A late-day rally in risk-assets on Friday saved equity markets from what was otherwise an ugly week and a challenging month.  The price action in markets throughout February illustrates that a change in character is underway: momentum, high beta, and risk are being sold, while low beta, defensives, and bond/bond proxies are being bought.  We’re going on four months since the election where the major averages have violently chopped sideways where only 8% of the S&P 500 is at fresh 52-week highs, well below the 25% share in early November when President Trump won the election.      

Bond yields are falling in spite of incoming data showing that inflation remains sticky to the topside and survey data hinting at forward inflation expectations remaining elevated.  The rising probability that growth is downshifting is behind the 60bps slide in the yield on the 10-year T-note from 4.80% on January 13th to 4.19% (seven straight weeks of falling yields).  Oil prices have slipped below $70/bbl, and this is less about ‘drill baby drill’ than a reflection of the weakening pace of economic activity.  A point investors witnessed firsthand with the latest release of the Atlanta Fed GDP now forecast for Q1 GDP plunging to -2.8% from +3% earlier in the quarter.  Don’t be too alarmed as a major contributor to this downward revision is the result of lumpy import/export activity due to tariff policy from the U.S. administration.  However, momentum behind U.S. economic growth has decelerated materially, as was confirmed in this morning's ISM manufacturing and construction spending releases.   

“Latest estimate: -2.8 percent — March 03, 2025

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2025 is -2.8 percent on March 3, down from -1.5 percent on February 28. After this morning’s releases from the US Census Bureau and the Institute for Supply Management, the nowcast of first-quarter real personal consumption expenditures growth and real private fixed investment growth fell from 1.3 percent and 3.5 percent, respectively, to 0.0 percent and 0.1 percent.”

As a result, it's of little surprise that market odds for a Fed rate cut are rising.  Fed fund futures for a May 7th cut have increased to a still low 26%, odds for a June rate cut has shot up to 74%, and for all of 2025, markets have repriced to 81% odds of 50bps of cuts this year (up from 62% a week ago).  Meanwhile, the U.S. stock market is underperforming its overseas counterparts this year by a significant margin: the Europe Stoxx 50 is up +12% year-to-date, Hong Kong’s Hang Seng Index has jumped +14%, and we are seeing the Chinese Tech stocks start to get a real lift. It doesn’t hurt that the Stoxx Europe 600 index trades at a sub-15x forward P/E multiple versus 22x for the S&P 500.  While part of the bid in the European market has come from hopes that the Russia- Ukraine war would end, a large chunk is coming from the reality that Donald Trump’s isolationist policies are forcing policymakers across the Atlantic to bond and engage in fiscal stimulus and dramatic expansions to the military complex.

It's hard to nail down with any precision the impact of this administration's use of ‘tariffs as a threat’ and ‘tariffs as a policy’ on growth and inflation, but it's not hard to conclude that it is having an impact.  We’ll get more insight on this front with Tuesday’s self-imposed deadline to implement a 25% tariff on all imports from Mexico and Canada, with a reduced 10% tariff on Canadian energy.  A month ago, all it took was a more proactive pivot “on border security” to get this administration to punt its initial deadline.  On Friday, we got some insight from Treasury Secretary Scott Bessent on how the trade hit could be averted once again, if Mexico and Canada merely decided to join the U.S. (“Are you with us or against us?”) in boosting tariffs on China.  He dubbed it “Fortress North America.”  This would prevent China from avoiding US tariffs by shipping products to Mexico and Canada intended for re-export to the US. So, tomorrow’s deadline, like its predecessor, seems to have some flexibility with its terms, but begs the question of where do proud nations (even strong allies) draw a line in the sand on these tactics.  Not that “Fortress North America” is necessarily a bad idea, but my guess is this administration is pushing the limits of Canada and Mexico’s patience. 

In addition to the tariffs on Canada and Mexico, President Trump has decided to go ahead with doubling the 10% blanket tariff on Chinese imports to 20%, not to mention reciprocal tariffs on other nations, in response to findings from the joint global trade and currency policy review by the Departments of Commerce, Defense, State, Treasury and the US Trade Representative. Those reports are due on April 1.  Keep in mind that there are retaliatory measures that need to be considered as well.  China is considering fresh measures on U.S. agriculture, and Canada is considering tariffs on Canadian energy to ensure U.S. drivers “feel the pain” of Trump’s trade war, not to mention retaliatory measures that are unknown at this time. 

