What is Happening?
At the risk of repeating what many have likely read or heard in the news, markets do not like uncertainty. Since January 6, the news and actions coming from Washington, DC have created a wave of uncertainty that is beginning to permeate its way through all sectors of the economy and the emotions of investors. It is not clear to me, or anyone else for that matter, when the news will settle down and calm the markets. It also didn’t help that the most recent GDP outlook from the Federal Reserve Bank of Atlanta released Monday came in at a negative 2.4% for the first quarter of 2025. That is a significant change from late February when their estimate was slightly above a positive 2% growth. They provide estimates on a weekly basis and as history has shown, their estimates are very volatile and could easily move back up in future estimates. Wall Street expectations remain in the positive 1.0% – 1.5% range for now.
In addition to the situation is the increasing prospects of a government shutdown tomorrow night which is not helping. More on that below.
Future vs Now
Stock valuations are driven by future expectations, not by current reality. By default, markets do their best to discount future growth which drives the buying and selling decisions being made today. Recent earnings reports from companies have been solid and in line with expectations.
But all of that is history the moment it gets reported. Analysts immediately ignore current reports and only focus on future earnings to determine their current opinions.
All public companies host conference calls the same day they report earnings. It is during these calls that managements provide an outlook on their operating environment and future spending/investment plans. The driving theme of most, if not all, post-earnings conference calls has been on unpredictable tariff threats and fiscal policies being floated by the administration. These types of concerns make it very difficult for a company to gauge its prospects over the next 6-12 months, or longer, much less investors and analysts. With all that uncertainty, it’s easy to understand why the markets are reacting the way they are.
Risk of Recession
It’s clear that fears of a recession this year have increased substantially over the past several weeks. President Trump, in an interview on Fox News this past Sunday, rattled investors’ nerves. He was pressed by Maria Bartiromo to address the risk of a recession and answered saying “We are in a period of transition.” He did not take the opportunity to deny that we may be facing a recession later this year. He did walk back that comment earlier this week when asked directly about the possibility of a recession saying, “I don’t see it at all.”
Many economists at firms such as Goldman Sachs, Bank of America, Moody’s Analytics, JPMorgan and others, have all raised their odds of a recession in the last several days. At the start of the year, odds of a recession ranged in the 5% to 15% range. Today, the range is roughly 20% to 40% with JPMorgan at the high end. The defining factor in all the predictions is their view on how the administration’s tariff negotiations will play out. Some feel the administration will pull back “if the downside risks begin to look more serious.” Others are less optimistic given comments from Commerce Secretary Howard Lutnick today when asked if the administration’s economic policies will lead to a recession, he replied “It’s worth it.”
It’s clear that the trade war unfolding is widely considered to be the underlying reason that could cause a recession. The imposition and collection of tariffs is not as straightforward as it may sound. It is a subject that requires more discussion than I will address herein. Suffice it to say that the ongoing threats of tariffs either imposed by the US on its trading partners or the tariffs being imposed by our trading partners on the US, is creating enormous confusion in the business community making it very difficult for companies to plan for the future.
All of this can change quickly so all eyes will be laser focused on the first quarter GDP number due to be released at 8:30am ET on April 30.
What Defines a Recession?
This is not an easy question to answer. The official definition is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” That statement is commonly interpreted to mean two consecutive quarters of a decline in economic activity. Again, this is another topic that requires more discussion than I want to attempt to include in this note.
Inflation Update
This week, the Consumer Price Index (CPI) came in slightly below expectations at 2.8% which is a relief for the markets. That said, economists point out that this is a historical number and has yet to reflect any impacts from tariff policies. Given that the Federal Reserve’s inflation target is 2%, no one is expecting a cut in interest rates at their meeting next week.
Government Shutdown Update
It’s all over the news that there is a significant risk of a government shutdown looming tomorrow night. To put things in perspective, there have been 21 shutdowns in U.S. history.
- Government shutdowns happen when Congress fails to enact legislation to allocate the money needed for the operation of government agencies.
- By law, most government agencies must furlough their non-essential personnel and stop or limit their activities during a government shutdown.
- While government workers pay is halted during a shutdown, all back pay is made up once the shutdown ends.
- While few government shutdowns last long, all have resulted in increased governmental costs and inconveniences for citizens.
The most recent shutdown was in 2019 and lasted 35 days. The Congressional Budget Office (CBO), a non-partisan agency that provides to Congress objective and impartial reports and cost estimates for proposed legislation, estimated the cost the economy at about $3 billion, equal to 0.02% of GDP at the time.
No one wins when these battles happen. The politics between both parties overshadow efforts to reach a compromise. A simple solution would be to pass a Continuing Resolution (CR), a commonly used way to kick the can down the road for a defined amount of time keeping current spending levels in place. This allows the parties more time to find common ground. In the end, though, markets have been through this before and will make it through again.
Unfortunately, it is coming at a time when uncertainty is already at high levels so the quicker lawmakers from both parties can resolve the situation, the better.
Our View
When there are so many factors impacting investor emotions, it is important to maintain our focus on the long term. The declines we have seen over the past 10 days have largely been driven price declines in the largest, most overvalued technology companies. That should not necessarily be a surprise. A correction in those companies was bound to happen at some point but the timing was impossible to predict. Such moves are often triggered by exogenous factors, such as those coming out of Washington, that create a very uncertain environment and make it difficult to assess future performance.
It’s important to keep in mind that while sharp declines in indexes are always uncomfortable for investors because of our intrinsic aversion to losses, price changes that move assets closer to their fair value are a feature rather than a bug of capital markets. They ensure more capital can be invested with the expectation of a reasonable return over the long term. As always, feel free to contact me or anyone on the team if you would like to discuss any of this further. These are not normal times to be sure.
