Holding Our Equity Forecast Steady
The S&P 500 Index fell slightly last week after a late week retreat on escalating conflict in the Middle East. Despite a more than 20% gain in two months, down weeks have been normal off the lows with four of the last ten weeks seeing the index lower. Nevertheless, the conflict adds a new variable, which we discuss below.
Still, what a run stocks have been on the first two months off the lows! We came into this year with everyone all bulled up after back-to-back 20% years, then stocks tanked in historic fashion after Liberation Day, with those same bullish strategists cutting their S&P 500 targets dramatically near the April lows. Now with stocks back up near new highs they are upping their targets, as this chart from Yahoo Finance shows.
We never cut our view on the S&P 500, leaving our target at a range of 12-15% for 2025, even when stocks were down 15% for the year on April 8. As we noted that exact day, it was still quite possible for stocks to come back to positive territory by the end of the year, especially with some good news on trade, and that’s exactly what has happened.
Historically, we’ve seen the S&P 500 down 15% or more for the year then end the year positive three times, and all three times the index gained more than double digits for the year, something we still think is likely this time around.
What a Two-Month Run
It is crazy to think just how bearish everyone was a little more than two months ago. Many analysts were convinced Trump’s tariffs were going to wreck our economy and crash the stock market. We did of course have a near bear market and one of the worst two-day drops ever after Liberation Day, so emotions were no doubt running high. Still, this is why sentiment is so powerful, as the opportunity was there to fade what nearly everyone was saying and be open to a major snap back, which is exactly what has happened.
We went from one of the worst two-month returns ever to one of the best. As we’ve noted time and time again this year, investors need to be aware that the worst and best days tend to happen in clusters and if you sell after some bad days, you’ll likely only miss out on the best days, which is exactly what happened to many investors.
So just how rare is it to see stocks up more than 20% in two months? Very rare and the good news is it is also very bullish. Only five other times since 1950 have stocks been up more than 20% in such a short period and those times were all great times to be looking for continued strength.
As you can see below, stocks gained after this rare signal 1-, 3-, 6-, and 12-months later every single time. Up a year later by more than 30% on average! Of course, all those other occasions saw much bigger prior selloffs, so we aren’t calling for such a big gain (but we wouldn’t complain!), but this is yet another reason to remain optimistic the second half of 2025. Look one more time at those dates: February 1975, October 1982, December 1998, April 2009, May 2020, and now. Those were times to be open to much better times ahead, which suggests this time may join them.
A New Bull Market? Nope
Stocks are officially up more than 20% from the near bear market lows of early April, so are we in a new bull market? We would say no, as we never left the bull market that started in October 2022.
Here’s a nice chart we’ve shared before that shows bull markets tend to be choppy and frustrating right around now, which sure played out this time. The good news though is once you can get past this rough part of the bull, better times have been ahead and could last many years.
Lastly, we found 17 bear or near bear markets going back to World War II and once the S&P 500 was up more than 20% off those lows, continued good times usually were right around the corner. You’d think up 20% would mean you’ve missed the rally, but history would say the bull still has plenty of gas left in the tank. Now this time wasn’t officially a bear market, but we think the same principle applies and incredibly after these bear or near bear markets, stocks were higher a year later after gaining 20% 16 out of 17 times, with a very impressive average return of nearly 19%. Oh, and that one time that didn’t work? It was because a once in a100-year pandemic popped up out of nowhere and killed the rally.
Perspective on the Escalating Conflict in the Middle East
Thursday, June 12, was a tragic and exhausting day. It started with the terrible crash of an Air India flight in India, killing over 250 people—the worst aviation disaster in India since 1996. Then the day ended with Israel striking Iran, targeting their nuclear program and killing several top Iranian military officials (including the head of Iran’s powerful Islamic Revolutionary Guards Corps).
This is coming on the heels of the Liberation Day tariff situation, which was subsequently reversed after the market went through a near bear market. The S&P 500 had just about been approaching its prior new high. And now this. However, as tragic as these events are, let’s keep some perspective, at least from a market standpoint.
From a long-term perspective, when it comes to markets chaos is normal. Here’s a chart that sums it all up nicely. Amid some of the worst events in history, stocks have continued to eventually move higher, suggesting all those scary times and lower prices were really good opportunities. They sure didn’t feel like it at the time, but they were. (Of course this is merely a market perspective. The chart doesn’t capture the heavy human toll these events can represent. But looking at the market perspective is the job we have to do.)
Even from a market perspective, that doesn’t mean you should ignore these events, as they can cause a lot of volatility in markets, and even the economy. Russia’s invasion of Ukraine tipped inflation over the edge, and we got the highest inflation in 40 years back in 2022—ultimately resulting in a bear market for stocks, with bonds failing to provide diversification. 9/11 was another tragic event that pushed the economy over the edge into a recession, and pulling the dot-com crash into its third year. But the reality is bad news eventually will give way to good news. What that chart above doesn’t show is all the good things that have happened throughout history and it is safe to say they dwarf the negatives. If anything, the fact that the line in the chart has moved up and to the right over time tells you about the dynamism of the US economy, and US companies in particular, as they navigate all sorts of crises.