So, how should investors think about their portfolio in such an environment?  From a policy standpoint, we need to recognize that the sequence with which this administration will implement its agenda is the polar opposite of Trump’s first term.  The things President Trump can control via executive order – i.e., trade and immigration – are a net negative as far as risk-assets are concerned (growth negative) and likely need to occur before Congress can move on legislating what markets view as positive metrics (tax cuts).  Given this sequencing challenge, markets will likely have to endure some short-term pain before getting to the potential long-term gain portion of the policy agenda.  As I’ve said for months, the margin for error for this second Trump term was/is razor thin, given the setup in capital markets. 

The price action in markets since the election has demonstrated just that.  Think of it from a big picture yet simplistic framework:

• Shrink a bloated government – this a drag on employment and economic growth, particularly because of how large the government has become as a percentage of U.S. GDP.  Why do you think you are starting to hear cabinet members like Commerce Secretary Lutnick discussing measuring economic growth excluding the government?  Because they know that shrinking it is going to negatively impact growth. 

• Tax imports to pay for tax cuts – putting aside who pays for the tariff and whether it is or isn’t inflationary – the notion behind tariffs is to find revenues for Uncle Sam to pay for tax cuts that maintain the status quo.  This isn’t an incremental positive; at best, it’s a wash, and at worst, it’s another hit to growth and a jolt to inflation.  Sure, there are ambitions to eliminate taxes of tips, social security, and over-time, but given the scoring from the Committee for a Responsible Budget, the bill the House passed last week will raise the deficit by $3.4 trillion over the next decade.  That will only put more pressure on interest rates and liquidity to continue to fund $36tn in federal debt that is already crowding out private markets.

• Immigration—The unemployment rate in the U.S. is already at five-decade lows of 4.1% and is at risk of rising due to cuts from DOGE and a more restrictive immigration policy. Once again, this is not a net positive for near-term growth, wages, or inflation. 

Please don’t take any of these comments as a hit piece against this administration's agenda.  I’m as tired of writing about them as you likely are of reading about them.  Moreover, I’m agnostic regarding party politics of Red or Blue.  For us, it's about measuring and mapping the impact of policies (good, bad, or indifferent) on things that matter to stewarding client capital.  That said, I see an environment where the risks of things going wrong continue to outweigh the reward of things going right.  It’s not a matter of being in the pro-Trump or anti-Trump camp. 

The price action in markets is telling investors that a slowdown in growth is underway.  So far its been a good rotation in equity markets where the S&P 500 is a little less than 5% off its all-time high while the Mag7 is down more than 10% from its high, momentum and high beta have sold off aggressively, while defensive areas of the market like Staples, Utilities, Healthcare, and low beta have caught a bid.  What I’m thinking about as we move forward is how and when the Fed reacts.  As I see it, the onus is shifting to them to use their policy tools to offset a growth scare from evolving into something more profound and prevent a global debt refinancing air pocket from getting going in Q3/Q4.  If the Fed does not act forcefully within this window of economic weakness to avert a deepening U.S. growth scare, a further unwinding of the U.S. exceptionalism trade that has been building for over a decade and reached a fever pitch at the end of 2024 is likely to get ugly.

Bottomline, the investment backdrop argues for taking less risk, not more risk, with your capital.  My advice is to throttle it back, take some chips off the board, and have some dry powder that gives you optionality in the future.  I’m not suggesting investors should abandon a prudent long-term strategy or a well-diversified portfolio.  Instead, just operate with a lower risk budget or reduced gross exposure for now.  I know, I know, come on Corey – you can’t time the market!  That’s not what I’m saying.  My advice is more along the lines of rebalancing while leaning in the direction of capital preservation rather than capital appreciation.  There will be a time and place to flip that switch back in the other direction, but not here and not now.  As I type the S&P 500 is approaching a must hold level at the bottom of its trading range that has been in place since early November, a decisive break lower likely opens the door for a trip down to its 200-day moving average around 5,720. 

We could bounce anytime now on a positive announcement, but I will start to consider putting some capital back into equities at the 5,750 level. It's not a back-up-the-truck moment by any means, but sentiment measures are flipping bearish, and positioning is getting a necessary prune.  Not to mention many areas of the market have gotten out right hammered, relative to the S&P 500.     

It is a busy week ahead: The U.S. ISM manufacturing PMI for February was released this morning and while not terrible, it was another data point confirming the ongoing growth scare. Tomorrow evening, we’ll get Donald Trump’s State of the Union address, and the tariffs on Canada and Mexico go into effect. Wednesday will be chalk full with ISM services PMI, ADP and the Fed’s Beige Book; the ECB is widely expected to cut rates -25 basis points again on Thursday to a two-year low of 2.5% which would be the sixth such move since last June; and closing the week with February nonfarm payrolls on Friday. We have five Fed speakers on the docket this week, but none is more important than Chairman Powell’s comments at the University of Chicago on Friday at 12:30 p.m. ET. 

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