Good Riddance, February
The second half of February was rough, as worries over the economy, tariffs, and large cap tech weakness dominated the conversation. Here’s the thing. Yes, the year-to-date gains we saw in January have vanished, but as we’ve noted before, early in a post-election year things tend to be choppy. Not to mention February is a weak month historically, especially in a post-election year. So in a way, this is normal and not a reason to panic.
Here’s a nice chart that shows the first quarter of a post-election year is the second weakest quarter out of the entire four-year Presidential cycle. In other words, after back-to-back 20% gains the past two years, maybe a well-deserved break to kick off 2025 is perfectly normal.
Here Comes March
In the end, the S&P 500 fell 1.3% in February on a total return bases, for the worst monthly return since April of last year. It is also the first time the S&P 500 is negative (although only down 1%) over three calendar months since October 2023. We continue to think the bull market is alive and well and the economy is on solid footing, but that doesn’t mean we won’t have scary headlines or worries. In fact, we were at new highs just two weeks ago, but that feels like a long time ago now.
As poor as February is historically (and that played out), it is worth noting that March and April are two of the better months of the year. The past two decades March is the fourth best month and April is the third best month. You should never blindly invest in seasonality, but just as February was ripe for potential trouble, be open to a nice Spring bounce.
Panic Is in the Air
How do you feel? Hopefully because you’ve been reading this then you know that even the best years have scary headlines and volatility and that volatility is the toll we pay to invest. But we’ve seen historic levels of fear in various investor sentiment polls over the past week, even with stocks less than 5% away from new highs.
The American Association of Individual Investors (AAII) Sentiment Survey showed more than 60% bears for only the seventh time in history (going back to when the poll started in 1987). Here’s the catch. Those other times we saw fear similar to this were times like the recession and near bear market of 1990, October 2008 and March 2009 during the Great Financial Crisis, and the end of the bear market in 2022. In other words, stocks were down substantially before fear truly spiked, making what we are seeing now truly rare and uncharacteristic.
Stocks were up about 28% on average a year after previous times bears were above 60% (and higher every time), so contrarian bells are ringing right now. But we looked at all the times bears spiked above 55%, to get a larger sample size. Once again, the returns going out a year were quite strong overall, but we did notice fear spiked in early 2008 and many of those returns were significantly lower a year later.
But assuming we aren’t heading into another financial crisis (we don’t think we are), the other times we saw this was quite bullish for investors willing to stay strong and not panic sell. The S&P 500 was up a median of nearly 13% six months later and 18% a year later.
Why does sentiment matter? Because the market is all about what is priced in and what isn’t priced in. For example, large cap tech stocks reported strong earnings across the board, yet many sold off hard on the news of their earnings. This was because the bar was set quite high, maybe too high looking back. When worry is in the air and uncertainty is high, this tends to be contrarian bullish, as better news eventually comes and clears that lowered bar. Given our overall still positive economic backdrop, to see this much worry in the air is actually rather bullish and why we don’t expect the recent weakness to spiral out of control.
Wait, Is GDP Growth Really Going To Be Negative in Q1?
Even as the world’s attention last Friday was focused elsewhere, we got a real doozy of a data update in a corner of the economic universe that usually doesn’t get much play. The Atlanta Federal Reserve’s Real GDP “Nowcast” for Q1 plunged from 2.3% to -1.5%. Yeah, that’s not a typo, nor is it a computation error by the folks who run what is normally a very good, and popular, GDP growth tracker (typically even better than economists’ consensus forecast, which right now is close to 2% for Q1). The GDP Nowcast is a running estimate of the GDP growth in the current quarter and is continually updated as data are released. However, as this latest batch of data just showed, the nowcast has a big flaw, which gets to why the GDP growth tracker collapsed. In short, you shouldn’t panic, though that doesn’t mean there are no concerns.
A Surge in Imports Drives the Nowcast Lower
The nowcast plunge was triggered by the advanced estimate of goods trade data in January. But it’s worth recapping the components of GDP first.
- Household consumption: 68% of GDP
- Nonresidential (business) investment: 14%
- Residential investment (housing): 4%
- Net exports (exports minus imports): -3%
- Federal government spending: 6%
- State/local government spending: 11%
Net exports are negative because the US imports more than it exports (a lot more). On the face of it, it looks like imports are a “drag” on GDP, but that is really not accurate (or how you should think about it). If a consumer or business buys something that’s manufactured abroad (like a TV), it doesn’t add to US gross “domestic” product. So, imports are just subtracting all the goods and services households and businesses buy from abroad, since it doesn’t add to domestic economic activity. In fact, if imports surge, that means there’s a lot of domestic demand, which will show up in higher consumption/investment and/or an inventory buildup (as businesses stock up in anticipation of higher demand in the future, or for another reason, like higher tariffs).
That brings us to the January trade data. Imports surged in January by 12% (you can see this in the chart below), whereas exports rose just 2%. It would be one thing if imports and exports were mostly equal, but imports run 1.5 – 2 times larger than exports, and so the trade deficit (net exports) widened by 26% in January. Over the last four months, imports surged 15% while exports fell 1%, leading to a whopping 40% increase in the trade deficit.
