Most perceptions regarding investing are created by experiences. Anyone actively engaged in investing for the past 10 years experienced a few corrections, two bear markets and higher-than-historical-average market returns led by the U.S.
The first bear market was Covid, which was very short; it was over for the markets long before it was over for our social calendars. This likely solidified the ‘buy the dip’ mentality. The second bear market was inflation/yield driven, longer in duration, yet not accompanied by a recession, which made it more tenable. Meanwhile, U.S. exceptionalism encoded a strong preference for U.S. equities, especially megacaps.
So, what have investors learned in the first quarter of 2025? U.S. exceptionalism has certainly been called into question, with the S&P 500 down -4.3% this year while international equities have crushed it, rising +8.3%.
But perhaps the biggest lesson has been to not overreact to the headlines. Listening to the headlines, especially around tariffs, could have easily caused investors to believe in doomsday scenarios for Canada and other trade-sensitive economies. Meanwhile, the TSX is up on the year, and Germany, another export-sensitive country, is up +13%.
2025 remains a challenging year, and not just because, for the previous two years, markets enjoyed outsized returns. Policy risk is real, and it has injected a higher level of uncertainty into the market, the economy, consumers and corporations.
Our strategy for this challenging year remains steadfast: listen to what people are saying, but don’t overreact. There will likely be opportunities for those who can remain more even-keeled and muster the fortitude to take advantage if the market overreacts.
Markets don’t appear to be overreacting to tariff risks at the moment, which may change. The situation remains very fluid and uncertain. However, we do believe a bigger overreaction may occur in the coming months from economic data softness. This level of uncertainty is causing behaviours to change for consumers and companies.
This may start manifesting in the data going forward. It is already evident in much of the soft data that is more sentiment-driven. If this transitions to the hard economic and earnings data, it may create the best buying opportunity of 2025. In the meantime, decent economic and earnings data appear to be mitigating the impact of higher uncertainty.
Will the Soft Data Translate to Hard Data?
Gauging the direction of the economy is anything but simple, but it is critically important to politicians, central bankers, large corporations, small business owners and individual households. To accurately and opportunely assess the economy, stakeholders use a combination of hard and soft data.
What’s the difference?
Hard data is like a fitness tracker: it records just the facts, like how many steps you’ve taken, your distance, speed, heart rate etc. These are measurable, objective numbers like GDP, unemployment, CPI, retail sales, etc.
Soft data, on the other hand, is more like a mood ring: it reflects feelings, expectations, and sentiments such as consumer confidence, investor sentiment and business outlook surveys. Soft data aggregates consumer and business sentiment, providing a near-real-time snapshot of confidence in the current and future strength of the economy.
Both types of data are useful. Hard data is accurate and reliable; however, it lags, sometimes quite materially. Soft data is more immediate, and it’s proven historically useful but inherently flawed.
Why soft data gets so much attention
One of the more prominent soft data releases is consumer confidence. Popular measures come from the University of Michigan, The Conference Board, and Bloomberg/Nanos. Each is survey-based; consumers are asked to assess their personal financial situation. After the surveys are completed, the results are compiled and aggregated into an “index” of consumer confidence.
As you can see in the chart below, consumer confidence is correlated with the strength of the economy at the time of the survey. Particularly when the economy goes into a recession, consumer confidence generally falls sharply. When the economy is in an expansion, confidence is generally at a high level.
The soft data does appear to show that these types of surveys provide good forecasts of future economic activity. Empirical studies have also shown that these confidence numbers do provide some useful information for predicting the direction of the economy, but consumer confidence is far from a super forecaster.
Declining predictive power
In a perfect world, we would just have hard data in a near-real-time manner. Real-time retail sales, durable goods spending, hiring and inflation numbers would be amazing. Unfortunately, that’s just a distant dream. Household and business confidence numbers do offer clues to future spending patterns, but the relationship is far from perfect.
One of the issues is that sentiment itself may be more skewed now. Sentiment is very much driven by what we see on TV every night, or maybe more likely what we see on our phones while “doomscrolling” in bed. The very definition of doomscrolling refers to the habit of repeatedly consuming negative news and social media content, often leading to feelings of anxiety, dread and helplessness.
Social media might be to blame, but it’s an easy scapegoat. The general population's behaviour and attitudes can become more erratic due to external factors like economic uncertainty, political instability and media influence. This can make it harder for surveys to capture consistent sentiment.
The soft data is not painting a very rosy picture
U.S. consumer confidence hit the lowest level in four years as higher prices and Trump’s trade policy uncertainty have dampened business and consumer sentiment. Inflation expectations are high and rising, consumers are miserable and even small business owners, who were jubilant after the election, are beginning to turn more negative.
Overall, the dour mood points to growing anxiety in the U.S. It appears trade wars are great at stirring price pressures and brewing insecurity.
Canada has not done much better, with Canadian consumers feeling very downbeat these days. Consumer confidence is falling, as seen in the Bloomberg/Nanos Canadian Confidence Index, and The Conference Board’s Index of Consumer Confidence plunged to a record low in March. Consumers are likely to stay cautious for some time.
Businesses are so worried that the CFIB Business Barometer Index recently registered an all-time low reading! To put this into context this is below the depths of the financial crisis and even peak Covid mania. Canadian businesses have never been more scared.
