Transitory—not again!
Stocks surged yesterday, with the S&P 500 experiencing its largest gain since July, while bond yields fell sharply following the Fed’s March meeting, press release, and news conference. Jerome Powell’s measured response to the potential economic impacts of Donald Trump’s trade war, specifically citing the potential for “transitory” inflation from tariffs, calmed investor fears and triggered a significant market rally. Powell emphasized that recession risk was “not high” and acknowledged the potential for tariffs to have a temporary effect on inflation, which reassured investors. Additionally, the Fed’s decision to slow the pace of balance sheet reduction, which lessens the amount of liquidity that it removes from the market, further fueled the market’s positive reaction.
Powell’s ability to “thread the needle” by balancing concerns about inflation and growth was key to the market’s response. Despite the Fed revising growth expectations for 2025 downward from 2.1% to 1.7% and increasing inflation estimates from 2.5% to 2.8%, the market focused on Powell’s dovish signals and the Fed’s planned reduction of Treasury holdings. The correction in stocks prior to the meeting had already priced in a more pessimistic economic outlook, allowing investors to capitalize on Powell’s reassuring statements. Market participants, who had significantly reduced equity holdings leading up to the meeting, began to rebuild their positions, driving the rally further.
Whether we like it or not, the reality is that the abrupt and significant change in government policies is very likely to have a short-term impact on consumer and business spending—it is logical. Investors reacted swiftly once it became clear that the tariffs and cuts to government spending weren’t just talking points. The S&P 500 is down -8% from its January high and -3.5% YTD. Chairman Powell calmed investors’ nerves yesterday, but that doesn’t mean the coast is clear for investors.
Downward earnings revisions for 2025
If we assume that the Fed’s forecasted slowdown in GDP is correct, at least directionally, it is also likely that corporate profits will experience downward pressure relative to currently forecasted growth rates. We have already heard about softness in spending from a number of CEOs in retail, travel, and other consumer discretionary businesses. We are about to end the first quarter of 2025 and will learn more in about a month when earnings season starts. In the meantime, analysts are already lowering expectations. Since the beginning of the year, corporate earnings growth for 1Q25 has declined from +12% to +7%. In other words, the profit growth rate has been lowered by 37%.
Ordinarily, changes in economic statistics are driven by changes in consumer spending, business investment, central bank actions, etc. Today, politics are the major force driving changes in the economy. This makes it difficult for the investment community to gain confidence in almost any forecast and will likely lead to more volatility than is normal, in our opinion. The nature of the uncertainty is different this time, one might say.
Looking for the silver lining
Until last evening, one noticeable surprise since the administration took office has been the absence of President Trump’s badgering of Chairman Powell to lower interest rates. Threats of firing the Federal Reserve Chairman have not been made. For a while, it seemed that someone had rightly focused the administration’s efforts on actions designed to lower the 10-year US Treasury yield rather than the Fed-controlled short-term rates. Long-term interest rates, which are set by the market, are the primary determinants for mortgage rates and companies’ cost of capital. Lower long-term rates could also enable the government to extend the US debt maturities, which would provide more flexibility in dealing with the nation’s mounting debt load.
We have highlighted this before, but it continues to warrant attention. A lower 10-year US Treasury yield is critical to the administration’s goal of improving economic growth and enabling President Trump’s ambitious tax reductions. Slower economic growth in the near term, whether it’s driven by tariffs or government spending reductions, may help achieve a lower 10-year US Treasury yield. The question is whether the economy can bend but not break. We will have to wait and see.
What about gold?
Gold has recently been hitting all-time highs. We’ve been analyzing the current investment landscape, particularly concerning the relative valuations of gold, real estate, and equities, alongside the macroeconomic backdrop. A simple comparison involves measuring all the above-ground gold—estimated at $20 trillion—with the $50 trillion value of U.S. residential homes and the $48 trillion market capitalization of the S&P 500. If we remove the gold used for industrial purposes and non-investment jewelry, we are left with about $11 trillion. Even with this adjustment, the sheer magnitude of gold’s value remains substantial and possibly excessive, especially when considered in the context of other asset classes like stocks and real estate.
Interestingly, in 2007, all the above-ground gold was estimated at $5 trillion, while U.S. housing was valued at $26.7 trillion. Coincidentally, the U.S. national debt has quadrupled from $9 trillion to $36 trillion, mirroring gold’s value increase. This correlation suggests that gold has, in essence, kept pace with the expansion of U.S. debt. Total U.S. debt is currently compounding at 6% annually. If the administration achieves its goal of reducing the annual deficit to 3%, the implications for future returns to gold investors could be disappointing if the recent historical correlation between U.S. debt growth and gold price appreciation holds. Of course, betting that Congress can maintain a sustained period of fiscal restraint is likewise hard to imagine.
Hockey great Bobby Orr turns 77 today, film director Spike Lee is 68 and actress Holly Hunter turns 67.
Christopher Gildea 610-260-2235