Rising Inflation and Declining Consumer Confidence Weigh Heavily on Wall Street

The latest "core" PCE inflation data, the Federal Reserve's preferred gauge for assessing inflation, exceeded expectations, rising 2.8% annually compared to the anticipated 2.7%. Simultaneously, the revised U.S. consumer confidence index dropped to 57 from an initial reading of 57.9—the lowest level since 2022.

These developments, combined with recently announced tariffs and additional ones expected on April 2nd, heightened fears of stagflation among investors. As a result, major indices took a significant hit, with the S&P 500 falling by 2% and the Nasdaq down by 3%. This explains the flattening yield curve, as the U.S. 10-year yield, linked closely to economic outlooks, dropped 12 basis points to 4.25%, and the 2-year yield, tied more to Fed policy expectations, fell by 9 basis points to 3.91%.

This scenario signals a challenging future for the Federal Reserve as it navigates between persistent inflation and slowing economic growth. However, part of this inflationary pressure might dissipate over the coming months. The current uptick appears driven less by structural demand growth and more by short-term expectations among businesses and consumers anticipating tariff-driven price increases.

Indeed, with Trump's expected election victory and the imposition of new tariffs, businesses have preemptively accelerated purchases, evidenced by annualized quarterly inflation rising sharply from 2.2% in August 2024 to the current 3.5%.

Yet, despite concerns, the U.S. economy might avoid the worst-case stagflation or recessionary scenarios. While consumer confidence has fallen rapidly—a pattern typically seen during recessions—consumer spending surprisingly rebounded in February, rising by 0.2% month-over-month after a notable 1.2% decline in January. This recovery is further supported by unexpectedly strong service-sector PMI data.

Still, the market requires time to digest current uncertainties. Historical context is instructive: in 2018, Trump's initial tariff applications in January and September triggered market corrections of 10% and 20%, each lasting roughly three months. Investors today might face another month of volatility as additional tariffs loom and other countries prepare reciprocal responses.

This uncertainty has prompted institutional investors to increasingly shift away from U.S. equities toward other regions or asset classes, leaving retail investors to bear the brunt of market downturns. Interestingly, despite 27 down-days in the S&P 500 this year, retail investors were net sellers on only 7 occasions, reflecting persistent optimism among individual investors and caution among professionals.

Moving forward, monitoring macroeconomic indicators such as consumer sentiment, retail sales, and PMI data will be crucial. A sustained decline or underperformance in these metrics could prolong market downturns. Conversely, stability or improvement could reassure investors of U.S. economic resilience and trigger a market recovery.

Periods like this underscore the importance of geographic diversification in portfolios. While the S&P 500 has declined by 5% year-to-date amid recession fears, other regions have performed strongly: Europe's Euro Stoxx 50 is up 9%, and Hong Kong's Hang Seng Index has surged 19%.

Europe and China present compelling investment opportunities due to fundamentally different economic and monetary trajectories compared to the U.S. In Europe, the ECB continues its expansionary policies, bolstered by substantial fiscal measures like Germany’s €500 billion stimulus and a potential €800 billion European defense plan. Additionally, Europe's potential to resume Russian energy imports could significantly reduce energy costs, boosting heavy industry.

Similarly, China has initiated the largest monetary stimulus since the pandemic, stabilizing the property market downturn. The Chinese economy is also set to benefit from substantial fiscal stimulus measures aimed at revitalizing wages and consumer spending.