A method to the madness?

Music City is booming! I love to see my beloved brother on trips to Nashville, plus there’s much more than just music. On any given day, there is a party bus or flatbed, complete with a hot tub, and bikini-clad ladies—this city tops the list for bachelorette parties, and is “not conducive to professional business luncheons,” shares a local banker. But Nashville also tops the list for business meetings! I spoke before an audience of 650 (if I may boast a wee) at the massive Omni Nashville Hotel. The market has been harder to love lately, with widespread selling, especially in some heady tech names. President Trump has said that he’s “not concerned” about the market’s response to tariffs. That may indicate the pullback will be a little more severe than market participants would like, but still likely a normal correction (limited to 10-15%). In February, the S&P 500 fell 1.3%, but nearly half (49%) of stocks gained, the best showing in a down month since February 2016. The Russell 1000 Value edged higher in February (0.2%) while its Growth counterpart fell 3.7%, a 95th percentile spread favoring Value going back to 1979. The S&P 500 and the Nasdaq may have support at their 200-day moving averages, and March and April are historically strong months for equities. With the market looking oversold, positive economic data could turn things around. Now, analysts have cut the Q1 earnings estimates for S&P 500 companies by 3.5% so far this year, well more than average. It appears that tariffs are to blame; so far at least, executives themselves think they’ll be able to handle the tariffs just as they did in the first Trump administration.

After another on-again, off-again tariff rollout, Trump has granted tariff exemptions until April 2 on goods from Canada and Mexico that are covered by the United States-Mexico-Canada Agreement (USMCA). That agreement is said to apply to 50% of Mexican imports and 36% of those from Canada, though in practice those numbers may be higher. The global reciprocal tariffs slated for April 2 remain on track—for now, anyway. Even more than in his first term, Trump has placed tariffs at the center of his ambitions. But it seems he is casting about for a position that will be defensible amidst a market decline. (Supposedly, the administration isn’t listening to equities, just the 10-year yield. The pullback from equity highs just hasn’t been enough, yet.) Unilateral tariffs against America’s neighbors have not won the market’s favor. Maybe reciprocal tariffs (a term that lacks firm definition) and tariffs against China will fare otherwise. The April 2 reciprocal tariffs will likely be broadly, yet selectively, applied. Broadly, because they can be applied against almost any country. Selectively, because Trump can thereby use them as leverage to influence behavior. Trump wants to renegotiate the USMCA trade deal with Canada and Mexico this year, rather than in 2026 as scheduled. A key point will likely be ensuring that the two countries align their tariffs on Chinese goods with US policy, to prevent China using Mexico or Canada as a conduit.

Markets (and employers!) hate uncertainty. Trump’s tariff plans have been walked back, but Treasury Secretary Bessent defended the overall tariff policy, saying that “access to cheap goods is not the essence of the American dream.” Will something break, though, as the administration seeks to shift the focus of the immense American economy away from consumption and towards production? I worry that the market could lead the economy downwards, if investors (and employers!) get panicked by the implications of heavy tariffs. Most of the tariffs are about raising money or asserting control over some other policy (such as immigration flows from Mexico), or simply about reciprocity. The tariffs against China, however, feel more visceral—not to change China’s behavior so much as to diminish the relationship itself. Trump has imposed more tariffs on China already than he did in his first term. The Federal Reserve isn’t predisposed to see tariffs as deflationary, something the 2018 Trump tariffs proved to be. It took a 20% dive in the S&P 500 to get the Fed to cut rates in that episode. Maybe that explains why the AAII’s measure of bullish sentiment stands at -38%, a hair better than the week before but still terribly depressed. Given that sentiment is a contrary indicator, this could be a good setup for a rebound, as we head into a seasonally strong period for the market. Fundstrat points out that going back to 1928, the S&P 500 has returned 8% but that without the 10 best days each year, that falls to -13%, a 2100 basis point swing. In other words, time the market at your peril!

