Introduction

Markets have taken a decisive turn lower over the past two weeks, which has reinforced our tactical stance of caution and rotation into defensive positioning, and our short-term bearish call on US equities which we first put out on February 17,2025. Many analysts on the sell side have now also joined the chorus of negative views on the back of the recent correction. At the time of writing, the Nasdaq and S&P500 both entered correction territory, declining 13% and 10.2% from their peaks on February 20, 2025, with the Russell 2000 small caps index falling over 18% from its highs. This market correction has surrendered all of its post-election gains from the Trump election and the market tone has shifted decisively as concerns around economic growth, inflation policy, and trade tensions weighing on risk sentiment and investor outlooks. The positive takeaway, however, is that in the near term, as was seen over the last 4 trading sessions, the market was able to rebound from the lows showing some signs of resiliency, which we believe could continue if market sentiment improves off the back of more positive news and economic data. In this article, we will look at some of the positive reasons for the bounce against the major events that led to the declines.

Positive readings on Inflation

Beginning on March 11, we started to see a shift in the selling pressure as some positive signs of inflation and trade policy were able to breathe a sigh of relief for beleaguered markets. The February CPI posted a reading of 2.8% vs. consensus estimates of 2.9%, with the larger pieces driving the index, either falling or remaining stable. Food and fuel inflation both retreated in February, with food at home subcategory falling 0.2% over the month, and food away from home remaining flat with a 0 percent increase. Additionally, fuel oil fell from a 6-month series high of +6.2% in January to +0.8%, likely responding to falling oil prices represented by both the Brent crude price and WTI oil benchmarks.  The ebbing inflation data was taken positively by markets as allowing the Federal Reserve policy leeway to act if needed should economic activity begin to slow and risk employment growth. Bank of America Strategist Michael Hartnett, put out a note, citing the recent declines and threats of recession would provoke a flip in recent trade and monetary policy, which we agree would reduce the risk of continued market selling.

A Bounce from Oversold Levels

The broader market indexes and many of their weightier components saw deteriorating technical pictures, leading technical analysts to point out that equities had a chance to recover from these levels in the short term. Analysis from Bloomberg highlighted the S&P 500 index’s 14-day relative strength index hovered around the 30 level, a level consistent with being oversold. We think that the slightly better inflation data, coupled with the follow-on announcements of Senate Democrats deciding to not force a shutdown of the government on Friday helped sentiment overcome the broader concerns about economic growth and weaker University of Michigan Consumer Confidence survey numbers. The component pieces of which were the lowest seen since November 2022. We believe this bounce back to the 5,638 level on the S&P 500 helped reestablish stability leaving the market on better footing entering the new week, and should we get better tariff and trade news from the White House, believe that this snap back can continue in the short term. However, the anticipation of a structural policy shift away from tariffs and towards normalization may be premature as these are principal policy actions coming out of the Trump White House.

Trade War 2.0: A Market Disruptor Returns

The latest escalation in tariffs and trade restrictions between the U.S. and its global counterparts is reigniting concerns of a full-blown trade war. The renewed trade conflict, particularly between the U.S, Canada and Mexico, has the potential to create significant headwinds for corporate earnings, economic growth, and financial markets. The Tax Foundation estimates that the Trump administration's tariff policies could impose an effective tax increase on U.S. businesses and consumers, reducing GDP by 0.6% in the near term. Meanwhile, Goldman Sachs has warned that these tariff measures could cut S&P 500 earnings by as much as 4% if they remain in place throughout the year and has led their US Equity strategy team to lower their forecast for the S&P 500 for the year from 6,500 t0 6,200.

The direct impacts on trade are already being felt, with supply chains experiencing renewed bottlenecks. S&P Global has highlighted that U.S. import costs have risen by 18% year-over-year due to tariff-related expenses, leading to a reduction in corporate profit margins. Capital Economics has stated that this trade war resurgence is not just a temporary disruption but marks a structural shift in global trade policy, particularly as China is now shifting supply chain reliance towards regional trade partners.

From a market perspective, we have seen equities with high valuations and high international exposure under the most pressure, those sectors being auto, technology, and consumer discretionary. According to a report by Saxo Bank, investors should expect increased volatility in export-heavy industries and rotation towards domestic defensive plays and consumer staples. As tariffs continue to cloud the economic outlook, market participants are pricing in a greater risk premium, reinforcing our stance that investors should reduce exposure to high valuation, momentum growth stocks in the short term.

Momentum Unwinds: The Great Reset in High Valuation Trades

One of the most important developments in this market correction is the market’s rejection of high-valuation, momentum-driven trades. With liquidity conditions tightening and earnings expectations under scrutiny, investors are rotating away from expensive market darlings. This is an essential reset of risk pricing after years of liquidity-driven speculation. As long as uncertainty around tariffs and economic growth remains elevated, we expect this rotation to continue, pressuring the highest multiple stocks the most. We are waiting for markets to rebound a bit further on technical levels before upgrading our defensive positioning. Bloomberg technical analysis points to markets still below the 200-day moving average as a sign that markets are still on soft footing. Additionally, we believe there hasn’t been enough time for a constructive picture on the market or economy to emerge which will lead us higher. Even as we view this correction as a healthy sign, there is still too much uncertainty in the near term and potential for the correction to continue given the recent blow to consumer sentiment and lagged Q1 2025 economic data.  

Our Tactical Stance: Defense is the Best Offense

We remain tactically negative on equities, maintaining our call for caution. Our strategy continues to focus on fixed income above equities for the moment. The Modern Capital Tactical Income Fund is currently tilted 60% towards fixed, 25% equities with the remainder in cash.

The current market environment demands discipline. While market rallies may occur in the short term, we believe that until there is greater clarity on tariffs, economic growth, and monetary policy, the risk-reward dynamics in equities remain unfavorable. Staying nimble and prioritizing quality in portfolio construction will be essential for navigating the volatility ahead.