Market News and Views - Heightened Uncertainty
Market volatility has returned.? After two years of the winds blowing in financial markets’ favor, the tailwinds have shifted to headwinds.? What’s going on?
Trade Policy Uncertainty
Markets hate uncertainty.? When the range of outcomes is wide with businesses and consumers finding it difficult to plan, discounts to future expectations become greater. That means the value of assets are worth?less today as a buffer against growing uncertainty. There are two areas where we see uncertainty rising off the charts. These are Trade Policy and Fiscal Policy.? The on-again, off-again nature of tariff rhetoric and the looming government funding feud with a potential government shut down after March 14th are top of mind for investors. Both measures exceed or rival levels last seen at the heights of the COVID-19 pandemic, and both have the potential for far-reaching effects.
The Federal Reserve’s Beige Book survey released on March 5th spoke specifically to tariff related uncertainty.? When businesses were asked about their input costs, they reported an uptick.? They expected this uptick would lead to higher consumer prices.
“Firms in multiple Districts noted difficulty passing input costs on to customers. However, contacts in most Districts expected potential tariffs on inputs would lead them to raise prices, with isolated reports of firms raising prices preemptively.”[1]
A look at S&P 500 company earnings reports finds a similar concern.? From December 15th through March 6th, 259 companies have included a reference to tariffs during their earnings calls. [2] The sectors with the most mentions of tariffs are the Materials, Industrials, Consumer Discretionary, and Consumer Staples sectors.? Companies within these sectors are also the ones with the largest cuts to earnings per share estimates for the first quarter of 2025.[2]?
Fiscal Policy
The U.S. budget deficit and accumulated debt is a well-known topic. The question is how to change the situation. For all the talk about government waste, fraud, abuse, etc., the budget deficit cannot be overcome by trimming around the edges. Neither can the trajectory of expanding deficits and debt be changed by cutting only discretionary spending.
The projected deficit for 2025, according to the Congressional Budget Office, is $1.865 trillion dollars. [3] A trillion sounds like a big number but what is it with some perspective??One trillion is 1,000 billion or 100,000 million.?
When someone cites a savings of $1 billion dollars, that sounds like a lot of money, but it is a 0.05% of the projected $1.865 trillion deficit for 2025. For 2025, there is projected mandatory spending of $4.228 trillion, discretionary spending of $1.848 trillion, and interest payments on the debt outstanding of $952 billion for total spending of $7.028 trillion.[3]?
Mandatory spending includes spending mandated by law.? It is primarily Social Security, Medicare, Medicaid, Child Health Insurance, the Child Earned Income Tax Credit, and Veterans Benefits.? The largest part of mandatory spending based on 2025 projections is Social Security at $1.572 trillion (37% of mandatory spending) and Medicare at $1.145 trillion (27% of mandatory spending).[3] Most of the deficit and debt problem is within mandatory spending.
Discretionary spending is a much smaller part of the projected 2025 budget at $1.848 trillion.[3] This is the running of government agencies, government functions, and defense spending. Note that eliminating ALL discretionary spending would barely close the 2025 deficit. This is not a realistic solution. Net interest on the debt is a number that can move somewhat but is driven mostly be the accumulation of additional debt through deficits. It will take time to change. Throw in an administration that wants to extend the Tax Cuts and Jobs Act and cut other taxes at a potential revenue cost of $5 - $11 trillion over ten years, and you have a recipe for skyrocketing fiscal policy uncertainty.[4]
The Effects of Uncertainty
Uncertainty immediately impacts confidence.? Both consumer and small business confidence soared after the election on optimism surrounding policy changes that people hoped would improve growth prospects.? Deregulation, improved trade deals, and tax cuts were some of the topics driving the outlook.? In reality, the sausage making process behind politics is quite messy.? This has been complicated by a chaotic administration that frequently changes its talking points and has undertaken extremely unorthodox methods. Higher confidence right after the election has given way to greater caution.
For the stock market, uncertainty and caution is impacting valuations today and may impact earnings in the future. A decline in confidence can become self-fulfilling if consumers and businesses cut back on spending. The VIX, or measure of financial market volatility, has risen sharply. Investors use the VIX to measure fear or stress in the stock market, at the same time, the S&P 500 Index price to earnings (PE) ratio has fallen. This is the stock market “pricing in” the uncertainty and declining confidence.
However, notice something about the two charts below. They only contain one year of history, but within just one year, there are similar spikes to the VIX and drawdowns in valuations. A longer history would show volatility recurs every so often as markets react to changing environments. Financial market volatility is normal.?This is particularly true for stock markets.?
History May Not Repeat But It Usually Rhymes
Market corrections happen but that doesn’t mean they’re any less pleasant when they occur. These are the times when investing fundamentals matter the most.
? Risk Doesn’t Go Away - A concentrated S&P 500 index in a few mega-cap stocks tempted people to chase investment performance by reducing portfolio diversification.? Just because financial markets are calm doesn’t mean risk doesn’t exist.? No one knows when financial markets will experience a downturn so knowing your time horizon and risk tolerance and staying in your lane can keep you from chasing performance that may result in your portfolio being too exposed to volatility in a downturn.
? Be Greedy When Others Are Fearful – Resist the temptation to panic.? Just like you shouldn’t chase performance on the upside, neither should you panic sell on the downside. Financial markets are one of the only places where people want to sell when prices are cheaper
? Market Timing Is A Bad Strategy – Studies show that emotional decisions cause the average investor to sell during downturns and depress their long-term returns.[5] Selling with correct timing also means buying back into the market with correct timing. Missing just the 10 best days in any single year can dramatically change your return.? As an example, from January 1, 2003 to December 30, 2022, missing the 10 best days meant a $10,000 investment only grew to $29,708.? Staying invested and capturing those 10 best days meant a return of $64,844. And those best days tended to happen around market bottoms when investors were still fearful and uncertain.[6]
? Plan Ahead – You should plan for market volatility just like you plan for anything important. We talk a great deal about financial planning at First Horizon Advisors. Market volatility is a big reason why. When you understand that your investments are structured consistent with your return needs and risk tolerance, you are more likely to feel at ease when market downturns hit. Financial planning incorporates market risk and stress tests your investments against your financial goals.? You can see illustrations that consider downturns in the process and show you are not off track.
Chief Investment Officer, First Horizon Advisors
Footnotes
1)Federal Reserve at https://www.federalreserve.gov/monetarypolicy/beigebook202502-summary.htm
2)FactSet Earnings Insight Report dated March 7, 2025
3) Congressional Budget Office January 2025 The Budget and Economic Outlook at www.cbo.gov/publication/60870#data
4) Committee For A Responsible Budget at https://www.crfb.org/blogs/trump-tax-priorities-total-5-11-trillion
6) Visual Capitalist at https://www.visualcapitalist.com/chart-timing-the-market/
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