Just another growth scare or more?

14 March 2025

Following the pause last week, the stock market sell-off unfortunately resumed this week. Global government bonds unhelpfully joined the downdraft as bond yields edged up. Equity markets are generally only slightly lower in Sterling terms but, for the third week in a row, the worst performers are concentrated in the US. Not only has the “Trump trade” that excited investors last year now completely unwound, but more than a few commentators feel that US markets could be in for a difficult longer-term phase – the ripples of which would spread across the world. In challenging times like this – particularly if our emotional reaction to abnormal behaviours of politicians can cloud perception, it is important to focus on the fundamentals. The case for stronger 2025 corporate profits is still there and, just as we thought investors were too excited about the US before, many seem to be too pessimistic now.

Waiting for the bounce.

Markets are undeniably nervous. The losses are piling up for US equities, and the S&P 500 which officially entered correction territory (-10%) on Thursday, is now negative on a six month basis. The jitters are showing up in a number of areas – not only in listed stocks but also private equity, as discussed in a separate article. It is somewhat telling that US bond yields rose on Tuesday, despite February’s inflation reading coming in lower than expected. You would expect a slower US economy to mean more investor demand for bonds (hence lower yields) and the fact this did not happen backs up the point we have made for the last few weeks: there is currently a distinct flow of capital out of US markets.

US stocks have come down enough that you would expect at least a short-term bounce – which we saw signs of on Wednesday and at the time of writing on Friday. Sentiment has shifted rapidly negative as illustrated by the American Association of Individual Investors’ “Bull-bear” ratio, which currently shows there are approximately three times as many bears as bulls (bulls/bears = 0.32).

As the chart of “drawdowns” from 2022 shows (and is backed by history going back to the 1980s), there tends to be a bounce when sentiment is so weak. But the ‘buy the dip’ mentality will only prevail if investors think the environment is still supportive for American companies – which is exactly what many are doubting, much as they did in 2022 before the rally took hold as the Summer ended.

We have to be careful and level-headed about this. Just a few months ago, the dominant narrative was about unfettered US exceptionalism – whereas now the commentary has swung to Trump-induced assumptions of the opposite. Such rapid swings are rarely a sign of level-headed analysis.

There are certainly still reasons to remain positive for 2025. Interestingly, while the ‘top-down’ forecasts for US company earnings (based on the broad macroeconomic outlook) have deteriorated, the ‘bottom-up’ earnings estimates (based on company-level data) are still looking decent. If the company-level data is right, that could be enough for some market reprieve.

How durable is European positivity?

European stocks had previously escaped the US selloff, but Europe’s markets also fell this week. We have written a lot about Europe’s improving growth prospects – fuelled by a defence spending spree – but investors recognise that a genuine US economic downturn would inevitably hurt growth on the continent too. Likewise, if Trump’s policy volatility really does result in more 200% tariffs, like the ones he promised this week on EU wine and spirits.

Europe’s bull run could well resume. Despite the dollar’s recent slide, for example, the US currency remains historically expensive on a trade-weighted basis – suggesting that on a ‘search for better value’ basis the US-to-Europe flow has room to run. But, the fiscal expansion that boosted European growth expectations could prove more difficult than hoped. Outside of Germany, European nations have limited scope to take on more debt. We will see soon whether the strong resolve politicians showed last week can carry on.

The UK seems to be an example of how a defence spending push might not actually mean fiscal largesse. The government seems to be more keen on funding its military through savings elsewhere than more borrowing. This is understandable, considering Britain’s significantly higher interest rates and lower borrowing headroom compared to Germany, but it does lessen the growth impacts we might have hoped for. Downing Street cannot increase defence spending while maintaining its self-imposed fiscal rules and promise of no tax rises. For now, the UK’s government is focussed on spending cuts, but we should not be surprised if the Treasury’s spring statement later this month includes new, if measured, tax hikes.

Risks are there but US fundamentals are strong.

Because of its global impact, markets are still focussed on the US economy and – perhaps unfortunately – on Donald Trump’s unpredictable policy announcements. Tariff threats have scared many investors (we talk about their rationale in a separate article) but the bigger fear for US consumers is the compression of federal spending, in other words fiscal austerity. Although US jobless numbers have stayed steady for months, it does seem harder for unemployed Americans to get new jobs – and many with public sector ties fear the axe of Elon Musk.

As we have argued before, president Trump is likely to enact stimulative policies soon to fend off a sentiment induced economic slowdown, which should get markets and his supporters feeling good again. Republican lawmakers are now being pressured by nervous constituents, and Trump promised this week to take a gentler, more precise approach to spending cuts. For markets, the big thing would be Trump’s promised tax cuts. The Continuing Resolution bill does not contain these but its passage is necessary for Trump to build a new, in his own words Big, Beautiful Bill for enactment in August. The current budget bill made steady progress through to the Senate, and looks almost certain to pass (although it could still fall at the final hurdle tonight, Friday 14th, and introduce the threat of an old-school US government shutdown).

That potential shutdown is just one of the reasons US sentiment could still get worse before it gets better. Another is that Trump seems to be preparing for a fight with the Federal Reserve for lower rates – despite the increasing likelihood that the Fed will shift to being more accommodative at its meeting next Wednesday.

Ultimately, the medium-term bullish case for the US economy has not fundamentally changed from a few months ago, but the sequencing of policy initiatives has created an air-pocket which has undermined the valuation optimism towards US equities from the beginning of the year. There have been few actual job layoffs but, equally, it appears that hiring has slowed sharply. At the bottom-up level, analysts expect company profit growth and productivity to remain strong (the latter might even be improved by Elon Musk’s sacked public sector employees migrating to more productive private sector employment) and will be boosted further by tax cuts and deregulation. The risks have undeniably grown in recent weeks but, in these challenging times, it is important to stay calm and focus on those fundamentals.

The one that holds particularly true for portfolio investors who need to decide about new investment in the remaining weeks of March is that at the very least they will be purchasing assets at a discount now, at prices last seen 6 months ago. Or in the words of the world famous investor Warren Buffett: Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.

Please note:

Data used within the Personal Finance Compass is sourced from Bloomberg/FactSet and is only valid for the publication date of this document. The value of your investments can go down as well as up and you may get back less than you originally invested.