There are a few things happening.
One, the dollar has appreciated by over 8% between October and January (partly in anticipation of tariffs), making exports more expensive and imports cheaper. We saw a similar dynamic in 2017 – 2019 when the dollar was also elevated. An elevated dollar is a drag on US exports, and the manufacturing industry. And lower exports are a drag on US economic growth. This is a risk we highlighted in our 2025 Outlook.
Two, there’s been a surge in gold imports. But this should ultimately not impact GDP, as gold is typically not widely consumed or used for production.
Three, there’s a good bit of tariff frontrunning. This is not unexpected given the tariff rhetoric (and we also saw a 10% increase in tariffs on Chinese goods). The threat of 25% tariffs on Canadian and Mexican goods also haven’t gone away, let alone tariffs on several other trading partners.
Now, as I mentioned above, imports don’t count toward GDP, since it’s offset by a corresponding increase in household or business consumption/investment or inventories. The problem is that we got data showing an import surge, but other data haven’t shown a corresponding surge in household consumption (in fact, we got the opposite), or business investment. That leaves an inventory buildup, but we’ve yet to get that data.
The Atlanta Fed is now estimating a whopping -3.7% contribution from net exports to Q1 GDP growth. Here’s the complete breakdown of how they get to -1.5% GDP growth for Q1:
- Household consumption: +0.87%-points (pp)
- Business investment: +0.56 pp
- Housing: +0.06 pp
- Government spending (federal + state/local): +0.34 pp
- Net exports (exports minus imports): -3.70 pp
- Change in private inventories: +0.40 pp
Now, this is just one month of data (January) and there are two more to go. We’re also likely to see a big jump in inventories when that data comes out. That should send the nowcast into positive territory.
Keep in mind that the tariff frontrunning is likely not over and we could see the impact continue into February—especially as companies look to import more steel, aluminum, and even cars and car parts, before new tariffs on these items are imposed.
There are also valid reasons for concern once you look beyond the import data. GDP growth is likely to slow down considerably from the 3% annualized pace we’ve seen over the past 2 years. Real GDP growth is likely to clock in anywhere between 1.5-2.3% in Q1. I already mentioned the headwind to manufacturing exports from a strong dollar. But we saw a pullback in consumption too.
Is It Time To Worry About Consumption?
The GDP nowcast estimates a 0.87%-point contribution from consumption to real GDP growth in Q1. That’s just about half the contribution we saw in 2023 and 2024. After adjusting for inflation, personal consumption fell 0.5% in January (equivalent to 5.5% on an annualized basis). This was driven by a 18.4% annualized decline in goods spending, as Americans bought fewer cars, furnishings, appliances, and recreational goods in January. There are several “one off” reasons for this, including the fires in California and unseasonably cold weather in the South—factors which suggest we could see a rebound in February and March.
At the same time, we saw real services spending rise at an annualized pace of just 1% in January, the slowest pace we’ve seen in a year. There’s been a bit of loss of momentum recently as well. Services spending was up 2.5% annualized over the last 3 months, and 2.9% over the last 12 months. Goods spending can be volatile, but what holds steady is services spending (which makes up 46% of GDP). It’s too early to tell whether the January services spending data is a blip. We saw the same drop in January 2024, but services consumption picked up and eventually rose 2.9% in 2024, well above the 2018-2019 average of 2.1%.
The good news is that income growth, which is what has driven spending for the last two years, was strong in January. Disposable income surged 0.9%, which translates to an annualized pace of 11.1%. This was mostly because social security benefits rose by 2.8%, as the government adjusted them higher for inflation. Looking at the last three months, disposable income has risen at an annualized pace of 6.7%. If you exclude the impact of government transfers (including Social Security, Medicare, and Medicaid) and things like dividend and interest income, you’re left with employee compensation, and that’s also strong. Employee compensation rose at an annualized pace of 5.4% in January and was up 5.7% annualized over the past three months. These numbers are well ahead of the pace of inflation. Headline inflation as measured by the Fed’s favored metric, the Personal Consumption Expenditures (PCE) Index, rose 2.9% annualized over the last three months.
Carson’s Proprietary Index Still Points to a Healthy Economy
The noise from discrete data points is one reason why we like to get a bigger picture view using our proprietary Leading Economic Index (LEI), which is something we populate for the US and 28 other countries. It tells us whether the US and other global economies are growing along trend, above it, or below it (and perhaps near a recession). For the US, our LEI combines various data, including consumption and labor markets, housing, business and manufacturing, as well as markets and financial conditions. As we have written in outlooks over the last two years, this was key in telling us that the economy would likely avoid a recession. Right now, our US LEI is sitting in fairly solid territory, indicating growth is close to trend, if not slightly above it.
Our LEI is also a “nowcast” and reflects the breadth of current data. But we recognize that things can change. As I pointed out above, and as we wrote in our 2025 Outlook, there certainly are risks and threats on the horizon. Which is why we’re going to continue keeping our ear to the ground but focus on the data that actually informs us as to what’s happening.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
Compliance Case # 7694111.1_030325_C
