Executive Summary
Corporates and consumers have become more conservative recently based on recent data, which has yet to reflect the full impact of the recent Tariff Tax Turmoil. The good news is that we have a largely domestic, services-oriented economy, and while tariffs are disruptive in the short-term, the impact can be contained if the recently-announced sizes are scaled back. However, we believe tariffs will probably settle above 10% effective tariff rate vs. 2.5% in January 2025. Beyond the White House, the Fed is a stakeholder focused on both inflation and full employment. While progress has been made off the post-pandemic peak, inflation remains sticky (we are monitoring if inflation expectations become unanchored), creating a challenge for the Fed to cut in the event of a slower growth backdrop.
Wall Street Industry analysts have been lowering their S&P 500 earnings per share estimates, but they remain high for 2025 and 2026, up 9.2% and 14.2% year over year, respectively. Those estimates are likely to fall over time, as estimates typically do since analysts tend to be too optimistic early in the calendar year. They will fall meaningfully if the magnitude and duration of the Tariff Tax Turmoil persists with increasing odds of a recession.
S&P 500 forward P/E is at 18.1x at 4/7/25. That’s relatively high given the downside risk to earnings. However, the forward P/E ratio on the S&P 500 has fallen from 22.2x to 18.1x, a material valuation re-rating. The 30-year average forward P/E is ~17x, and a typical recession reading is roughly 15x with a Great Financial Crisis (GFC) type downside to 10x. We do not believe this is a GFC scenario.
As for fixed income, we still prefer quality and maintain a bias for investment grade corporate bonds and municipals over high yield. In our view, the Fed is going to be on hold for the 1H and then cutting in the 2H of 2025. The bond market rallied (price up / yield down) over the course of the week, but backed off last Friday and Monday this week as Powell said they are on hold as tariffs could prove to be inflationary. However, inflation likely moderates over 2025 especially now as commodity prices have recently tumbled. We believe the market volatility will challenge the housing market, making price increases harder to come by. If housing prices moderate and energy prices remain anchored, goods inflation from tariffs likely will not be enough to significantly re-accelerate inflation. As for credit markets in fixed income, we would look for spreads at 6-10% as part of the mosaic of potential market capitulation and a sign of a possible market bottoming. To end last week, spreads widened to 427 bps again cheaper, but not cheap.
Finally, our focus on recession indicators includes not only high yield spreads but also initial jobless claims. Historically, high yield spreads have widened several times without initial claims rising, resulting in non-recessionary buying opportunities. Thus far initial claims have remained anchored, but the increase in layoff announcements usually leads to higher unemployment claims. We are being patient and are focused on high quality income and equity opportunities.
Equities
The S&P 500 returned -9.1% as President Trump unveiled tariffs much larger than anticipated and expected; markets began to price in a substantial economic slowdown, and higher inflation as the result of a potential full-blown trade war. Mid cap stocks returned (-9.1%) and small caps (-9.6%). Energy (-14.1%), technology (-11.4%), and financial services (-10.2%) were the hardest hit sectors in the S&P 500; no sectors had a positive performance. EAFE markets returned -6.9%; EM markets returned -2.9%.
From a valuation perspective, no markets trade above +1 standard deviation based on historical forward P/E ratios with the S&P 500 at +0.7. The NASDAQ is at +0.1. For the next 12 months, EPS growth for S&P 500 is expected to be 9.8% (vs. 6.9% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 16.4% (vs. 10.7% annualized over the last 20 years). The S&P 500 (US Large Cap), NASDAQ, MSCI EAFE (Non-US Developed Market Equities), and MSCI EM (EM Equities) trade at or above their 20-year averages based on forward P/E ratios while the Russell Midcap (US Midcap) and the Russell 2000 (US Small Cap) are inline.
Fixed Income
Investment grade fixed income sectors had positive returns as yields fell sharply across the curve, though offset by spread widening. Municipals returned +1.7%, US AGG returned +1.1% and US IG returned +.6%. HY bond returned -1.8% as spreads widened 87bps while bank loans returned -1.4%. EM debt returned -1.8% as the US dollar fell 1.0%.
Rates
Rates fell sharply across the curve as markets began to price in slower economic growth. The recession-watch 3M-10Y spread widened 22bps to -27 and remains inverted. The 2Y-10Y spread was unchanged at +34. Rates fell in Europe and the U.K. but rose Japan. The BTP-Bund spread is at 1.19%. 5-year breakeven inflation expectations rose 23bps to 2.40% (vs. a low of 1.88% on Sept 10); 10-year breakeven inflation expectations fell 17ps to 2.19% (vs. recent low of 2.03% on Sept 10); the 10Y real yield fell 8bps to 1.80%. The market now expects between three and four cuts in 2025 vs the Fed’s guidance of two cuts. At year-end 2025, the market expects the Fed Funds rate to be 3.4% vs. the Fed’s guidance of 3.75%-4.00%.
Currencies/Commodities
The dollar index fell 1.0%. The commodities complex fell 6.7% while energy prices fell 9.2% for the week. Brent prices fell 11% to $66/bbl. US natural gas prices fell 5.6% while European gas fell 9.5%, both due to forecasts for slower economic growth.
Market monitors
Volatility rose sharply for equities and for bonds (VIX = 45, MOVE = 126); the 10-year average for each is VIX=18, MOVE = 78. Market sentiment (at midweek) remained negative at -40.
