After last week, hopefully everyone is still maintaining a regular heartbeat and breathing pattern. It seems like every day recently has brought new headlines that are triggering not just daily, but intraday market-moving bouts of volatility.
Look no further than last Tuesday’s trading session. Equities initially surged in the morning, up 4.5% before reversing into the close at -1.5%, for total intraday move of 6%.
Not to be outdone, Wednesday saw markets down over 3%, only to see the S&P 500* close almost 10% higher. It was an over 13% intraday move.
If it wasn't already clear, these types of whiplashes are causing historic volatility merely due to new headline news throughout the day. Why is that the case?
Let's rewind a bit. In Cornerstone’s opinion, there has been significant uncertainty regarding two potential paths for the market and the economy. One path leads to the economy and markets reaching a positive outcome. The other steers towards a potentially unnecessary recessionary environment.
Prior to last Wednesday especially, the uncertainty of which path would be taken was causing extreme volatility.
The positive path includes extensive bilateral agreements leading to a reduced trade deficit and strategic, unified cornering of China. It’s an effort to force the country to play by traditional global trade rules for the first time.
Put another way, the U.S. and many other allies would form an economic treaty organization of sorts. They would then combine to combat China’s trade practices.
The other path, known as the negative path or the “Peter Navarro path,” ends with huge reciprocal tariffs on everyone. In this scenario, the across-the-board tariffs would be in place for an extended time, effectively freezing the economy.
The negative path’s biggest risk would be that American businesses continue to not know how to react, plan or invest while the government would be effectively nationalizing the cash flows of multinational companies.
In the scenario, the concern of some would become reality. That is, the White House is not acting strategically, but irrationally.
This path would be confirmation the “covenant of capitalism” we talked about last week has truly been broken.
Now understanding the two paths at play, last Wednesday (as well as the development over the weekend exempting some tech tariffs) marked an obvious, meaningful turn towards the positive path with the 90-day delay in reciprocal tariffs:
This sent a clear message to China. As the administration opened a 90-day negotiation window with every other country, it simultaneously increased the tariff rate on China for the third time, all the way to 125%.
In our opinion, there were multiple positive developments that created the environment for an immediate, V-shaped market recovery right around 1 p.m. Eastern last Wednesday. It nearly erased all the losses absorbed by the market two Thursdays ago when the tariff escalation began.
This began to restore market confidence, which we believe can be summarized by three positive developments.
First, the 1 p.m. announcement reestablishes the credibility of the “White House administration put,” as we saw a willingness by the administration to intervene if downside pressure threatened broader sentiment. This adds confidence for investors who might otherwise fear a bidless tape if both the Federal Reserve and the White House were sidelined.
Second, companies have a new narrative to guide forward expectations, even if it's to cut guidance, without triggering panic. We can look specifically to last Wednesday, when Delta Airlines stock went up 22.91% on the day despite withdrawing full year guidance that morning. This is an example of how investor expectations may be recalibrated more constructively.
Finally, the temporary tariff pause introduces the probability of the longer-term shift that allows for de-escalation and a new economic trade coalition via negotiation. That shift will open the door for renewed optimism around corporate earnings and economic growth. Ultimately, this helps improve market psychology, potentially beginning a short-term rally that could morph into a V-shaped recovery.
Of course, some wonder if this has been merely a “dead cat bounce.” That’s yet to be determined. Since 1929, only four of 11 instances similar to this one with V-shaped bottoms retested lows after moves like last Wednesday:
More likely is that the “V-bottoms rule” unfolds, where we see a recovery almost as fast as the decline:
It's too early to tell for sure, but we're beginning to see technical factors suggesting the low was in place and that market breadth bottomed. Treasurys rallied last Wednesday after a successful Treasury auction and seemed to have calmed the early morning uproar over tightening credit swap spreads:
Furthermore, from a technical perspective, it appears that the S&P 500 held the 50% retracement level of its 2022-25 advance at around the 4,800 level. This is an extremely important technical support level.
Keep in mind, after last Wednesday's aggressive V-shaped rally, the market closed at almost 5,400. Now we must see if the market can exceed the next support level of 5,500. While we don’t often write about technical data, in extremely volatile periods like now, these technical support levels become vital to provide clarity into the market.
Let’s finish with another plea to take a deep breath and remember that it’s crucial to stay invested so you don’t miss the market’s best days. If you miss them, your returns suffer greatly.
Since 2015, without the 10 best days in the market each year, the S&P 500’s average annual return drops from 12% to -10%:
Don’t be one of the ones to emotionally exit the market. If you do, you’ll miss out on critical daily rebounds like what happened last week and put long-term performance at risk.
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