Positives

• A method to the madness? China’s retaliatory tariff increases are much lower in scope than what the US has imposed, while the actions against US companies avoid taking aim at major firms. This measured response suggests Beijing wants to preserve space for negotiations with the Trump administration and avoid further escalation. Also, the Chinese government set a budget deficit target of around 4.0% of GDP, the highest level in years, an indication the government plans to open its purse strings to boost economic growth. Meanwhile, Germany announced an era-defining change in fiscal policy to boost defense and public investment as Europe scrambles to adjust to a new security reality without a benign US protector. Invoking Draghi’s famous "whatever it takes" remark, Germany's incoming chancellor said he undertook the move “in view of the threats to our freedom and peace on our continent.”
• AI to the rescue? Nonfarm business productivity rose 1.5% in Q4, leaving Q4/Q4 productivity up 1.9% for 2024, compared to the 1.6% pre-pandemic trend. Unit labor costs rose at a 2.2% annualized pace in Q4, leaving the pace of unit labor cost growth at 2.0% over the year in Q4, down from the 2.7% pace in the pre-revision report. Piper Sandler suggests that the welcome upward productivity revisions for 2023 and 2024 attest to the power of the AI-driven capex cycle—putting downward pressure on unit labor costs (compensation gains minus productivity gains), helping cool core inflation last year.
• Good news, here and there The trade deficit widened in January for a third consecutive month to a record $131.4 billion, driven by large gold imports. Exports expanded by 1.2% over the month, while imports spiked by 10.0% (or $36.6 billion). However, imports from China, Canada and Mexico rose $3.3 billion, $3.0 billion, and $0.9 billion, respectively in January, signaling that front-loading from these may not be to the extent feared. Elsewhere, construction spending contracted 0.2% in January, matching expectations. The surprisingly strong 13.2% rise in building permits suggests January's unusually cold weather may have temporarily hampered activity. And, the Fed’s Beige Book summary of regional business contacts reported economic activity rose "slightly" from mid-January through February 24. In many districts, contacts expressed optimism about the economic outlook, tempered by domestic policy uncertainty. 

Negatives

• Payroll employment growth was acceptable as it was better than whisper fears, but less than consensus estimates. Payrolls rose 151K in February, but the influence from DOGE should start to hit next month. The unemployment rate edged up to 4.1%. Average hourly earnings are up 0.28% m/m, which translates into a still strong 4.0% y/y gain. Also, in February’s Challenger, Gray & Christmas report, employers announced plans to cut more than 172,000 jobs, a dramatic increase from January's 50,000 and the highest level since July 2020. The federal government led the cuts, shedding over 62,000 jobs.
• Manufacturing signaling stagflation? The ISM manufacturing index slipped to 50.3, barely indicating expansion, down from 50.9 in January. The ISM new orders component contracted sharply, falling to 48.6, its largest monthly decline since April 2020. The employment index fell to 47.6, indicating contraction for the eighth time in nine months. Price pressures intensified significantly, likely fueled by tariff concerns. However, with weakening demand signaled, it's unclear how much of these price hikes will stick and what the ultimate impact on consumer prices will be. Trahan Macro reminds there’s always a moment in the cycle when “stagflation” fears flare up, usually right after the Fed stops hiking rates—new orders cool off quickly, while inflation lingers.
• Mixed signals from Services The ISM Services PMI rose to 53.5 in February, up from 52.8 in January, exceeding consensus expectations of 52.5. While this signals continued expansion in the services sector, the details of the report reveal some underlying concerns. New orders, a key indicator of future demand, increased to 52.2, but commentary suggests this strength may be artificially inflated by businesses stockpiling concerns. The prices-paid component accelerated to 62.6, a concerning development pointing to persistent price pressures in the services sector, as were seen in the manufacturing sector. The breadth of data suggests GDP running in a 1% to 1.5% range for Q1, according to ISI.

What Else

A method to the madness? Watching Trump impose tariffs on America’s largest trading partners reminds Strategas of the 2016 Republican primary when Trump went after Jeb Bush, the frontrunner. By knocking out Bush first, he was left with less competitive candidates. Trump showed his tariffs are real. Europe in particular should be looking to build out their offers for fewer tariffs as they could be next.

It’s all about the earnings S&P 500 forward EPS suggests that actual EPS also will rise to a new high during Q1, says Yardeni Research. Also, during Q1, the profit margin is likely to rise closer to its record high. Strategas notes that over the past 45 years, every recession has been preceded by a negative y/y change in forward EPS.

Consumers need relief Renaissance Macro notes that subprime auto loan delinquencies have reached a 30-year high, signaling growing financial strain on American consumers. Fitch Ratings reports that in January 2024, 6.6% of subprime borrowers were at least 60 days delinquent on their car loans, the highest rate since data collection began in 1994. The New York Federal Reserve reported a fourth-quarter peak of 3% of all auto loans transitioning into serious delinquency (90+ days past due), a level unseen since 2010. To the positive, Strategas highlights the surge of tax refunds in February, which may be an underappreciated consumer boost.