As the economy and equity markets begin to choose their paths, we at Cornerstone continue to closely monitor macroeconomic developments, particularly around the ongoing trade tensions with China.
Just last Wednesday, we once again saw the importance of examining the latest happenings. That’s when Treasury Secretary Scott Bessent gave a mid-morning speech at the Institute for International Finance. It provided support for an extremely bullish day for markets.
Our increased attention to Secretary Bessent’s comments stemmed from earlier reports indicating a closed-door discussion between Bessent and JP Morgan's clients. Bloomberg reported that he refocused the situation with China, saying it’s likely to de-escalate from its current state:
Furthermore, Bessent said the two nations were unlikely to decouple (a positive), though a long-term deal could take years. This progress is additionally supported by comments from the White House saying the administration was reviewing 18 documented trade proposals, along with ongoing discussions with 34 more countries.
While these are positive developments, it’s also clear some of the economic consequences from the ongoing trade situation are being realized. For instance, local freight numbers are steady, but forward-looking long-haul data is already down 20%:
This data suggests a deep weakness in supply chains, which could lead to the possibility of local retail issues within a few months. This is the type of data that could lead the administration to accelerate its efforts to get deals done before the expiration of the 90-day reciprocal tariff moratorium.
If so, the recent conciliatory messaging makes sense.
While supply chain risks are a potential issue, we’re encouraged that high yield spreads have kept falling. That typically happens alongside a significant drop in volatility (more on that soon) and importantly, not before a recession:
One additional positive development supporting the markets last week was President Trump’s clear statement that he has no intention of firing Federal Reserve Chair Jerome Powell.
This was a vital development because maintaining Fed independence is critical. Still, this once again highlighted the significant influence on market reactions to policy, positive or negative.
Taken together, these developments and evolving data have been enough for the markets to remain range-bound. That reflects a “wait and see” approach, suggesting investor sentiment has already priced in any significant negatives.
For instance, after the market closed last Wednesday, Tesla* announced earnings, missing estimates significantly. Regardless, the stock rose. We take that as a sign that investors have already priced any negatives in the earnings.
Policy-Driven Uncertainty
Understanding the current the macroeconomic landscape, let’s now address the terrifying “R word” – recession. Policy-driven uncertainty is at its highest level since the pandemic.
Our friends from MAPsignals put together a study on how Google searches for “recession” align with general policy uncertainty:
Some may view that as negative. But being the contrarians that we are, we know that historically when the crowds go to the extremes, it rarely plays out as expected.
That’s reflected in the forward average gains for the S&P 500#:
When economic fear is at its highest, the S&P 500 averaged 19% in the 12 months that followed.
Anecdotally, one of the reasons for this disconnect is that recessions and other significant economic issues tend to happen unexpectedly. So, when people see the possibility of recession, policymakers tend to adjust appropriately to avoid that risk.
While there's still some uncertainty regarding the current recession risk, the attorney in me must point out an important barrier. That is, there's little chance that President Trump would be able to get Congress to pass a law authorizing his overarching, sweeping tariff agenda.
This is important because on April 14, a group of businesses sued the administration over the legality of the tariff policy in the absence of prior congressional approval. Without going too far into the weeds, this matters because to enact these tariff measures, the administration cited a national emergency.
That gives the White House broad authority to act unilaterally without Congress under the 1977 International Emergency Economic Powers Act. But since 2022, the Supreme Court has been clear that when an agency or executive claims this authority to resolve policy issues with vast economic and political significance, it still must point to clear congressional intent.
There's a high likelihood these tariffs aren't mere regulatory tweaks, but transformative economic policies. So, I would argue that this Supreme Court precedent doesn’t offer a clear mandate for such sweeping actions.
Taking all these developments and data together helps provide support as to why volatility has plummeted when looking on the surface. And while many haven't noticed, recently we’ve begun to see stocks gain ground.
To help visualize this, let’s turn to important data provided by our friends at MAPsignals. In general, keep in mind that when we see selling volumes surge, stocks fall aggressively. This increase in volume is an indicator of forced selling, margin covering, and so on.
In the trade volumes chart below you can see the initial increase in volume in late February and early March (yellow arrow) overlaid against the S&P 500. The index dropped, followed by a lull, and then fell further on tariff announcements (red arrow). This created extreme capitulation, forcing stocks to crash. There’s since been a bounce back, with elevated volumes and volatility, as indicated by the green arrow.
Most interestingly, when overlaying this volatility with institutional buying and selling, we see the increases in selling that correspond with the increased volumes. Whereas since volumes and volatility settled, there has been almost no significant selling of any kind, allowing equities to begin stabilizing after capitulation:
When you understand this pattern, it helps explain things:
1. Everyone has a fear of missing out (FOMO) and buying seems to never end.
2. Outflows begin to increase, creating a peak in equity prices.
3. Selling begins to take over, which is when most pullbacks end.
4. In this case, capitulation occurred with an absence of buyers amid horrific headlines, which is rare.
Here’s an important caveat: we must remember that any headline can change the path we’re on. That said, most investors fail to realize how quickly equity markets shift from selling to buying because they're stuck in the moment and not looking forward to what is on the horizon.
As mentioned last week, the “all clear” will be when buyers begin to reintroduce themselves. But while we wait, let’s address a last positive underlying market signal: volatility.
The CBOE Volatility Index (VIX)^, which is often dubbed the market’s “fear gauge,” almost recovered more than 50% of the widening spreads last week, dropping down to 28.56 as of this writing:
That’s a stunning volatility crash.
What can we learn from history?
Our friends at MAPsignals did the work. Since 1990, there have been about a dozen instances where the VIX ascended to 40 only to subsequently drop below 30. Stocks rose from one month to two years later:
Drilling further, going back to 1990, there are only two previous instances of the VIX rising to 50, then dropping to 30. Forward performance is even more bullish:
Sitting here today, we know capitulation has come and gone, while volatility has continued to melt away. These are positive forward-looking indicators.
But as always, we’ll continue to focus on data. That’s how we ensure no changes from headlines, policy, or anything else will force us off the current path.
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*Past performance does not guarantee future results.
* TSLA is owned in Cornerstone client accounts.
# The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
^ The CBOE Volatility Index is a measure of the short-term volatility of the S&P 500 indexes, indicating how quickly market sentiment changes and the level of investor confidence or fear in the market.
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