February ended with losses of 1.4% and 1.6% in the S&P 500 and Dow Jones Industrial Average, respectively, and even bigger losses of 4.0% and 5.4% in the Nasdaq Composite and Russell 2000, respectively. Yet this was not surprising since February tends to be the third-worst performing month in the annual calendar, averaging a small loss over the last 75 years. The only other months with worse historical performances are September and August.
The Political Calendar
However, with politics dominating the geopolitical and financial landscape, we found the observations in The Stock Traders’ Almanac (TSTA) regarding the election year cycle and differences between Republican and Democratic administrations, interesting and timely. It is no coincidence that the post-election and midterm years are the weakest years of the four-year election cycle.
According to the TSTA “wars, recessions and bear markets tend to start or occur in the first half of the presidential term and prosperous times and bull markets, in the latter half.”
More importantly, over the last eighteen election cycles the TSTA found a marked difference between the two parties during the post-election and midterm years. “More bear markets and negative market action have plagued Republican administrations in the post-election year whereas the midterm year has fared worse under Democrats.” This is partially explained by the fact that Republicans have often taken the White House after foreign difficulties (Korean War, Vietnam War, the Iran hostage situation) and administered tough fiscal action right away.
Democrats have often come to power following economic duress or leaner times. This allowed Democratic administrations to enact favorable fiscal policies and benefit from an economic recovery phase (1961/1993 recessions, the Financial Crisis, the Covid-19 pandemic). As a result, the post-election year tends to be the weakest year in a four-year Republican administration and the midterm year is usually the weakest year in a four-year Democratic administration. This was proven true in the Biden administration and may be a template for the current Trump administration.
A Normal Correction
In our view, the market is undergoing its first 10% correction since the 2022 low, which is normal and long overdue. The Nasdaq Composite index and Russell 2000 are trading below their 200-day moving averages and are down 9.0% and 14.0%, respectively, from their recent highs. The Dow Jones Industrial Average and S&P 500 are down 5.5% and 4.8% from their record highs, respectively, yet remain above their key moving averages. The S&P 500 tested its 200-day moving average, currently at 5723.23, on an intra-day basis this week. And while the S&P has broken its 200-day moving average on occasion it proved to be a key support level in October 2023 and August 2024. In this regard, the equity market is at a pivotal point from a technical perspective.
One indicator that suggests this decline is not the start of a bear market is the American Association of Individual Investors sentiment index. This week bullish sentiment tumbled 9.8% to 19.4% and bearishness jumped a massive 20% to 60.6%. A combination of 20% or less bullishness and 50% or more bearishness in the AAII survey is rare and has been a positive sign for the market. The current 19.4%/60.6% split has driven our 8-week bull/bear spread to negative 9.7%, the lowest and most favorable level since May 2023 (during the 2022-2023 low). Plus, our 25-day up/down volume oscillator is at negative 1.27, which is above a negative 3.0 oversold reading, which would display a substantial increase in activity in declining stocks. In a bull market, oversold readings in the 25-day oscillator do appear but should be brief and trigger a rebound. A test may still be ahead for this indicator.
There are many market-moving events this week, which include pausing military aid to Ukraine, 25% tariffs on nearly all goods from Mexico and Canada, Canadian energy taxed at a 10% rate, additional 10% tariffs on all imports from China, and retaliatory tariffs announced by China and Canada.
On March 4, these escalating trade tensions rattled global markets and sent the Dow Jones Industrial Average on a roller coaster ride of down 823 points at 11:30 am, up 109 points to 43,082 at 3:25 pm, only to close at 42,520.00, down 670.25 points for the day. However, Secretary of the Treasury Scott Bessent’s statement that he believed China would absorb the 10% tariff increase, much as they had with earlier tariffs, did little to calm markets. And all of this chaos is taking place hours before President Trump presents his State of the Union address on Tuesday evening. Political pundits are indicating that the Democratic party is planning multiple forms of protest during President Trump’s presentation to the joint Congress. With or without protests, this State of the Union address will be widely watched around the world!
The Positive Side of the Coin
The good news about the current geopolitical situation is that the tariff threat is now a reality as are retaliation tariffs by Canada, Mexico, and China. In our experience, markets can deal with good news or bad news, but uncertainty is what generates the greatest fear and biggest market declines. All in all, we believe the US can withstand the tariff battle better than our counterparts although there will clearly be winners and losers in terms of individual corporations. But if we are right, this correction will generate a longer-term buying opportunity for investors. Our concern is that slower economic activity for key trading partners will negatively impact the US, as well as multi-national earnings. Time will tell.
Another trigger for the recent market weakness was the release of the Atlanta Federal Reserve’s GDPNow estimate. This indicator is actually less of a forecasting tool than it is a calculation based upon released economic data; however, the GDPNow moved from targeting first quarter GDP growth of 2.3% on February 26, to a negative 2.8% growth rate on March 3. This massive swing in expected first quarter GDP resulted in an immediate 50-basis point decline in the 10-year Treasury bond yield and stirred fears of a recession. Again, note that the stock and bond markets are currently discounting a series of negative events and pessimistic forecasts that may or may not happen.
This week we also discuss the second monthly decline in pending home sales, a weakening new home sales trend, a favorable ratcheting down in the PCE deflator and its underlying components, solid personal income growth but a deceleration in real personal disposable income growth, a rise in household savings, and a small decline in the ISM manufacturing index for the month of February.
The employment report for February will be reported later this week and given the state of the stock market it could be a market moving event.
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