Volatility Is Normal
Investing in stocks doesn’t come easy, and the return premium you get for investing in stocks over bonds (and pretty much most other asset classes over time) in part reflects the fact that stocks are volatile and volatility is hard to stomach. We just went through a near bear market in April, with the market dropping just about 19%. We don’t know what will happen over the next few days, or even weeks, but we do know that another bout of volatility would not be surprising. A market correction of 10% happens most years, and sometimes more than once. They are more normal than you might think.
For another perspective, the table below shows geopolitical events that have occurred over the last 80+ years (note that they vary a lot in terms of scale), along with median performance of the S&P 500 over the following year. The median return is a bit lower than the historical average return overall. The average return is also weaker than the median return for these events, signaling some asymmetrical downside risk. But context here is very important.
It is worth noting that much of the negative market behavior after these geopolitical events is often not driven by the event itself. For example, the U.S.S. Cole bombing was coincident with the tech bubble bursting in 2000. What stands out from the chart is not so much the downside risk of geopolitical events, but the coincidence of drawdowns and recessions independent of geopolitical risks. If you look at the major drawdowns, most take place during or near a recession, including 1956, 1973, and 2000-20001.
But there are cases where geopolitical risk played some role in the decline. For example, Russia’s invasion of Ukraine worsened already building inflationary pressures, eventually contributing to an aggressive Federal Reserve and weighing on equity markets. But that has been the exception rather than the rule. Markets saw strong gains despite the start of the Iraq invasion in 2003 and Israel’s Six-Day War in 1967. And, of course, the bigger picture beyond the more tactical 12-month time frame is that the markets have always recovered.
Despite several Middle Eastern conflicts that did not lead to market drawdowns, there are some that had market and economic repercussions. The Yom Kippur War in 1973 played at least some role in the ensuing market sell-off. In October 1973, an Arab coalition led by Egypt and Syria launched a surprise attack against Israel on Judaism’s holiest day, Yom Kippur. After detecting Soviet resupply to Syria and Egypt, the U.S. began a massive resupply of Israel. The oil cartel OPEC responded by declaring an oil embargo against the U.S. and other countries. In 1973, the U.S. had grown increasingly dependent on foreign oil. As a result of the embargo, oil prices tripled and the added strain on the economy was one of the causes of the recession.
Could oil prices surge again? Perhaps, but OPEC has plenty of capacity to ramp up production (and will be under immense pressure from the Trump administration to do so). US shale production will also be bolstered by oil prices rising above $70/barrel, and that is another major potential source of supply. Of course, the scale of disruption matters here, as we saw after Russia’s invasion of Ukraine. Inflationary pressure from higher oil prices is one of the biggest risks, especially if the conflict expands, but this is not the 1970s and the US is no longer heavily dependent on OPEC for oil.
Diversification Helps, Even More So Now
Diversification has not been a portfolio allocator’s friend over the last decade, but it’s proven its mettle this year after the Liberation Day tariffs. Uncertainty related to policy has been high this year, but as we’ve noted throughout the year, during periods of high uncertainty in particular diversification can be your friend. Current geopolitical risks just extend this. We do remain overweight equities, but are underweight small and mid-cap stocks, which helps reduce overall portfolio volatility. Also, since the beginning of the year (even prior to Liberation Day) we moved to a more neutral weight across US and international stocks.
One striking thing that’s happened post-Liberation Day is that even as stocks (and bonds) have more or less retraced their moves, the dollar has continued to weaken. During the early moments of the latest Middle East tensions, it was noteworthy that the dollar didn’t strengthen as much as it has during previous risk-off situations like these. S&P 500 futures plunged over 1.5% after the news came out, but bond yields didn’t drop as much as you’d normally expect given the situation. Within a few hours of the strikes, the US dollar index was up less than 0.3% and the 10-year yield was down just 0.02%-points (and later moved higher). It was clear that the typical “safe haven” bid for the US dollar and US Treasuries was missing. It’s hard to say whether there’s a structural shift—there’s enormous uncertainty around that. But if the dollar continues to weaken, that’s going to help international stocks relative to US stocks.
Even beyond stocks, one thing we have been discussing for a couple of years now is the need to diversify our diversifiers and go beyond bonds to diversify portfolio risk. Bonds may work well in a deflationary recession-type environment, but not in one where we see more inflation volatility. And that’s certainly a possibility given potential supply shocks across the world (including tariffs, but also geopolitical tensions). This is why we are overweight low volatility stocks and include other non-correlated asset classes like gold and managed futures (which often includes commodities exposure) within our diversifier bucket. At the same time, we still have longer-term bonds as part of the mix.
The Carson Investment Research team has not changed its overall market outlook in response to this new geopolitical risk, but we continue to monitor the situation closely. The economy is not as strong as it was a year ago, or even two years ago. The labor market is looking more shaky amid weak hiring, and elevated rates and tariff uncertainty has led to struggles within the housing and manufacturing sectors. Our proprietary leading economic index tells us that risks are higher than they were at the end of last year, and that’s something to be aware of. This is a big reason why we’re cautiously overweight equities, rather than pedal to the metal (as we were over the last two years). And why our portfolios are more diversified than they have been in the past.
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.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
Compliance Case # 8076292.1_061625_C