Weekly Commentary
Investment Commentary – April 7, 2025
Stuart Katz
Executive Summary
Corporates and consumers have become more conservative recently based on recent data, which has yet to reflect the full impact of the recent Tariff Tax Turmoil. The good news is that we have a largely domestic, services-oriented economy, and while tariffs are disruptive in the short-term, the impact can be contained if the recently-announced sizes are scaled back. However, we believe tariffs will probably settle above 10% effective tariff rate vs. 2.5% in January 2025. Beyond the White House, the Fed is a stakeholder focused on both inflation and full employment. While progress has been made off the post-pandemic peak, inflation remains sticky (we are monitoring if inflation expectations become unanchored), creating a challenge for the Fed to cut in the event of a slower growth backdrop.
Wall Street Industry analysts have been lowering their S&P 500 earnings per share estimates, but they remain high for 2025 and 2026, up 9.2% and 14.2% year over year, respectively. Those estimates are likely to fall over time, as estimates typically do since analysts tend to be too optimistic early in the calendar year. They will fall meaningfully if the magnitude and duration of the Tariff Tax Turmoil persists with increasing odds of a recession.
S&P 500 forward P/E is at 18.1x at 4/7/25. That’s relatively high given the downside risk to earnings. However, the forward P/E ratio on the S&P 500 has fallen from 22.2x to 18.1x, a material valuation re-rating. The 30-year average forward P/E is ~17x, and a typical recession reading is roughly 15x with a Great Financial Crisis (GFC) type downside to 10x. We do not believe this is a GFC scenario.
As for fixed income, we still prefer quality and maintain a bias for investment grade corporate bonds and municipals over high yield. In our view, the Fed is going to be on hold for the 1H and then cutting in the 2H of 2025. The bond market rallied (price up / yield down) over the course of the week, but backed off last Friday and Monday this week as Powell said they are on hold as tariffs could prove to be inflationary. However, inflation likely moderates over 2025 especially now as commodity prices have recently tumbled. We believe the market volatility will challenge the housing market, making price increases harder to come by. If housing prices moderate and energy prices remain anchored, goods inflation from tariffs likely will not be enough to significantly re-accelerate inflation. As for credit markets in fixed income, we would look for spreads at 6-10% as part of the mosaic of potential market capitulation and a sign of a possible market bottoming. To end last week, spreads widened to 427 bps again cheaper, but not cheap.
Finally, our focus on recession indicators includes not only high yield spreads but also initial jobless claims. Historically, high yield spreads have widened several times without initial claims rising, resulting in non-recessionary buying opportunities. Thus far initial claims have remained anchored, but the increase in layoff announcements usually leads to higher unemployment claims. We are being patient and are focused on high quality income and equity opportunities.
Equities
The S&P 500 returned -9.1% as President Trump unveiled tariffs much larger than anticipated and expected; markets began to price in a substantial economic slowdown, and higher inflation as the result of a potential full-blown trade war. Mid cap stocks returned (-9.1%) and small caps (-9.6%). Energy (-14.1%), technology (-11.4%), and financial services (-10.2%) were the hardest hit sectors in the S&P 500; no sectors had a positive performance. EAFE markets returned -6.9%; EM markets returned -2.9%.
From a valuation perspective, no markets trade above +1 standard deviation based on historical forward P/E ratios with the S&P 500 at +0.7. The NASDAQ is at +0.1. For the next 12 months, EPS growth for S&P 500 is expected to be 9.8% (vs. 6.9% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 16.4% (vs. 10.7% annualized over the last 20 years). The S&P 500 (US Large Cap), NASDAQ, MSCI EAFE (Non-US Developed Market Equities), and MSCI EM (EM Equities) trade at or above their 20-year averages based on forward P/E ratios while the Russell Midcap (US Midcap) and the Russell 2000 (US Small Cap) are inline.
Fixed Income
Investment grade fixed income sectors had positive returns as yields fell sharply across the curve, though offset by spread widening. Municipals returned +1.7%, US AGG returned +1.1% and US IG returned +.6%. HY bond returned -1.8% as spreads widened 87bps while bank loans returned -1.4%. EM debt returned -1.8% as the US dollar fell 1.0%.
Rates
Rates fell sharply across the curve as markets began to price in slower economic growth. The recession-watch 3M-10Y spread widened 22bps to -27 and remains inverted. The 2Y-10Y spread was unchanged at +34. Rates fell in Europe and the U.K. but rose Japan. The BTP-Bund spread is at 1.19%. 5-year breakeven inflation expectations rose 23bps to 2.40% (vs. a low of 1.88% on Sept 10); 10-year breakeven inflation expectations fell 17ps to 2.19% (vs. recent low of 2.03% on Sept 10); the 10Y real yield fell 8bps to 1.80%. The market now expects between three and four cuts in 2025 vs the Fed’s guidance of two cuts. At year-end 2025, the market expects the Fed Funds rate to be 3.4% vs. the Fed’s guidance of 3.75%-4.00%.
Currencies/Commodities
The dollar index fell 1.0%. The commodities complex fell 6.7% while energy prices fell 9.2% for the week. Brent prices fell 11% to $66/bbl. US natural gas prices fell 5.6% while European gas fell 9.5%, both due to forecasts for slower economic growth.
Market monitors
Volatility rose sharply for equities and for bonds (VIX = 45, MOVE = 126); the 10-year average for each is VIX=18, MOVE = 78. Market sentiment (at midweek) remained negative at -40.
Disclosure and Source
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