Research.LeutholdGroup

The market decline will almost certainly be accompanied by a recession. For months we’ve maintained that the wealth effect had become the main support of an expansion whose list of beneficiaries had been narrowing like that of stock breadth and leadership. The administration’s draconian tariffs will deserve some blame, but it’s not partisan to underscore that the expansion was on precarious footing long before the Tariff Tantrum.

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The stock market losses in 2025 have materialized so rapidly that many investors might feel trapped, hoping for a bounce that provides better exit prices. The challenge may be that an imminent bounce and the “new narrative” to support it will seem so compelling that the urge to exit may dissipate.

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The risk is now extremely high that the breakdown in confidence will become self-fulfilling. The near 30-point collapse in Consumer Expectations from the post-election high could translate into a reduction in real-GDP growth of more than two percentage points over the next year.

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The gap between the ISM Manufacturing Price Index and the New Orders Index has blown out to dangerous levels, indicating that price increases are outstripping growth in orders—a stagflationary condition historically detrimental to stock prices. 

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The stock market declines of April 3rd and 4th were a mass liquidation with no distinguishing between Growth or Value. Still, there are signs that a rotation from the former to the latter is underway. And keep in mind that the most reliable catalyst for a transition in leadership is a bear market.

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On April 4th, the S&P 500’s loss from its February 19th high reached -17.4%, a decline we’d consider a “severe correction”… if we thought it had fully run its course.

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There’s been an intriguing relationship between the speed of a severe decline and the likelihood of a strong recovery. Yet, the cyclical backdrop is also a key factor, and today’s message from a range of economic measures is that the current correction is not a safe one to buy.

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Prior to Liberation Day, there was growing talk of a new bull market in a practice that had not experienced one  in years: Diversification. After being in the green all year until recently, our simple proxy for a diversified portfolio is now down 2.1%, but compared to the domestic equity benchmarks, that seems rather palatable.   

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It’s worth considering that “this time” is not different. In fact, this time and may well be the same as it ever was, and the recent stock market collapse could morph into a perfectly normal cyclical bear market. Based on the average loss of the last 13 (non-recessionary) bear markets, SPX could drop to 4,153. 

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This cycle’s earnings performance has been exceptional. If EPS were to top out today, the peak-to-peak annualized performance from the last cycle high will have been the strongest among six cycles since the early 1970s. Nonetheless, nominal growth in EPS has been boosted by elevated inflation, which has supplied almost one-half of the last five years’ growth rate.

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Early this month we trimmed net equity exposure to 50% across tactical allocation strategies. Breadth, leadership, and momentum into the SPX high on February 19th all showed divergences that could have been pulled from an “analyst’s handbook” of bull market tops.

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Given the prominence of the wealth effect in recent years, it’s hard to fathom the economy not succumbing to a declining stock market. But, keep the Y2K example in mind if the economy doesn’t appear to justify a falling stock market.

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Our composite of S&P Cyclical sectors topped more than three months ago. However, the action in this index looks even more ominous when compared to recession-resistant sectors like Consumer Staples, Health Care, and Utilities. 

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Flip-flopping about tariffs has damaged confidence and at a time when the economic expansion already looks fragile. Back in 2017 and 2018, Trump Tariffs 1.0 occurred with an economy much better positioned to absorb the tariffs themselves, as well as the confusion surrounding them.

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Federal receipts are projected to move higher in the months ahead, as capital gains taxes are collected. Lately, though, growth in tax receipts has fallen short of that forecast. After 16 years of a mostly rising stock market, we wonder if investors have been trained not to sell.

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A number of S&P 500 valuation measures are challenging the peak levels seen just before the Y2K Tech Bubble blow-up. Ironically, despite the stock market being vastly larger today relative to the economy (197% of GDP vs. 137% in February 2000), present day consumers are not nearly as euphoric as they were 25 years ago.

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For months, the euphemism to describe the weakening labor market has been “normalization.” Our preferred terminology has been “pre-recessionary,” and the numbers continue to trend in that direction.

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Only time will tell if the S&P 500’s February 19th high will turn out to be the ultimate top for this bull market. One dynamic for which we do have high conviction is that the tide has turned away from the large-cap growth crowd that has trounced all challengers since the market lows in October 2022.

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A sudden loss in investor confidence, like the recent plummet in the AAII Bull-Bear Spread, can occasionally become a self-fulfilling prophesy—and the current backdrop raises the odds that might be the case. Furthermore, consumers’ assessment of their Present Situation (Conference Board Survey) is now lower than at the October-2022 bear market bottom.

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Since the onset of the current bull market over two years ago, the S&P 500 Normalized P/E multiple has resided in its top historical quintile. That is an incredible feat—but one that has borrowed from the future.

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