Hope is not a strategy: The risks of a bullish scenario

The stock market needs unequivocally good news, not just less bad news, to sustain its growth.

Unfortunately for market optimists, the likelihood of such good news is small, as earnings disappoint, valuation multiples remain steady, global trade and growth weaken, and bond yields rise.

Since when does -1 + 1 = +1? Ask the stock market, which somehow can turn a crisis into a triumph. Thus, the S&P 500 strives back toward historical highs despite weaker conditions compared to those when the index peaked in February.

The island of “dead cat bounce” is becoming uncomfortably crowded, but it’s hard to build an analytical case otherwise. The bullish scenario seems based on ongoing improvement in trade policy (more Scott Bessent, less Peter Navarro); tax cuts that stimulate growth but do not increase fiscal risks; and the well-known momentum and fear of missing out (FOMO) that attracts more people as previous highs are surpassed.

But let’s start with the basics. One of the best indicators for the medium-term market trend is simply the crossing of the 13- and 26-week moving averages for the S&P 500. This turned negative in early April, i.e., the 13-week average fell below the 26-week. It is unlikely to reverse soon, as the 13-week average is still declining.

Negative regimes are usually associated with weaker stock performance or volatile, sideways trading. This corresponds to many of the fundamental factors for the stock market.

Tariffs triggered the stock decline, but the trade outlook is now gloomier than at the start of the year. There are already signs of a global cyclical slowdown, visible in semiconductor stocks. As the chart below shows, they lead South Korea’s exports, which is a leading indicator for global growth and trade, considering South Korea is a small, open economy linked to global supply chains.

Preliminary data for South Korean exports (first 20 days of April and first 10 days of May) show a significant drop.

This data precedes the US-China announcement on temporary tariff reductions. But the inevitable truth is that the US does not want to maintain trade deficits as large as before, and tariffs will be their main tool to reduce them. Assuming key tariffs remain at 10%, and tariffs with China do not exceed 30%, this still leaves the average tariff rate much higher than it has been since the 1940s.

It’s worth emphasizing this point. Although tariffs may not be as bad as initially feared, they are still likely to be higher than they have been for the past 80 years, at a time when the US is a massive net contributor to global demand through its trade deficit, rather than an absorber with a trade surplus as it was then.

Expansion of valuation multiples was a driver of stock growth until it stumbled. Now only earnings, margins, and buybacks contribute positively to market returns.

P/E ratios have somewhat recovered with the market rise, but their outlook is not favorable. Price pressures are building—despite what some inflation indexes say—as inflation expectations rise. The increase in prices paid in the ISM manufacturing survey shows that P/E ratios will feel additional pressure.

Extremely high stock valuations were partly justified by the perceived exceptionalism of the US. It does not require a complete rejection of the US—just that it becomes slightly less exceptional in investors’ eyes—to justify a lower P/E, albeit still significantly above its long-term average.

Earnings are likely to start disappointing compared to previous expectations. The cyclical slowdown in the US, which began before the tariff issues, points to lower earnings today than expected last year. Forecast earnings for the S&P have barely declined and are likely still conditioned by the trade outlook, as it was before Trump became fully the “Tariff Man.”

Therefore, much depends on margins and earnings to support stocks. Margins remain high, and—in the absence of new fiscal spending increases—it is unlikely they will be a deus ex machina for the market, as consumer inflation expectations continue to rise and tariffs force companies to absorb hits on their bottom lines. Earnings are unlikely to accelerate as the economy enters a cyclical weak phase, as indicated by sideways movement in the leading US indicator.

We are left with buybacks to reduce the number of shares and raise the price. They have strengthened significantly this year, helped by the continued weak supply of IPO shares, according to JPMorgan.

This is not much for a convincing bullish scenario, especially as government bonds become less impressed by weaker-than-expected CPI data and instead increasingly focus on more structural risks, such as weakened domestic and foreign demand, fiscal generosity, and rising inflation expectations.

At some point, the negative geometric effects of higher yields on the present value of stocks are likely to manifest, outweighing the positive but only linear impulse from better (or less bad) earnings expectations.

Nothing is impossible, of course, and stocks can “fake it till they make it,” i.e., reach new highs and create a self-fulfilling better environment for growth. But it is hard to escape the strict constraints of the cyclical slowdown, the built-in weakening of global trade, and the highest tariff rates since World War II. April may soon turn out not to have been the harshest month after all.