The stock market is currently experiencing a corrective/consolidation phase with bearish narratives having dominated daily trading since the S&P 500 hit its most recent all-time high on February 19th.

The question of the day thus becomes, why has the market's tone suddenly changed? I believe the answer can be summed up with one word: uncertainty.

One of the basic investing realities is that markets hate uncertainty. And uncertainty over tariffs and trade retaliation has become the name of the game over the past three weeks. In short, concerns over the impact of the trade war on the economy and inflation is affecting both consumer and investor sentiment.

The concern is that tariffs and a trade war are likely to drive up costs of all kinds of goods and services, as well as inflation expectations. All of which can affect corporate earnings – and not in a good way.

Stocks Were Due For a Pause

One of the primary causes for last year's big rally in stocks was the expectation for strong earnings growth to continue in 2025. At the end of last year, consensus earnings were expected to grow by more than 15%. So, despite stock market valuations having reached what we viewed as extremely high levels, investors continued to buy stocks - oftentimes with both hands.

Our take is that investors effectively "pulled forward" gains based on strong earnings growth expectations for calendar year 2025. In other words, everybody bought based on earnings that were "coming." As such, I've been of the mind that the market needed to "chill" for a few months in order to allow earnings to catch up with prices. And given the sideways action seen in market leaders such as Nvidia (NVDA), my take was that the market was indeed pausing.

However, with news of tit-for-tat tariffs hitting the wires on what seems like a daily basis, investors now fear that those stronger-than normal earnings may not come in as expected. And with stock valuations in the nosebleed zone, some "adjustments" needed to be made. Hence the pullback in stock prices.

In addition, weaker-than expected economic data, softer consumer spending, DOGE layoffs, and the possibility of a government shutdown, are also weighing on the growth outlook.

Stock Prices Discount The Future

As I have mentioned a time or two hundred over the years, the stock market is a "discounting mechanism of future expectations." So, this is what "corrections" are all about. When a new narrative crops up, investors wind up making adjustments to the prices they are willing to pay for a dollar of future earnings.

Corrections are Normal

At times like these, it is important to note that corrections are a normal part of the stock market's behavior pattern. Stocks don't move in a straight line higher. No, the market typically travels in a stair-step fashion (two steps forward and one step back – rinse and repeat).

History shows corrections in the stock market occur on a fairly regular basis. If memory serves, the S&P 500 averages 2.5 pullbacks of at least 5% per year and one correction of 10% or more. And since these moves tend to be short and sweet (especially when they are driven by news), I've learned that unless the fundamental backdrop has changed, it is usually best to stay seated on the bull train.

Macro Backdrop Remains Positive

On that note, we believe the macro backdrop remains positive. First and foremost, it is important to remember that this is a bull market until proven otherwise. In addition, my take is that most of the big-picture market drivers remain upbeat. The economy is strong. Inflation is trending lower. The Fed is relatively friendly. Earnings are growing at a strong pace and are expected to come in at record highs.

So, from a big-picture perspective, things look pretty good. Once we get through the current corrective phase, of course.

A Bad News Panic

Near term, we believe we are seeing a news-driven market, or something Investors Business Daily's founder Mr. William O'Neil termed a "bad news panic." What we've learned over the years is that these "panic" markets tend to follow a similar pattern.

First, stocks dive on the fear of the day – in this case, what tariffs are going to do to the economy and earnings. The negative market environment and the extreme volatility tends to last until the bad news stops flowing.

But experience has taught me to remember that at some point, good news happens. And then as folks realize the sky is not actually falling, stocks experience a "sigh of relief" rally, which is usually an explosive move higher.

I was asked this week when will the selling end? My response was short and sweet: When the bad news stops happening.

A New Bear in the Offing?

Can a corrective phase turn into a bear market? Sure. But, based on what we are seeing at this stage, we do not believe this will be the case. My thinking is this will wind up being a fairly typical, albeit scary pullback within an ongoing bull trend.

However, as active managers, our job is to adapt to the market environment. If conditions change, our strategies are designed to help us adjust our positioning accordingly. And while many indicators are suggesting we "sit up and take notice," giving the bulls the benefit of doubt is the current plan.

Thought for the Day:

Progress is walking from failure to failure without a loss of enthusiasm - Winston Churchill

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research, a Registered Investment Advisor

Market Models Explained

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: NVDA - Note that positions may change at any time.

NOT INDIVIDUAL INVESTMENT ADVICE. IMPORTANT FURTHER DISCLOSURES