A widely forecast stock market correction has played out, with NASDAQ experiencing its worst day, March 10 since 2022.
The rising trade protectionism of the current Trump administration, taking the form of tariffs on crucial imports, such as a 25% tariff on steel and aluminium, finally broke the back of bullish sentiment.
March’s bearish narrative driving stock market correction
Investors are starting to fret about stagflation, the worst-case scenario where the economy experiences higher prices in a backdrop of economic contraction.
Retaliatory tariffs in the short term could lead to higher prices, supply disruptions and shortages.
In the long run, if the economy can transition by supplementing imports with domestically manufactured goods and raw materials, there is an economic benefit.
There is also a time lag for an economy to transition to making more domestically, relying less on imports.
So, investors could be worried about stagflation in the short term.
“Bond investors are starting to fret that inflation is not under control.
QT, plus DOGE spending cuts, could trigger a sharp recession.” written in a piece, “Rising Treasury Bond Yields,” posted on February 24 2025.
“The rising trade protectionism of the current Trump administration, taking the form of tariffs on crucial imports, such as a 25% tariff on steel and aluminium, finally broke the back of bullish sentiment”
WIN INVESTING
A stock market correction was highly probable, with such a high stock valuation and a spike in the VIX fear index
US stocks are trading about 22 times earnings.
The last time it was at this level was in the 1990s, during the tech bubble.
The difference this time is you have better earnings supporting tech stocks than in the 1990s.
However, US stock valuations are high from a historical perspective, bearing in mind the long-term price-earnings PE average should be about 16 to 17 times earnings.
We are at the high end, so when investing at such price levels, being exposed to negative surprises is high.
“US stocks are trading about 22 times earnings”
WIN INVESTING
The stock market correction could be due to a hint of a slowdown in earnings
Relatively low levels of interest rates support high multiples.
The 10-year treasury bond yield is 4.3% at the time of writing.
So, with the 10-year offering of approximately 4.3% and the six-month treasury bills paying a similar amount, also being safer than a cash deposit account.
The risk premium of being in stocks valued at 20 times earnings, PE 20, is 5%. In other words, the risk premium of stocks at current PE levels is 0.7%, which is too low.
The Stock market correction could be about too much risk relative to reward.
Picking up pennies in front of a steamroller comes to mind.
Moreover, there is a risk with stagflation that earnings decline and interest rates remain elevated, which could make the risk premium of holding stocks zero or negative.
So, traditionally, investors want to be compensated for the extra risk associated with equities.
Currently, that extra risk premium is non-existent at these market levels.
“This administration [and] President Trump are committed to the policies that will lead to a strong dollar”
– Scott Bessent, Treasury Secretary
The anomaly to stock market correction, the USD decline
Typically, when investors become risk-averse, the stock market sells off, and there is a capital flight to safe-haven assets and currencies, such as CHF and USD.
March stock market correction saw CHF appreciate 3% against the USD.
So, as a perceived safe haven currency, the USD underperformed in the recent scramble out of risk assets.
The anomaly to the March stock market correction is that the USD Index (DXY) declined by 4.1% in one month
That marked the worst decline for the index since the 2008 financial crisis when the index slid 4.8% over the same period as the Global Financial Crisis.
The USD decline contradicts the current US administration’s policy.
“This administration [and] President Trump are committed to the policies that will lead to a strong dollar,” said Treasury Secretary Scott Bessent in a recent March interview.
Moreover, what is even more perplexing is that current central bank interest rate differentials favour USD.
In March, The European Central Bank ECB lowered three key ECB interest rates by 25 basis points to 2.50%, 2.65% and 2.90%.
The Bank of England a month earlier, in February 2025, reduced its bank rate by 0.25 percentage points to 4.5%.
The Bank of Canada also cut rates by a quarter point to 2.75%.
So, a question comes to mind.
Why is there not a flight to the perceived safety of risk-off assets, like treasuries and the USD dollar in this recent stock market correction?
Typically, market calamity triggers investor demand for treasuries, sending corresponding yields tumbling.
Moreover, the US Dollar Index (DXY) would rally because treasury and USD demand are complementary.
“The defence budget is 840 billion dollars” – Win Investing
Post-March stock market correction, are more Fed rate cuts coming?
A move in Fed rate cuts could halt the correction, setting a support price floor level under stocks, causing USD to drop.
With recession risks rising, investors could be betting more rate cuts are on the cards.
As recently as mid-February, most investors believed the Fed will cut interest rates once this year at the very most.
Now, the majority expect three cuts by the end of the year.
Many believe the current rates are too high for a nation with so much debt and argue that the US cannot afford these higher rates.
Putting it in perspective, 22 years ago, the last time we had 5.5% Fed funds, the national debt was 5.6 trillion dollars and is now 32.6 trillion dollars.
If the US had to pay 5.5% interest on the national debt, that is 1.8 trillion dollars in interest on the debt.
The defence budget is 840 billion dollars.
Interest on debt is more than twice what the US spends on the national debt.
The stock market correction, declining hegemony and USD?
If Europe can no longer shelter under the yoke of a US-centric world and has to invest more in its security architecture, that could cause Euro governments to repatriate capital, hence Euro appreciation.
In a Guns and Butter policy, EU leaders propose to increase their defence budgets.
The German government recently said it intends to exempt defence spending from budget control measures.
European defence sector stocks are up 40% year to date.
