A stock market riding a heater of historic intensity into last week didn't need to look far to find a few tidy excuses to cool off. Perched atop a 23% ramp from the tariff tantrum low in early April and sitting just 3% below its all-time peak from three months earlier, the S & P 500 was handed a Moody's downgrade of U.S. government debt, a fevered Treasury-market sell-off stoking overwrought talk of fiscal breaking points and the re-emergence of punitive presidential tariff threats against the two transnational economic blocs, the EU and Apple. A week ago here, after running through the credibility earned for the rebound rally through broad participation and the clearing of several technical hurdles, I noted that "pullbacks to relieve the tape's current overbought condition should be both expected and well-contained." We've now got the to-be-expected 3%-ish pullback. Is it likely to remain well-contained? Based on what one can see and surmise, probably so, as long as "well-contained" is defined broadly enough to allow for some more churn and air pockets, with the chance for a few more percent of downside leakage in the indexes. Bespoke Investment Group clocked the prior 15 times the S & P 500 has rallied from a 15%-or-greater decline to within 3% of the former peak and found, "History shows that once we get this close to fully recovering big drops like we saw from February through April, new highs are ultimately not far off." To be specific, the ensuing weeks were a coin toss, but by six months later, the index was up every time, on average by almost 10%. When such reassuring historical tendencies are aired, skeptics are quick to offer reasons why present circumstances are more hazardous or uncertain than past episodes. This impulse is stronger than ever right now, when the degree of policy flux – much of it dialed up or down by the president alone – feels unique. Fair enough, though by definition a quick 15%-plus drop in the stock market is usually a response to some destabilizing and often novel shock. And, for sure, there are a couple of past instances of such a comeback rally ultimately failing beyond the six-month window. One was the lead-up to the Global Financial Crisis, the other the 2019 recovery which eventually gave way to the Covid Crash. Risk/reward from here? What's fair to say is that stocks at their recent highs a week ago had priced out some, but surely not all, policy uncertainty. Some measure of further de-escalation in the tariff standoffs with major trading partners had been assumed. The market arguably had "used up" the relief that came from the rollback and pause on the most extreme China tariffs two weeks ago. Rampant fears of consumer stress and potential recession seven weeks ago have given way to greater comfort in the resilience in the "hard data," allowing investors to make peace for now with a "wait-and-see" posture by the Federal Reserve. The extreme bearish sentiment and defensive positioning of early August are no longer strong tailwinds. Tony Pasquariello, head of hedge-fund coverage at Goldman Sachs, notes that while professional investors are far from overextended in their equity exposure, a fair amount of re-risking has occurred and "relative to recent trend, the intensity of demand is clearly slowing" at a time when the "fundamental risk/reward is not all that alluring, and the market would likely need incremental good news to make another gap higher." Part of that fundamental risk/reward calculus is an S & P 500 back above 21-times forward earnings, say 1.5 P/E points below the exuberant post-election peak. Last week showed the limits of just how relaxed Wall Street could become under prevailing conditions - halfway through the original tariff-pause period and with the Treasury market acting twitchy either because of, or merely coincident with, the Federal budget package laboring its way through Congress. Even after the S & P 500's 23% resurgence, over six weeks the CBOE S & P 500 Volatility Index never managed to recede below 18, which is the upper end of the "normal" range, even as corporate-credit spreads have been unbothered. The VIX blipped up to a more agitated 22 Friday after President Trump's tariff-threat posts, even though the market finished well off its lows and ahead of a three-day weekend, which would typically bleed expected volatility from the market. July is shaping up as a consequential confluence of several uncertainty currents: The expiration of the broad tariff pause, likely final budget bill details, the last summer Fed meeting before seven-week gap and the first tariff-inflected earnings season. 'Bond vigilantes' The climb in longer-term Treasury yields has been the handiest excuse for equity investors to fret, tied up as it is with nagging worries over the structural Federal deficit path, possible capital flight from U.S. and idiosyncratic inflationary pressures from tariffs. Still, it's always tricky to tie daily or weekly moves in the bond market to the long-term, slow-evolving fiscal imbalances of the U.S. government. The phrase "bond vigilantes," coined in the 1980s, is more catchy than truly descriptive. And Treasury yields have not exactly become unanchored from long-prevailing trends. The 10-year was at the current level just above 4.5% in September 2023 and in April and November of last year. The five-year maturity, off which a lot of private-sector debt gets priced, is right at its two-year average. The 30-year bond yield has broken out, no doubt, above 5%. Yet on an absolute basis, these yields need not be burdensome on an economy still likely on pace for 4-5% nominal GDP growth. Such rates were common in the late 1990s and mid-2000s, though it's true there is far more debt now and yields are up sharply from a few years ago, so the economy must prove it can make peace with each new threshold reached. One argument for the market's ability to accept the backup in Treasuries so far is the way high government indebtedness contrasts with (enables?) far lower leverage in the corporate sector relative to equity values, as Bank of America illustrates here. The recent bond-market struggles are being treated by a growing chorus of investment professionals as an ominous message about the unreliability of once-safe assets, the obsolescence of the balanced stock-bond portfolio and the need for new sources of diversification. Perhaps so. What's pretty clear, though, is that adding long-term Treasuries here surely qualifies as both a deeply contrarian stance and an implicit bet that the forces of long-term mean-reversion have not been repealed. Here's the trailing ten-year annualized total return of Treasuries of 15-year maturities and longer, going back 90 years. For comparison, the trailing 10-year total return of the S & P 500 sits at 12.7%, well above average but not at the kind of historic extremes that have marked the top of mega-bull markets such as in the late-1960s and in 2000. As ever, staying involved while keeping expectations in check is a reasonable way to play the probabilities. Key level for the S & P 500 As Wall Street contemplates such heady questions about whether things are truly different this time, the stock market itself has retreated to a rather familiar spot. The S & P 500 finished the week just above 5,800. That's the level it popped above two weeks ago in response to the China tariff pause. It's also equal to its first-quarter low in January and is a threshold it vaulted over on Nov. 6, the day after the presidential election. .SPX 1Y mountain S & P 500, 1-year Since the first trip here around the election, we've seen two quarters of low-double-digit earnings growth from S & P 500 companies, a broad reaffirmation of AI-investment spending intentions and a reignition of manic retail-trader risk-seeking rolling through the buzzier precincts of the market. Such supportive undercurrents help explain why the tape has hung in there in the face of capricious policy-making and putrid consumer sentiment, allowing the market to process extraordinary and sometimes scary stimuli into what looks, for now, like a setback that's more routine than wrenching.
