Now What?
Last week, we discussed how the S&P 500 officially moved into a correction (down more than 10% from the February 19th peak). We noted then that most years (even some of the best years) see volatility and scary headlines, with many of those years seeing a 10% correction at some point in the year.
Another angle on the correction though is how quickly it happened. If your head is spinning at going from an all-time high to down more than 10%, then you aren’t alone, as this was one of the quickest trips ever to do just that. In fact, it took only 16 trading days to achieve this dubious feat, but it turns out this isn’t really bad news.
We found six other corrections off an all-time high that took place in less than one calendar month (or about 21 trading days) and the good news is quick snapbacks are quite common. In fact, the S&P 500 has never been lower three and six months later, with an average return six months later of an extremely impressive 14.7%. Who said roller coasters weren’t fun?
We are on record that we don’t think this will turn into a full-fledged bear market, which means stocks won’t be down 20% or more. That right there is a reason not to sell, but assuming that is the case, we found 12 other times stocks moved from an all-time high into a correction, but didn’t fall into a bear market. Looking into this showed stocks were higher six and 12 months later every single time, with much better than average returns as well.
What we found incredible was that five of those 12 times saw stocks bottom the day they moved into a correction (which in the current case is Thursday, March 13th). That is way more than I would have ever expected. Will we do it again? Well since we haven’t violated the March 13th low yet, we think there’s a chance.
Some More Good News
Some more good news and why you shouldn’t sell right now is we saw a potential buying thrust, consistent with higher prices coming. How do weak markets end? I like to say when the selling stops. Kind of obvious, but with all the negativity we’ve seen anyone who wanted to sell likely has done so, leaving only buyers. Well, the buyers showed up a week ago Friday and last Monday, as both days saw more than 90% of the components of the S&P 500 higher. This is extremely rare but could be a clue a major low is in place or trying to form.
The last time we saw this was in early October 2022, right as that bear market was ending. You can see on the table below we’ve seen strong returns after previous buying thrusts, with the S&P 500 higher six months later 10 out of 11 times and up nearly 11% on average. This coupled with the data from above suggests the potential for better-than-expected returns over the next six months, which might surprise many investors who are positioned for the worst.
Not All Corrections Become Bear Markets
We found 13 official bear markets (down 20% from recent highs) going back to World War II, with many asking whether this could become number 14. We don’t think so, and a nice way to show this is to highlight that most corrections don’t become bear markets.
We found only 13 of the previous 39 corrections eventually turned into bear markets. Or as we like to say, all bear markets started as a correction, but not all corrections turn into a bear market.
The Fed Is Stuck Waiting, and That’s a Problem
The Federal Reserve concluded its latest policy meeting Wednesday and opted to keep the fed funds rate unchanged, leaving it at a target range of 4.25-4.5%. This was not unexpected, but all eyes were on the Fed’s “dot plot” (expected path of interest rates) and the rest of its Summary of Economic Projections (SEP). The SEP is updated every three months and contains individual member estimates of the fed funds rate over the next few years, as well as estimates of key economic variables (unemployment rate, inflation, GDP growth). The last update was in December and was viewed hawkish. This time around, there was a big question around what members would do with their inflation projection, especially in the face of tariffs, and how they would shift their policy rate projections. It was interesting to say the least, with members projecting higher inflation, higher unemployment, and slower growth:
- Their 2025 core PCE projection rose from 2.5% to 2.8%
- The 2025 unemployment rate projection rose from 4.3% to 4.4%
- Real GDP projection for 2025 fell from 2.1% to 1.7%
To be clear, these levels are nothing close to stagflationary, even if the direction of travel was akin (at a much smaller scale) to stagflation, with inflation expectations moving further away from their inflation target of 2%. In addition, the median member projected a policy rate of 3.9% in 2025, implying two rate cuts this year, unchanged from December. In fact, their core inflation projection for 2025 has decidedly moved away from their target over the past year and half, even as their policy rate projection has stayed put. By itself, this is quite dovish, and it’s not a big surprise why equity markets rallied and bonds gained as interest rates pulled back.
“Transitory” Makes an Unexpected Comeback
It was three years ago at the March 2022 Fed meeting that Fed Chair Jerome Powell said inflation was likely transitory. Of course, Powell, and the Fed, have been haunted by that ever since. However, “transitory” is back, at least going by the dot plot.
