The key risks that drove the S&P 500's worst first quarter in 3 years aren't going away

Stocks are ending the first quarter of 2025 near their lows of the year. President Trump's tariffs have been a major driver of the recent market sell-off, with the S&P 500 falling 5.75% in March alone.

But now, with Trump's "Liberation Day" on April 2 fast approaching and investors expecting to hear more details about the president's plans for reciprocal tariffs, strategists aren't confident that tariff answers will solve all of the market's developing issues from the first three months of the year.

"We are not dip buyers as the risks that drove the sell-off linger," Citi head of US equity strategy Stuart Kaiser wrote in a note to clients on Sunday.

To Kaiser's point, the recent equity market sell-off hasn't just been driven by one straight flavor. If anything, it's been a smorgasbord of worsening vibes across earnings expectations, consumer and business sentiment, and weakening economic data.

Big Tech has borne the brunt of the selling action. As the S&P 500 entered the year with valuations near multi-decade highs, many had called for a relaxation of the "seven stocks driving the whole market higher" narrative of the past two years.

In late January, the rise of DeepSeek's low-cost AI offering in China first spooked the tech trade. Then, when tariffs further threatened investors' risk appetite, the market's top winners of the past few years led the selling.

Now, after the Magnificent Seven's worst quarter against the S&P 500 in more than two years, it's unclear whether the hottest trade of this bull market will once again be able to help power the S&P 500 higher. But given their outsized weighting, strategists have pointed out it's unlikely the benchmark index could have a sustainable rally back toward record highs without participation from the largest stocks in the market.

"We are positive [on Big Tech], but I would put it more like medium to long term," Barclays head of US equity strategist Venu Krishna said during a media call with reporters last week. "In the near term, we find hardly any catalyst for that [trade] to really recover."

A 'weakening' economic backdrop

A key issue not just for the Big Tech sell-off but the overall market has been a rerating of growth expectations for the year. Entering 2025, consensus centered around another year of above-trend growth for the US economy.

But three months in, the data has told a different story. Consumer spending declined for the first time in nearly two years during January. February saw a smaller comeback than economists had expected. Goldman Sachs now believes the US economy grew at an annualized pace of 0.2%, down from an initial projection of about 2.4%.

The inflation picture hasn't improved much, either. The most recent reading of the Fed's preferred inflation gauge showed core prices increased 2.8% in February, a move higher from January.

Citi's Economic Surprise Index has fallen since this year's peak in mid-January as data comes in short of consensus expectations. The chart below sums up the story of the first quarter in economic data. The majority of data points have been worse than expected.

Now, with the index off its lows for the year, the question is whether growth forecasts have fallen far enough for markets to once again be surprised to the upside.

"The economic backdrop is weakening relative to consensus expectations, earnings are likely to be reset lower at a time where valuations are improved but not compelling," Truist co-chief investment officer Keith Lerner wrote in a note to clients on Monday. "Thus, we expect the choppy market environment to persist over the next several weeks and likely months, and we are not likely to see a quick return to new highs."

Weaker forecasts

The market's current issue is that the aforementioned headwinds wouldn't be a welcome sign for stocks in any environment. But they're particularly worrisome when President Trump's looming tariff policy is only expected to exacerbate the market's pain points. Uncertainty over Trump's policies has sent consumer sentiment to its lowest level since 2022.

The most recent survey of consumers from the University of Michigan showed two-thirds of respondents expect the unemployment rate to move higher in the year ahead, the highest reading since 2009. CEO confidence has crumbled, too, with Chief Executive magazine's optimism outlook hitting its lowest level since 2012. There's growing concern that the weakening consumer and corporate vibes could eventually weigh on actual growth in the US economy. While not the base case, recession chances have risen too, with Goldman Sachs recently raising its probability of one in the next 12 months to 35% from 20%.

Yardeni Research president Ed Yardeni summed up the current mood well in a note that also included the second downgrade to his year-end S&P 500 target in the past month.

"Admittedly, it’s getting harder to be optimistic, but we are doing the best we can under the circumstances," Yardeni wrote.

Yardeni is one of several strategists cutting their outlooks for the S&P 500 this year as tariff uncertainty meets already slowing growth data. The equity strategy team at Goldman Sachs isn't confident that the dawn of a new quarter will bring much change to what's been a muddling outlook for stocks.

Goldman Sachs chief US equity strategist David Kostin's baseline forecast is for the S&P 500 to bottom "this summer, slightly ahead of the trough in economic growth in our forecasts." His firm has a three-month target for the benchmark index of 5,300, about 5% lower than current levels.

"We continue to recommend investors watch for an improvement in the growth outlook, more asymmetry in market pricing, or depressed positioning before trying to trade a market bottom," Kostin wrote.

Source: www.finance.yahoo.com