Volatility Returns: What’s Driving the Market Swings? After a period of relative calm, stock market volatility has surged to levels not seen since late 2020. Last Friday marked the end of a streak of six consecutive trading days where the S&P 500 moved up or down by more than 1%. What’s causing this stock market whiplash, and what should investors make of it? Tariff & Trade Uncertainty In the run-up to the 2024 Presidential Election, now-President Trump considered import tariffs to be a central part of his economic plan. The implementation of tariffs - targeting both allies (Canada & Mexico) and rivals (China) - has introduced significant uncertainty, fueling market instability. Whether these tariffs serve as a negotiation tactic for fairer trade or a means to pressure bordering nations on immigration and drug control, the lack of clarity is breeding concerns about economic growth and stock market volatility. Each day, and sometimes each hour, brings another curveball. Investors remember Trump’s first term when U.S./China trade tensions in 2018 led to a turbulent market. In Q4 2018, the S&P 500 dropped 13.5%, wiping out healthy year-to-date gains. Stock Market Impact The S&P 500 has already experienced a 10% drawdown from its February 18th peak. Last week, the Nasdaq entered correction territory, and now sits 12% off its recent high as investors sought alternatives such as fixed income, dividend-paying equities, and international markets. The correlation between tariff discussions and market pullbacks is no coincidence. The uncertainty surrounding these policies has led investors to take a more defensive stance, shifting toward value-oriented stocks and away from high growth sectors. Historically, the S&P 500 experiences declines of 5% roughly once per year, while 10% corrections happen about every other year. While the triggers for these declines may change -this time, tariffs and geopolitics - the pattern of market corrections remains a normal part of investing. Shifting Tides - The Case for Diversification Following is something we frequently discuss on CNBC - in fact we did so yesterday on Power Lunch. Watch Matt’s latest appearance here:

Deepseek and its Low Cost Claims The final week of January was a whirlwind for the stock market, with tech stocks taking center stage. On Monday, the Nasdaq saw its sharpest decline in over a month following news from China about DeepSeek, a ChatGPT competitor. NVIDIA, a dominant force in AI infrastructure, faced a staggering setback, losing nearly $600 billion in market value - the largest single-day dollar loss in U.S. stock market history. DeepSeek claims to operate at a fraction of the cost of U.S. competitors, requiring less processing memory to train and run. While the long-term implications remain uncertain, this development introduces increased volatility and uncertainty in the near term. Earnings Sensitivity Last week also brought earnings reports from four of the Magnificent Seven, along with other key U.S. companies. So far, 77% of S&P 500 companies that have reported Q4 2024 earnings have exceeded expectations, while 63% have surpassed revenue estimates (FACTSET). Historically, positive earnings surprises have led to modest stock price increases, while negative surprises resulted in declines. However, recent quarters have shown heightened market sensitivity to earnings results. For example, IBM exceeded expectations and issued a strong outlook, leading to a 13% one-day gain. Conversely, Lockheed Martin fell 9% after reporting lower-than-expected revenue and offering cautious guidance. Recently, S&P 500 companies that beat both sales and earnings expectations saw an average stock price gain of 3.6% post-announcement, well above the five-year average of 0.9%. Meanwhile, companies that missed estimates saw an average 5% decline, compared to the historical average of 3.1%. Market Concentration With the S&P 500 trading at above-average earnings multiples, investors are watching earnings reports closely. All 11 sectors of the index are expected to see earnings growth in 2024. Why does this matter? The Magnificent Seven currently make up 30% of the S&P 500’s value and accounted for 50% of the index’s gains in 2024. To sustain market growth, the remaining 493 companies will need to contribute more significantly. While the market has reached new highs over the past two years, those gains have been driven by a small group of companies. For context, the only other time such a limited number of stocks dominated performance over a two-year period was during the late-90s dot-com bubble. This narrow market leadership presents a double-edged sword. On one hand, it raises concerns about whether a handful of companies can continue to outperform. On the other, it creates an opportunity for broader market participation, with the rest of the S&P 500 looking more attractive from a valuation and diversification perspective. Periods of concentrated market leadership often lead to increased volatility as investors weigh sticking with what has worked - the Magnificent Seven - versus diversifying to reduce risk. The S&P 500 is currently top-heavy, with its 10 largest companies accounting for 30% of the index. January managed to post gains, but not without some turbulence. We expect market volatility to rise in 2025, compared to the relative calm of the past two years. Last but not Least - Tariffs Additionally, tariffs have recently moved to the forefront. While new tariffs on Mexico and Canada were announced and then delayed by a month, the U.S. moved forward with tariffs on China. The uncertainty surrounding potential tariff impacts adds another layer of market unpredictability. In summary, markets face increasing uncertainty from new AI competition, earnings sensitivity, narrow leadership, and trade policy developments. While diversification may not have been "in style" in recent years, it remains a valuable tool for managing volatility. As always, investors should maintain a long-term perspective and avoid getting caught up in short-term market swings. If you have questions or concerns about your individual situation, please don’t hesitate to contact us.

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