Stocks Fell Again
The S&P 500 had a late week bounce on Friday last week, but still fell more than 3% for the week for the worst week for the index since early September 2024. The worries are growing, from a potentially slowing economy, to a growing and more aggressive trade war, to worries over Washington policy. The bottom line is headlines are driving much of the volatility and investors are worried.
As we’ve discussed before, early year weakness in a post-election year isn’t abnormal. Early year weakness after a 20% year isn’t abnormal. And early year weakness the past 20 years hasn’t been abnormal either. No, no one should ever invest purely on the calendar, but March has had some nice lows over the years and as we show below, the past two decades it has been perfectly normal to see late February to early March weakness, but then a nice bounce.
March Madness
It is important for investors to remember what happened two years ago this month, as the 16th largest bank in the United States went under virtually overnight and many expected the Regional Bank Crisis to spark a new bear market, but it didn’t. The S&P 500 actually finished that month higher. Then five years ago we shut down our economy during a once-a-century pandemic. Stocks eventually fell 34% in five weeks, but then bottomed on March 23, 2020 and finished with a solid 16% gain in 2020. Then who could ever forget the Great Financial Crisis ,which bottomed on March 9, 2009 after a down 56% generational bear market? The point is you might feel scared, frustrated, and confused now, but there have been many other times this has happened and many of them have taken place in this very month, but all were major lows as well.
Volatility Is the Toll We Pay to Invest
If you’ve read these missives before then you’ve probably heard us say that volatility is the toll we pay to invest. So 2025 won’t be the first year ever to go up each day and never have a scary headline, because that’s just not the way that markets work. This is officially the first 5% mild correction of 2025, something that even the best years tend to see, and no reason in itself to become pessimistic. In fact, we had two 5% mild corrections last year plus a 10% correction, and one mild correction in 2023, but both years that gained more than 20% when all was said and done. And trust us, during each of those times the past two years fear was rampant on the weakness, just as we are seeing currently. Could this weakness turn into a 10% correction? Given stocks are down about 6% from the recent high, that is quite possible, but we do not expect things to get much worse and the odds of a full-blown bear markets are quite slim. As uncomfortable as this recent volatility feels, know that it is the toll we must pay to invest.
Tariffs a Concern but Job Market Not Recessionary
We shared an extended analysis of tariffs earlier this week. Our basic conclusion was that while we did see an increase in economic risks, it did not change our baseline view. We had a chance to further elaborate on this after the most recent job data came out on Friday.
The February employment report was a bit mixed. It didn’t tell us much that is new about the US economy, but that in and of itself is a story, depending on your expectations:
- If you were expecting near recession-like conditions, we don’t have that.
- If you were expecting GDP growth to be closer to 3% in 2025 (like the last two years), you have to re-rate that expectation to something much closer to 2% (if not slightly lower in the near term).
The economy created 151,000 jobs in February, more or less consistent with expectations. Of course, as we’ve pointed out in the past, monthly data can be noisy and that’s why a 3-month average is useful. That’s running at a strong 200,000 pace right now, thanks to a massive 323,000 gain in December, which will roll off next month. In reality, job growth is likely running between 140,000 – 180,000. That’s not bad, and slightly ahead of what’s needed to keep up with population growth.
The big picture is that we’re not anywhere close to a recession. In fact, job growth in the construction industry, which typically foreshadows broad weakness in the labor market, is at cycle highs and up 2.1% from a year ago. That’s a slower growth pace than a year ago, but nothing close to what would be concerning. This is especially notable, given the drag on residential investment from high interest rates.
But … The Economy Has Slowed Down
The US economy grew at an annualized pace of almost 3% (2.9% to be exact) over the last two years, after adjusting for inflation—faster than the 2010-2019 pace of 2.4%. Even as recently as six weeks ago, it seemed like the market narrative, and sentiment, was expecting a rerun of this pace: stocks had risen to record highs and more tellingly, interest rates were really elevated as investors expected the Federal Reserve (Fed) to hold rates “higher for longer” amid a strong economy. In fact, there was a notion that the Fed even “got it wrong” by cutting rates as much as they did (they cut policy rates 1%-point from September through December). I’ll note that we were decidedly not in this camp. We’re optimistic about growth, and markets in 2025, but not overly so. As we wrote in our 2025 Outlook, we thought (and still think) interest rates are still too restrictive and a drag on cyclical areas of the economy (like housing and investment) and that tariffs are a threat that could create volatility (which is being manifested now).
Cue to last week, and there’s been a big swing in sentiment. It’s not just the uncertainty from tariffs. Economic data has been coming in on the softer side (but not recessionary), and the February payroll data confirm the slowdown.
The unemployment rate rose to 4.1%, though that’s lower than historical averages. Even the prime-age (25-54) employment-population ratio, which corrects for an aging population and definitional issues around who is unemployed, pulled back from 80.7% to 80.5%, but that’s still higher than anything we saw over the last two expansion cycles (2003 – 2007 and 2009 – 2019). Other data show that layoffs remain low, but it’s getting a little harder to find a job.
Also, the composition of job growth tells us that we’re not getting the cyclical acceleration needed to take GDP growth above 2.5%. About 49% of jobs created in February were in health care and social assistance (+63,000) and government (+11,000). The DOGE is likely making its presence felt at the federal level, where jobs fell by 10,000, but this was more than offset by net job creation of 21,000 at the state and local level. (State/local government employment is almost 8-9 times larger than at the federal level.)
The support from non-cyclical areas of the economy in February continues a theme we’ve seen over the past six months to a year. Over the past six months, payrolls have grown by 1.14 million, of which health care and social assistance accounted for 39% (+444,000) and government accounted for another 16% (+185,000). The cyclical economy wasn’t completely dead, with another 26% of jobs created within the leisure and hospitality, transportation/warehousing, and construction sectors. But these were partly offset by a loss of 35,000 jobs in manufacturing and 18,000 lost jobs in professional and business services. Not what you want to see if you’re looking for an acceleration in economic growth.
Ultimately, what matters for the economy is aggregate income growth across all workers in the economy, since that’s what drives consumption. That’s a combination of employment growth (running ok), wage growth (strong), and hours worked (weak). Aggregate income growth has slowed to a 2.8% annualized pace over the past three months. That’s an alarming slowdown on the face of it, but it’s partly driven by a drop in hours worked due to weather-related issues over the past two months, which will likely reverse soon. Again, this is not recessionary, but income growth is likely running well below the 4.5 – 5% pace we saw last year.
Of course, the question on everyone’s mind is tariffs. As we wrote in the piece cited above, it’s hard to gauge the precise impact of these tariffs. For one thing, we don’t even know what the tariffs will be. But therein lies the uncertainty.
The largest, and perhaps adverse, impact of the tariff overhang is that it keeps the Fed waiting on the sidelines for longer before continuing with rate cuts. Elevated rates are clearly hurting parts of the economy, but the Fed doesn’t look ready to provide relief anytime soon—they’re going to want to wait to see what happens with tariffs. The Fed would likely act sooner rather than later if they thought the labor market was deteriorating, but the February data tells us that’s not the case. That takes away any urgency for further rate cuts. But that also raises the probability of something actually breaking before they act. (I’ll note that the housing market in particular is not going to function well with near 7% mortgage rates.) It comes back to the biggest risk we highlighted in our 2025 Outlook, the risk of interest rates staying too high, which could cause a break in the cyclical economy that drags everything else lower. There’s also a risk that the big drivers of recent employment gains (health care and state/local governments) start to see headwinds amid federal government cuts that result in less money being sent to the states (including for Medicaid, particularly in rural areas).
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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