Between 2022 and 2024, the S&P 500’s total market capitalization rose from $30 trillion to $54 trillion, adding $24 trillion in value.
For reference, it took 28 years for the S&P 500 to add $24 trillion in value between 1995 and 2022.
But now, within the space of just a few weeks, we’ve seen the S&P 500 give back $5 trillion.
Many believe that this incredible melt-up over the last couple of years was completely unsustainable and that this recent correction is just the beginning of a major unwind…
Something that would make the Great Depression look like child’s play!
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Now, before we buy into all the doom and gloom, we have to transform the linear chart of the S&P 500 into what’s called a log scale chart.
Putting the S&P 500 index on a log scale helps us compare today’s price action to what was going on in the 1980s and ’90s when the S&P 500’s market cap was much smaller.
For instance, in 1985, the S&P 500’s market cap was $1.5 trillion.
By 1987, it was $2.5 trillion.
In dollar terms, that’s a much smaller increase relative to what we’ve seen today.
But in percentage terms, both moves represented about a 70% rise in the S&P 500’s market cap.
So the S&P 500’s most recent move looks a lot more reasonable relative to history.
Historical Comparison: 1990s vs Today
If we copy and paste the price action from the 1990s onto today, we see that the steepness of the rally in 2024 is actually incredibly similar to what it was back in the 1990s.
The only difference is that in the 1990s, the stock market continued posting the same kind of strong returns for multiple years after.
So yes, we’ve certainly been in a very strong market over the last couple of years…
But nothing says we couldn’t actually continue to see the S&P 500 provide the same kind of strong returns over the next few years.
Of course, for such a melt-up, we require the right conditions in place.
Economic Growth Requirements
Each incredibly strong period of stock market performance had very specific conditions in place.
When we put real economic growth on the stock market, we see that all of these big market melt-ups occurred when real economic growth was extremely resilient.
In the 1980s and ’90s, real GDP growth stayed between 3% and 5% on quite a consistent basis.
Since 2022, we’ve seen real economic growth average about 2.5% to 3%, which has been enough to sustain the recent rally in the stock market.
The more complicated question is whether Donald Trump’s tariff policies are about to put a dent in the steady economic growth we’ve seen over the last couple of years?
The most direct negative impact of tariffs is that they reduce corporate profit margins.
Lower corporate profit margins can lead to cost-cutting measures such as layoffs.
This leads to rising unemployment – a typical characteristic of a recession where you see a steep decline in economic growth.
But here’s the twist:
Trump has also just announced a 90-day pause on these tariffs, meaning they are not being implemented just yet.
Some argue that the 90-day pause does nothing to reduce recession risks, as the economy will grind to a halt in these uncertain economic conditions.
Others say the pause on tariffs does reduce the risk of a recession as the market will quickly gain clarity on the situation while avoiding immediate negative impact.
We’re cautiously optimistic.
If effective negotiations follow, we could narrowly avoid a recession.
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Inflation Predicts Economic Growth
We believe that tariffs aren’t the only thing that can influence economic growth in the United States.
We can show this by adding a simple line to the chart of economic growth in the US that actually predicts what real GDP is going to do over the next 8 months.
This line is the inflation rate in the US, but it has been flipped around and shifted forward by 8 months.
You see, inflation represents the cost of living, particularly for essential things like gas, food, medical insurance, and shelter.
If the cost of living for these essentials is rising, people will likely reduce their overall spending in other areas.
When the consumer is weak, the economy weakens and typically heads into a recession.
This model has predicted every significant slowdown in economic growth going back to the 1980s, with the exception of 2020 (pandemic-induced).
In each case, inflation went up first, and then 8 months later, economic growth collapsed.
Over the past 8 months, we’ve seen inflation remain quite steady.
This suggests we should expect economic growth to remain steady for at least the next 8 months.
But, an external shock can still break the economy, even without a rise in inflation.
Today, many people believe today that’s exactly what’s going to happen…
We’re not PhD economists, and we’re not taking a big stance on this right now.
But if the tariff recession is avoided, then the data points to stable growth in 2025.
Still, we agree that one shouldn’t rely solely on government data.
To get beyond the monthly government data, we’ve constructed a basket of publicly traded commodities that gives us a real-time view of inflation.
This includes things like cotton, wheat, corn, soybeans, as well as metals like copper and nickel that are essential in manufacturing.
When mixed all together, this index give us a good sense of real-time inflation.
Right now, our commodity basket is telling us that inflation is indeed remaining quite stable, just as the government data suggests.
Our Current Strategy
We’re at a make-or-break point for the US economy.
Avoiding a recession in the near term could mean seeing stocks continue a very healthy bull market throughout 2025.
But, a recession would lead to more pain.
Luckily, as traders, we don’t need to make a call on this right now.
Our trading strategy is based on making high-probability trades yielding large returns during favorable market conditions.
The goal in these current conditions should just be not to get ripped apart by volatility.
That’s why we’re being very selective with our Trades, until we see an improvement in the technical and internal structure of the stock market.
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