Climbing the wall of worry

Make sure you can withstand high anxiety in the markets

Financial markets have a long history of advancing during periods of uncertainty which is often described as “climbing a wall of worry.” This wall is not built of bricks and mortar, but of uncertainty, where investor sentiment oscillates between fear and greed. It is an understandable dynamic given the market’s recent pattern, which has felt like a rinse-and-repeat cycle of sharp declines followed by equally sharp rebounds.

Today’s wall is a familiar one filled with obstacles and supports. We note that inflation has eased from its post-pandemic peak but remains above the Fed’s 2% target and a hotter than expected rate on the Producer Price Index that came out on Feb. 27 did nothing to ease that concern. Rates have remained relatively benign but are still high enough to influence borrowing and spending patterns…commonly referred to as “affordability.”

Despite the President’s frustration, most members of the current Fed maintain that short-term interest rates are already sitting in a neutral “not-too-hot, not-too-cold” range. When Kevin M. Warsh takes over as Fed Chair in May, he is widely expected to adopt a more dovish stance. Markets are looking closely, as Mr. Warsh has previously advocated both meaningful rate cuts and a substantial reduction in the Fed’s balance sheet in his role as Trump’s National Economic Advisor. Investors worry that a combination of aggressive easing and rapid balance-sheet contraction could ultimately put upward pressure on longer-term inflation.

Bricks in the wall of worry

The ongoing Middle East “excursion” continues to reverberate through financial markets, with stocks and bonds oscillating in mirror image opposition to oil. The conflict’s macro-economic impact primarily through rising energy prices and renewed strain on supply chains, has slowed global growth just enough to keep forecasters continually revising their pre and post war outlook.

Assuming the Iran conflict is relatively short-lived, the U.S. economy could return to above-trend momentum with some unconventional projections forecasting GDP growth that could surpass 5% through the second quarter of 2026. These ambitious expectations, however, rest on the assumption that the U.S. can maintain – and potentially expand – its trade surplus. As a reminder, the gap between imports and exports directly affects GDP: a trade surplus adds to growth, while a trade deficit subtracts from it.

Another macro-economic headwind is the softening in the U.S. labor market. The latest report from the Bureau of Labor Statistics shows a meaningful decline in job openings, and for the first time in recent memory, there are now more job seekers than available positions. This shift suggests that labor market tightness, which has been one of the economy’s strongest tailwinds, is beginning to crack, raising questions about the durability of the economic momentum.

Against this backdrop, it might seem counterintuitive that the S&P 500 Index has found solid support at the 200-day moving average (200-day moving average is ~6,650). At least for now!

It is also important to understand that investors rarely wait for clarity. Markets tend to advance as long as economic conditions remain solid enough to support corporate earnings and financial stability. Ancillary concerns are absorbed, debated, and repriced.

Eating volatility

Along the way, investors must be willing to sop-up disproportionate volatility, which from our perspective characterizes the steepness of the wall of worry. Sharp pullbacks are part of the journey, particularly when headlines are dominated by policy shifts, inflation readings, oil price shocks, and the unintended consequences that accompany geopolitical conflict. The key is to recognize that while uncertainty colors the landscape, equity markets have repeatedly demonstrated an ability to move forward albeit on an uneven path.

The appropriate investment strategy must incorporate diversification to manage risk, allowing investors to maintain perspective. Climbing the wall of worry is uncomfortable. Coping requires the financial equivalent of a safety harness to steady the anxiety associated with short-term noise and a reasonable forecast about the economy’s mid-to-long-term trajectory.

Richard Croft is Founder, Chief Investment Officer, and Portfolio Manager of R.N. Croft Financial Group Inc.

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R N Croft Financial Group Inc. is a Licensed Discretionary Portfolio Management and Investment Fund Management company serving investors and investment professionals across Canada since 1993.

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