NEWS
What Happened Last Week
The sentiment of US consumers has fallen in recent weeks, particularly due to increased expectations of inflation, rising unemployment and lower expected pay raises.
This sentiment is also reflected in the AAII Sentiment Survey, which shows a significant increase in expectations of downward market movement within the next six months. Extreme fear is the result of the Fear & Greed Index.
The fear of stagflation has driven markets into volatile territory, due to the uncertainty surrounding tariff talk (expected to go into effect for Canada and Mexico tomorrow on March 4).
The Conference Board’s US Consumer Confidence Survey dropped below 80 in February, which triggers their warning of possible recession.
The yield curve inverted, meaning the 3-month Treasury yield has just surpassed the 10-year yield.
Inflation data showed prices increased as expected, with the core Personal Consumption Expenditure (excluding volatile food and energy prices) rising 0.3% for February.
How I See It
Markets have been trending sideways since November.
We’re bordering on what might be called a “pullback” in the markets. And they never happen in a vacuum.
Essentially the drop is due to this fear: that tariffs will cause out-of-control inflation at the same time that unemployment is rising.
While there’s no easy answer to forecasting future economic realities, the intensity of this fear appears to be the result of investors imagining possibilities that aren’t all that likely, in my view.
Total US imports only make up about 11.2% of US GDP. Accordingly, consumer’s expectations for inflation rose from 5.2% to 6% for the next twelve months.
But I think it’s important to remember that, when pricing stocks, investors typically consider what’s most likely to occur over the next 3 to 30 months. When markets become fearful, they focus on the lower end of that range.
President Trump’s tariffs on China, which Biden left in place, didn’t cause a spike in inflation. Companies found ways to work around it and find new suppliers. And Trump has made it clear that he is using tariffs as negotiating tools, which leaves an open question as to just how long they would actually be used (at least at the proposed levels).
Finally, the Federal Reserve predicts 2.5% average annual inflation over the next ten years, which is similar to levels predicted throughout 2022-2024. While that affects stock prices a bit, the recession fears are not as dramatic when viewed from this broader lens.
What is clear is that investors are taking this seriously, which helps to keep markets efficient before they spiral into a bubble.
In summary, I don’t believe a recession is likely at this point. But a correction in the markets (-10% to -20% from the high point) is an increasing probability.
The increasing uncertainty over Ukraine’s future may also swing sentiment in the days ahead. Local wars very rarely impact the stock market in a serious way long-term. A world war is a different story, but one which appears unlikely as America continues to seek a diplomatic and economic solution rather than a military one. And Europe is unlikely to make military moves without the backing of the US.
Sentiment swings markets over months. Fundamentals cause months to turn into years.
Right now, this looks largely like sentiment driven by uncertainty and not necessarily by likelihood.