A $54 trillion asset class is recovering from a crash with intensity matched only by the pandemic and the Great Financial Crisis.
A record 60% of households have exposure to the stock market today.
So naturally, the question on everyone’s minds is whether this rally is actually sustainable.
We’re facing 3 possible scenarios for the market’s path forward:
- A V-shape recovery, with stocks immediately recovering back to their highs and resuming their bull market
- A deeper pullback, taking the market down past the low it made on April 7th
- A consolidation, where price stays within a range for weeks or months before eventually resuming higher
V-Shape Recovery: Possible But Unlikely
For a V-shape recovery to occur, we’d need to see a 180-degree flip in the economic outlook.
This would mean all concerns priced in during the early 2025 correction completely disappear in the coming weeks.
The news of a trade deal between the US and China has led many to believe the skies are clear for stocks to continue higher.
We’ve already seen this kind of V-shaped recovery before.
The most recent example was during Covid in 2020.
Back then, the market crashed 35% only to snap back to all-time highs almost in a straight line.
We also saw something similar toward the end of the great financial crisis.
Investors quickly shifted from expecting a financial collapse to strong economic growth.
The problem?
In both cases, huge amounts of monetary stimulus were responsible for these V-shaped rallies.
We can see this by looking at the Federal Reserve’s balance sheet.
The 2 biggest jumps in liquidity occurred right before these V-shape recoveries – something we’re not witnessing today.
But there is some good news for this scenario:
Stock market earnings have been remarkably resilient, despite the 20% market drawdown.
Earnings estimates for the S&P 500 are actually higher now than they were in January.
Several factors are driving these stronger earnings:
- Recent US dollar weakness is helping boost international revenues
- Lower gas prices have helped consumers
- Fed interest rate cuts over the past year may be starting to stimulate economic activity
Despite these positive factors, we don’t believe the V-shape recovery scenario is the most likely.
But that doesn’t mean we’re shorting the market…
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The Deeper Pullback Scenario
A deeper pullback scenario requires conditions to deteriorate further from today’s levels.
History shows numerous examples where things got worse after brief market bounces.
In May 2008, stocks staged a rally after a sharp correction, but it didn’t last.
The market eventually broke to new lows and fell much further.
Similar failed rallies played out multiple times in 2001 as well.
If that happens again today, most people already know what that means…
It’s what everyone has been warning about since tariffs made headlines – a recession.
In fact, the first red flag is already here: Q1 2025 posted a negative GDP print.
That’s exactly how things started in 2008 and 2001, both of which went on to become full-blown recessions.
In each case, the initial GDP contraction was followed by further contraction and stocks dropped over 50%.
So, if GDP keeps contracting, there’s a real risk that this year’s drawdown could just be the start of something bigger.
However, negative GDP prints can also occur outside of recessions – like in 2022, 2014, and 2011.
These isolated episodes of economic weakness were actually excellent buying opportunities.
What separates recession-triggering GDP contractions from isolated contractions?
Initial jobless claims tell the story.
During 2001 and 2008, initial jobless claims were rising – layoffs were accelerating.
But during the isolated contractions of 2022, 2014, and 2011, claims remained stable.
Today, we haven’t seen any pickup in layoffs despite the negative GDP print.
The Most Likely Scenario: Consolidation
This leaves us with the consolidation scenario, where the market chops around for a while digesting the bad news.
But the economy avoids a 2025 recession, and eventually the market looks toward a brighter future.
A perfect example was 2011, where stocks declined by 20% during the European debt crisis, then went sideways for months before moving higher.
Something similar happened in 1998.
The Asian financial crisis triggered a 20% correction and recession concerns.
But the market chopped around for months and ultimately recovered when the economy avoided recession.
In our opinion, this scenario is the most likely today.
Fortunately, we don’t need to predict the exact path of the S&P 500 to profit from markets.
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