Bouncebackability of equities

The term “bouncebackability” was coined by former football manager Iain Dowie. He made it famous during his time at Crystal Palace covering the 2003-2004 season, where the team went from near relegation to earn promotion through the play-offs. Similarly, the term could be used to describe stocks if they continue to recover from the recent lows following the surprise of President Donald Trump's broad-based and substantial tariff hikes announced on “Liberation Day” on 2 April.

To get an idea of whether this recovery is sustainable we looked back at US equity corrections. Since 1985 the S&P 500 fell into bear market (typically defined as a 20% peak to trough decline on closing prices) territory five times within 100-days. We included any intra-day movements where the market fell by up to 20% from its peak during the day’s session to increase the sample size. For example, this included the correction in 2018 where the market sold off over trade tariff concerns under the first Trump term and rising US interest rates.

Once the bear market threshold had been reached, all five examples showed gains over a subsequent 12-month period. These recoveries are often attributable to policy changes, which calm investor’s nerves. For example, during the pandemic in 2020, material monetary and fiscal policy stimulus was used to offset the risk of physical lockdowns on the economy. In the current market volatility, we have seen a significant bounce in stock markets on the partial reversal of Trump’s tariff measures.

Two significant bear markets, the dot-com bubble in 2000-02 and the Global Financial Crisis (GFC) from 2007-early 2009, are excluded from the analysis due to their distinct characteristics. These were not marked by sharp corrections, but rather prolonged declines driven by systemic issues, such as elevated valuations and corporate scandals, e.g. Enron and WorldCom, during the dot-com bubble. The GFC was marked by excessive leverage in the financial system, a housing market collapse, inadequate subprime lending practices and a global economic recession.

In terms of catalysts, several factors could drive US stocks up from here. First, if President Trump continues to ease back on his protectionist measures and negotiates favourable deals with trading partners, it would create an environment conducive to market growth. This looks possible. Commerce Secretary, Howard Lutnick, emphasized that the "Liberation Day" tariffs were designed to encourage trade negotiations and dealmaking with global partners. Meanwhile, Treasury Secretary, Scott Bessent, noted that over 75 governments were discussing tailored agreements to avoid disruptive tariffs. Clearly, there is plenty of risk around whether Trump de-escalates the trade war he started.

Second, the weakening US dollar signals that there is potentially money on the sidelines that could go back into the riskier assets like equities. While the dollar is losing value it looks less attractive as a safe-haven asset, encouraging investors to seek better returns elsewhere. This shift in sentiment could drive increased investment in equities, especially in sectors poised for recovery or growth. The falling dollar also boosts the competitiveness of U.S. exports, potentially supporting corporate earnings and further incentivising investors. However, if the dollar falls uncontrollably, it could undermine investor confidence in financial markets, including stocks.

Third, companies delivering and/or beating analyst earnings’ expectations could also boost stocks. Although the full impact of the US tariff increases is not yet known, the latest earnings season of the first quarter for those US companies in the S&P 500 that have reported so far (90/500) are still positive. Bloomberg data shows that actual earnings are 5.9% higher than analyst forecasts in the first quarter, down only marginally from 7.1% in the fourth quarter, but it is up from 4.8% and 2.7% in the third and second quarters, respectively. 

Outside the US, it is possible that companies come out of the tariff war with higher profit margins. Take Sony. It recently hiked the retail price of its PlayStation 5 by 25% in certain regions, like Europe and Japan, citing “a challenging economic environment”¹.  However, there is a 90-day pause on US “reciprocal” tariffs and it is not clear why the prices were raised in Europe. This could improve profit margins. 

There are multiple risks that emanate from trade tariffs. These range from the uncertainty coming out from policy changes from the Trump administration to retaliatory action from other trading partners of the US, especially China, and bond market volatility. 

Arguably, one key risk watch is whether the US slips into recession. If that were to happen that could lead to lower company earnings and potentially, another leg down in equities. Investors have a good reason to worry about a US recession. According to JPMorgan's analysis of data spanning the past century, the average S&P 500 correction during recessions has been around 35%. 

US recession fears are growing. The Atlanta Fed’s GDP nowcast, an early read of economic performance using macro data already reported, shows that the US real GDP is likely to decline by 2.3% in the first quarter¹. However, it is worth noting that when the Atlanta Fed’s GDP nowcast is adjusted to exclude a sharp rise in imported gold on fears of tariff increases, its estimate shows US real GDP is essentially flat. 

Crucially, the US labour market remains resilient. That’s probably because corporate profit margins are high enough to cushion against significant layoffs. While the full effects of tariffs are yet to materialise in payroll data, high-frequency indicators, like jobless claims, remain stable for now. This suggests that the risk of a US recession is still low.

Equity markets are likely to remain volatile presenting both opportunities and risks. Equity valuations have become less demanding compared to a month ago. Should Trump row back on some of his extreme tariff agenda and/or deals are reached with US trading partners, this could create an opportunity for equity investors. 

However, diversification remains crucial amid heightened volatility, and investors are increasingly turning to gold as a safe-haven asset. Gold prices have climbed, supported by central bank purchases, US dollar depreciation and declining trust in the greenback as a store of value. While the US president's policies may shift, gold remains a steadfast choice for investors in these uncertain times.

1. LSEG Datastream / Evelyn Partners