Actions for Stock Investors: Gaining perspective on the current situation is essential.

Key Takeaways

• Recent US tariff announcements have led to economic concerns, driving stock market sentiment to its most bearish level in over 30 years, according to one measure.

• Historically, extreme sentiment levels have often been followed by stock market increases over the subsequent 6 to 12 months.

• In previous instances, maintaining investments in US stocks during periods of extreme bearish sentiment has frequently proven beneficial.

Let's be straightforward: The US stock market is facing unprecedented uncertainty due to recent announcements on US tariffs, leading to a significant and unified expression of concern.

But is the crowd's reaction justified?

It's challenging to determine with certainty. US trade policy has evolved so quickly in recent months that finding a modern historical parallel is difficult. What we do know is that the magnitude and speed of the recent tariff announcements hinder firms from promptly addressing supply-chain challenges. Consequently, these announcements could heighten short-term downside risks to growth and increase upside risks to inflation. This, coupled with the uncertainty about who ultimately bears the tariffs (exporters, importers, or consumers), is central to the market's negative response.

Our primary focus should be on the internal rotations and sentiment shifts occurring beneath the market's surface, as well as the historical market responses to similar sentiment declines.

To begin, let's assess the current level of market anxiety to determine if it is truly extreme. The super chart CBOE SKEW Index, which measures perceived “tail risk,” indicating how concerned investors are about an extreme and unusual market event. Like the well-known VIX index, it evaluates this by analyzing investor activity in the options market.

It's crucial to understand that a score of 100 is considered "normal" on this scale, representing a baseline level of tail risk. Since 1990, the long-term average has been 122. In February, the index reached a new 30-year high amid the initial wave of US tariff announcements, before stabilizing somewhat in March. By the end of March, the index was at 148, which is 48% above "normal" and significantly higher than the long-term average.

Is the fear justified?

The justification for market fears hinges on the impact of US tariffs—and the resulting reciprocal tariffs from affected nations—on economic growth, inflation, and geopolitics.

Let's examine each factor briefly:

• Economic growth: Historically, tariffs have acted as a tax, creating demand headwinds that can slow down consumption. This is arguably the most significant threat posed by the latest tariffs.

• Inflation: Tom Barkin, head of the US Federal Reserve Bank of Richmond, recently cautioned that tariffs could increase inflation. However, history indicates that tariffs do not necessarily lead to sustained inflation. For instance, inflation decelerated in 1971, 2002, and 2018 following tariff implementations.

• Geopolitics: The geopolitical effects will depend on how targeted countries respond to US tariffs. China has already announced reciprocal tariffs, and Europe could swiftly retaliate, with other nations potentially following suit.

Recession Fears Surge

Google Trends search data clearly mirrors the current market sentiment. By March 2025, searches for "recession" had skyrocketed to the top percentile of their historical range, with data tracing back to early 2004 when Google Trends first launched.

Is a recession imminent? While the exact outcome remains uncertain, the rapidly changing landscape and the unpredictable actions of policymakers are crucial factors in shaping the future.

The market is not waiting for confirmation. It is operating under the assumption that a recession is near, and has already made significant adjustments to prepare for this possibility.

What Is the Best Course of Action?

History shows that selling during times of extreme market bearishness is often a mistake. By the time bearish sentiment peaks, adopting a bearish stance in your portfolio is typically too late if you have a long-term perspective.

For example, I analyzed the S&P 500 Index's 12-month returns following periods of intense bearishness. To gain comprehensive insight, I developed an index of negative sentiment that includes the CBOE SKEW Index, economic policy uncertainty, and consumer confidence measures.

Recently, this measure of bearishness nearly reached its multidecade high, approaching the level seen in 2020 at the onset of COVID. Since 1990, when negative sentiment has hit such extreme levels, the S&P 500 index's forward 12-month returns have averaged over 30%.

Reflecting on 2004, when Google searches for “recession” surged into the top 5% of queries, US stocks experienced significant gains over the following 12 months.

Now, a common concern arises: Some spikes in recession searches have coincided with major recessions and severe bear markets—such as 2007 to 2009—where stocks fell sharply. Are we on the brink of another "big bear"?

This is a crucial question. Over the past seven decades, there have been three "big bear" markets: those beginning in 1973, 2000, and 2007. Apart from these, stocks have consistently risen in the year following a dip into bear territory (or near-bear territory). However, during the big bears, stocks typically lost an additional 30% on average after initially entering bear territory.

How can you determine which type you’re in? You can’t. Yet, historically, there has been a strong correlation between the speed of a bear market and subsequent returns. Faster declines have statistically led to larger and quicker rebounds.

The big bears took a considerable time—averaging 315 days—to reach bear territory. In contrast, this recent decline ranks among the fastest three in history.

Conclusion

Stock investors face numerous considerations in early 2025. Some bulls have been unsettled by recent developments, and further short-term volatility—either upward or downward—is possible.

Nonetheless, historically, such situations have often been an inopportune moment to sell. Over the long term, maintaining stock exposure within a diversified portfolio has consistently benefited investors.

Best Regards,

Stock Market Charlie aka The Hound of 317