Truths assert themselves across markets as economic difficulties bite

Bloodied and bruised, few investors in global equities will mourn the end of the first quarter of 2025. With the US benchmark S&P 500 down 4.6%, it has been the worst three month stretch in three years. Is this just a correction after two years marked by soaring equity valuations? Or is this the start of a longer, more protracted bear market?

To answer that, it is essential to separate meaningful trends from background noise — no easy task in a quarter riddled with volatility. But last week’s broad-based sell-off, which shaved 2% off the S&P 500 in a single session, felt material. It could mark a turning point.

The rout was triggered by the release of US personal consumption expenditure (PCE) data, which raised concerns on several counts. To understand why markets baulked, it helps to distinguish between “hard” and “soft” data. Soft data — typically survey-based measures of sentiment — can be useful leading indicators, hinting at future economic behaviour. But it can also just be wrong. Gauging the mood of a few hundred consumers or business leaders offers, at best, a hazy forecast.

There is an important proviso here — macroeconomic activity, and specifically aggregate demand, is in a sense nothing more than the agglomeration of sentiments. If people feel negative and pessimistic, and start consuming less and saving more, then an economic slowdown can theoretically be a self-fulfilling prophecy. This is what Keynes referred to as animal spirits.



Yet sentiment surveys should be seen as just that, and more importantly should be used to discern direction, rather than absolute levels. The critical indicators are, first, if they are consistently moving in one direction over a series of months or quarters (in this case, down), and second, if they are starting to presage shifts in hard data.

If soft readings worsen but the hard data from the economy stays consistent or even strengthens (as happened during the inflation of 2022) then it is possible the economy will soften, but should not go into reverse; the solid economic fundamentals should pull consumers and managers out of their existential torpor and back to saving and investing.

However, one should then similarly be very wary of when the opposite happens; after a period of consistently poor soft data (as we have seen since late last year) similar trends start to show through in poor “hard” data coming out of the real economy. This can presage a recession and, worryingly, is exactly what was seen on Friday.

The specific data release on Friday was poor on a number of levels. First, it showed that price levels are moving in the wrong direction. Economists have been warning that inflation could, due to US President Donald Trump’s tariffs, remain stickier for longer than had been expected as recently as November when forecasts were for several interest rate cuts through 2025. Friday’s data showed anything but; core personal consumption expenditure rose 2.8%, or 0.4% month on month, the biggest monthly rise since January 2024. This measure of inflation, which is closely watched by the Fed, pushes out the chance of an interest rate cut any time soon, which is much needed for giving some additional impetus to the US consumer, at a point when even high income earning US consumers are starting to feel the pain of high prices.

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