Market Correction 2025

The S&P 500 moved closer to a market correction—a 10% decline from the peak reached earlier this year—amid an escalating trade war, DOGE-related controversy, and geopolitical tensions. Market corrections are typically caused by a decline in economic fundamentals, but the recent volatility is largely attributable to rising uncertainty about the government’s economic policy plans. While discomforting, the recent 10% pullback in stocks is below the average annual of 14% dating back to 1980. This retracement, when coupled with the change in administrations and back-to-back 20%+ returns in 2023 and 2024, should not come as a huge surprise.

Although economic fundamentals remain reasonably strong, the economy is in a more fragile state compared with 2022. There is much less stimulus, higher consumer prices and interest rates, and the labor market shows early signs of softening. After years of spending, lower-income consumers are showing signs of value-seeking and increased caution.

Although the risk of recession is increasing, we think a growth slowdown is more likely than a recession. Employment, though coming down from historically strong levels, remains high. Consumers are spending, corporate earnings are strong, and inflation is slowly coming down. If there is a recession, it will be one that is “made in Washington”—that is, a recession prompted by policy decisions rather than broader conditions. The bigger risk is that signals coming from DC prompt a contraction in consumer and corporate spending, along with commensurate job cuts. A lack of visibility can cloud business as usual and cause economic actors to adopt a bunker mentality. While this may be more based on perception than reality, perception sometimes can create its own reality.

The consensus thinking among investors to start the year may have been too about the impact of Trump’s tariff threats, DOGE-inspired disruption, and geopolitical risks, with the latest developments challenging some of that complacency. Investors have been assuming that tariffs are negotiating tactics and will be renegotiated before doing much economic damage, as was the case in Trump’s first term. Today, there is more of a realization that Trump’s “market unfriendly” actions (tariffs, DOGE) will disrupt growth first, while his “market-friendly” actions (deregulation, manufacturing reshoring) may provide benefits later.

Tariffs are likely to be inflationary and increase the price level in the short term but will depress economic activity and possibly be deflationary in the long term. Lower-income households are disproportionately hurt by inflation, higher interest rates, and a less robust job market.

Market volatility can create opportunity as well as risk. We are looking to add to holdings that we think have fallen excessively in response to recent volatility while critically evaluating holdings that may face a more challenging outlook. Caution is appropriate given the elevated level of uncertainty, so we will be vigilant in maintaining liquidity and balance in portfolios. We advise against making any material asset allocation changes in response to market volatility, though we understand it can be tempting to try to time the market. Unless there is a change in your goals, cash needs, income, or obligations, it is prudent to stay the course with your long-term asset allocation.

The catalyst for the pullback in stocks was that rising uncertainty naturally demands a higher risk premium. The pullback will likely end when there is greater policy certainty that helps to provide clarity for investors. That clarity can either come from more certainty about which of the various policies will be implemented (tariffs or otherwise) or a slowdown of the pace or reversal of policy actions.

Daniel Kern
Chief Investment Officer
+1 617.345.1044
dkern@nixonpeabody.com