculated 1-year/1-year forward inflation expectations, which is inflation expected in the second year from now (roughly 2026). That’s risen to 2.7%, the highest since November 2022. “Normal” levels, at least going back pre-pandemic levels, were around 2.2 – 2.3%. Again, what’s worrisome here is that these changes are not because of higher energy prices (which have hovered in a fairly tight range recently). Instead, this is likely where the tariff uncertainty is being manifested. Interestingly, we didn’t see a similar increase in 2018 – 2019 amid the trade war, but this time around markets may be sensitive to the fact that we’re in a generally higher inflation regime.
The good news is that longer-term inflation expectations, which is what the Fed cares more about, are consistent with its 2% target, though embedded into these is the expectation that the Fed will have to keep rates higher for longer.
All in all, the mood seems dour, whether for consumers, businesses, or even at the Fed. That’s not what we need for a lift in animal spirits. It doesn’t mean the economy will go into a recession — we still believe underlying strengths will overcome some of these headwinds. And keep in mind that the S&P 500 jumped on Thursday on some better inflation news and some delay in tariffs. But if sentiment doesn’t improve, it could be the difference between an ok year versus a great year. And it’s not over yet by any means. Positive news on the tariff side, plus progress on a tax bill in Congress, could lift spirits. But we would need more clarity and for now disruption and uncertainty have been more the order of the day.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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