While recession fears are rising, we’re a long way off from two consecutive quarters of negative GDP growth. What the soft data is pointing to is more or less a “vibecession.” This refers to a period where consumer and business confidence is deeply pessimistic. Whether or not this precipitates an actual recession is too soon to tell. We saw a similar situation back in 2022. Rising inflation caused a dark cloud of negative sentiment that never materialized into a technical recession.
Soft data is not a reflection of the actual economy. The economy is a complex apparatus, a system of interconnected entities and interactions. It’s these micro-level interactions that all add up to the grand macro-level outcomes of the economy. Within this complexity, individual decision-making is based on expectations and gut feelings. For this reason, economists and investors who discount the soft data are taking a big risk.
Hard data has slowed but is holding up
Then there’s the hard data, which in aggregate shows that the economy is cooling but hardly dropping off a cliff. Job gains in the U.S. remain steady, unemployment has ticked up in both Canada and the U.S., and job openings have fallen but are off the lows.
Factory output shows no real concern; it even came in higher than expected in February. Inflation data in both Canada and the U.S. is rising, which is concerning, but the pace and level are not at alarming levels. It even eased in February, notching the slowest pace of price growth in four months.
The Canadian housing market has steadied, aided by falling rates. However, there is no real pickup in activity. Our unemployment rate is higher at 6.6%, but it has come off slightly from the recent high set in November.
Current market signals: it’s complicated
Whether you’re glancing at the mood ring or the fitness tracker, they’re both giving off mixed signals. The soft data is showing real concern over the economy. Unfortunately, the hard data is lagging but isn’t setting off alarm bells. We’ll have to wait and see over the next few months to see if the economy is slowing faster than expected.
As of yet, we don’t see much evidence. It’s this waiting and uncertainty that becomes very tiresome for investors. My mother always said, “Patience is a virtue.” However, this virtue appears lost to both Wall Street and Main Street. Uncertainty breeds anxiety, which is exactly what we’re seeing in the markets.
When markets are anxious, discount rates go up, risk premiums go up, and valuations come down. Hence the market correction. The first leg was more or less an off-gassing of an overheated market. Looking back, it’s easy to see we were due. Markets will likely have a brief reprieve, followed by the second leg: a growth scare if the soft data is correct.
Market Cycle & Portfolio Positioning
The market cycle indicators have ticked slightly lower but remain relatively healthy. This doesn’t capture the bigger story, which is a rotation beneath the aggregate headline number.
Over the past month, there has been a steady erosion of indicators for the U.S. economy. General indicators, including leading indicators (3m change) and GDPNow (a faster data indicator for GDP), both flipped bearish. PMI, new orders and energy demand turned bearish for the U.S. manufacturing grouping. Additionally, the trend is six signals improving with 13 eroding, compared to 12 improving and only eight eroding last month.
Some data has been a bit squirrelly of late due to the risk of tariffs. It has caused many companies to increase inventories beforehand, likely pulling forward some economic activity. This may result in a dip in the data in the coming months, whether tariffs are implemented or not.
Another factor to consider is DOGE. While the number of layoffs is hard to quantify, this will likely start showing up in the labour reports in the coming months as well. We could very well see a further drop in economic data.
On a positive note, international keeps gaining momentum from a market-cycle perspective. Emerging markets (EM) and Baltic freight both turned bullish compared to last month. This helped partially offset the bearish switches for the U.S.
Over the past month, we have not made any material allocation changes. The defensive tilt with extra cash and diversifiers certainly helped during the recent period of market weakness. Having an overweight international and a bit of an equal weight tilt within U.S. equities also helped. The market weakness was really focused on those megacap technology names, highlighting just how concentrated the U.S. market has become.
The narrow market sell-off focused mainly on the megacap technology names was starting to look interesting. We did a little buying in our more active growth strategy, but now with a partial bounce back, we are less enamoured. The partial market recovery could be the Trump Put in action. Over the past couple of weeks, it feels like there has been a decline in attention-grabbing antagonistic policy statements. From oversold levels, we believe the market can bounce on even a slight drop in uncertainty.
This could change at any moment and is likely to change as tariffs become clearer (if they do, who knows?). Markets usually prefer to know, even if there’s bad news compared to continued uncertainty. So, this bounce may have some legs.
Unfortunately, months of uncertainty are starting to have an impact on economic data and corporations. Some early reporting companies have not filled us with much confidence for the Q1 earnings season. Add to this the impact of DOGE, which should start showing up in labour data in April.
This may cause a period of market weakness in the coming months, with talk of recession risk. This could be the better buying opportunity for 2025.
Final Note
Markets continue to wrestle with tariff concerns and some cooling expectations around AI. We do believe that if markets decline, it is likely that the policy talk out of the U.S. could soften. This would be the Trump Put we have written about.
Of course, we don’t know what level of weakness is required to cause policy talk to pivot. Perhaps the silver lining is this period of uncertainty is almost 100% self-induced by U.S. policy, which can be easily adjusted. Time will tell, as this volatility will likely continue.
Of greater interest will be if all this uncertainty starts to meaningfully show up in the hard data, either the economic data or the earnings reports. Q1 earnings season kicks off in mid-April, and we would bet many companies will be cooling their guidance given the uncertainty. Corporate uncertainty will also start to show up in the data. And in the coming months, all those DOGE-related layoffs may also start having an impact. Recession talk may be on the horizon.
If this does occur, it may create one of the better buying opportunities in 2025. Hopefully, we don’t get there, but if we do, it is best to have some dry powder to potentially take advantage.
— Craig Basinger, Derek Benedet and Brett Gustafson
Sources: Charts are sourced to Bloomberg L. P.
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