Even as Fed members increase the 2025 core PCE projection to 2.8%, they left the projection for 2026 at 2.2% and for 2027 at 2%. In other words, they think tariffs may simply cause a one-time shift upwards in the price level, boosting inflation temporarily, after which inflation will revert back to the expected trend (although price levels will be higher). There’s some irony that a lot of people in the current administration who are embracing the transitory narrative around tariffs are some of the same people who mocked Powell and Co for saying inflation was transitory a few years ago.
The transitory narrative kind of explains why the median policy rate projection didn’t shift. Why move policy rate projections if higher inflation is expected to be transitory? Powell also mentioned that long-term inflation expectations remain stable, downplaying the popular University of Michigan survey, which showed 1-year inflation expectations surging to 4.9% and 5-year ahead expectations jumping to 3.9%, the highest we’ve seen over the past decade. This is likely colored by politics (though not all of it), and Powell was quick to dismiss it as an outlier.
BUT the Fed Is Not in a Hurry to Cut, Amid a Lot of Uncertainty
Powell: “I don’t know anyone who is confident of their forecast.”
Powell rationalized the apparent dovishness of the dot plot by saying the risk of slower growth balances out the risk of higher inflation. However, he said there’s a lot of uncertainty here, and the dot plot illustrated this quite nicely.
The median dot, which is where the projections come from, hides a lot of varied thinking across Fed members. Back in December, four members (out of nineteen) projected less than one cut in 2025, with three projecting one cut and one projecting none. In March, eight members now project less than two cuts, with four projecting one cut and four projecting none. On the other end, back in December, five members projected three or more cuts in 2025. That’s fallen to just two members now.
Along with their dot plot, Fed members also put out their expectations for uncertainty and risks around economic variables like inflation and unemployment, assessing whether it was lower, broadly similar, or higher. This got a lot of play in December, as there was a big jump in members who viewed uncertainty and risks around inflation to be higher. Even more members think this as of March.
- 17 of 19 members now say inflation uncertainty is higher, versus 14 in December
- 18 members say inflation risks are higher, versus 15 in December
At the same time, members are a lot more worried about a slowing economy and rising unemployment.
- 16 of 19 members say uncertainty about the unemployment rate is higher, versus just 8 in December
- 17 members say risks to the unemployment rate are higher, versus 7 in December
The data above highlights the Fed’s quandary. Policy rates are clearly restrictive. The policy rate is 4.4% right now, well above the “neutral” rate of 3% (the rate that is neither too accommodative nor too tight). Under normal circumstances, they’d likely be easing rates already, especially since they’ve repeatedly made clear that they want to hold on to labor market gains, even as the inflation outlook looks good. Powell once again noted that the labor market isn’t a source of inflationary pressure, which is important because that’s usually where the Fed can apply pressure to rein in inflation.
However, Powell’s been explicit that Trump administration policies across four dimensions have created a lot of uncertainty for them. Tariffs are the main cause, but also immigration, fiscal policy, and deregulation. Tariffs have created enormous uncertainty about short-run inflation, preventing them from easing rates further. Powell was clear:
“We now have inflation coming from an exogenous source.”
On the other hand, there’s uncertainty around growth and employment too. For now, the hard data suggests the economy is doing fine, but sentiment is weak (though that doesn’t mean it has to translate to a weaker economy). At the same time, hiring is clearly weak, with the hire rate running close to 2013 levels—by no means terrible, but much lower than it was in 2018-2019 or even 2022-2024. The good news is that the unemployment rate remains low because layoffs are low. This balance has held for 6-8 months now, but there’s uncertainty around whether that continues, or breaks one way or the other. It’s an important question. Do hires pick up from here, or do layoffs increase?
All this means the Fed is on hold, as they maintain that they’re not in a hurry to cut rates. They’re going to wait for more data to come in and then react to it. This is a big difference from last year. The unemployment rate climbed from 3.9% to 4.2% from April to July, which was still historically low. But the Fed decided to “go big” with a 0.5%-point cut in September to preempt further weakness. Contrast that to today. They’re essentially going to wait until things really break before acting. In fact, Powell admitted that members were uncertain and as a result inertia took over, and most members stayed in place with respect to their rate cut projections.
The problem is the economy may not be able to handle the Fed sitting on their hands while rates remain restrictive. As we wrote in our Outlook 2025, elevated rates are still a big risk to the economy, especially for cyclical areas like housing. Looks like that’s going to continue for now, on top of policies from the other side of DC.
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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