The month or so since our last note certainly qualifies as an extraordinary time. With the Trump administration appearing to prioritise tariffs over tax cuts, the prevailing market narrative has been turned on its head; from near universal acceptance of ‘US exceptionalism’ to fears of a sharp economic slowdown or even recession. Such a marked change in the outlook has, unsurprisingly, sent tremors through the previously unassailable US stock market. In this update, we summarise recent market movements and ask whether the worst might now be behind us. Our conclusion?
We suspect not.
At the time of writing, broad measures of the US equity market are between 8% and 12% below their mid-February highs. Dollar weakness has exacerbated the decline, adding another two percentage points or so to the losses suffered by sterling-based investors in US equities. Prominent among the casualties have been a number of the technology titans which had fuelled the market’s phenomenal gains in recent years: Microsoft and Apple are 15% and 17% respectively below their December peaks; Amazon, Alphabet and Meta are down 19%, 20% and 21% from their February highs; even after a 10% rally in recent days, Nvidia is 21% below the all-time high it reached in early January. As troubling as these numbers are for six of the so-called ‘Magnificent 7’, they pale in comparison to those of the seventh.
As CEO Elon Musk embedded himself within Donald Trump’s inner circle, the Tesla share price rocketed from $142 in April last year to a peak of $480 in December. Incredibly, this 238% rise happened even as forecasts for the company’s profitability were being slashed: earnings per share this year and next are now expected to be just half of what was envisaged only twelve months ago (Fig.1).
Fig.1: Tesla Share Price and Forecasts Earnings Per Share for 2025 & 2026
Having defied the downward march of earnings forecasts throughout much of last year, Tesla’s share price finally appears to have responded to the deteriorating outlook. At the time of writing, the share price has halved from its December peak, marking a $750bn decline in the company’s market value. Investors who sat out last year’s meteoric ascent might conclude – perhaps with no little schadenfreude – that this was the inevitable end to a speculative bubble. We suspect, however, there is more to come.
Firstly, despite its recent fall, Tesla stock still trades at an astonishing 82x forward earnings: the share price needs to fall much, much further to bring valuations down to levels at which a valuation aware investor would consider them. Secondly, Tesla faces mounting competition. Importantly, this is not simply a case of cheaper brands becoming increasingly available. Both China’s BYD and Germany’s Mercedes have unveiled technology that dramatically reduces charging times for electric vehicles. At a stroke, Tesla’s battery technology and its global network of 65,000 ‘Supercharger’ stations appears, if not obsolete, then at least far from the impregnable competitive moat many had thought it to be (investors in AI infrastructure, take heed!). This raises serious questions over the company’s growth prospects, yet the share price is merely back to where it was six months ago. Thirdly – and from our perspective perhaps most intriguingly – despite these developments, retail investors continue to buy the stock aggressively. A recent report from JPMorgan highlights that, in the space of just twelve consecutive trading days in March, retail investors bought $7.3bn of Tesla stock, swamping previous record buying streaks. Clearly, a sizeable number of investors continue to believe – or at least to hope – that Elon Musk is a visionary worth backing at any odds.
We find this last point particularly interesting because of the behavioural insights it offers. Are the retail investors buying Tesla shares scrutinising the firm’s future earnings potential, its competitive edge, its (aggressive) accounting practices? Or might it simply be that “buying the dip” has worked so well for so many over the past few years that retail investors are now preconditioned to view any share price weakness as an attractive buying opportunity, whatever the underlying cause? More precariously still, how many of the retail investors buying now at $240 were also buying at $480, and are doubling down, hoping against hope to recover the losses they’ve suffered in the space of three agonising months?
From its staggering valuations to the tribalism provoked by its CEO, Tesla is clearly unusual. However, while perhaps an extreme example, we believe it is instructive for those seeking to make sense of recent events more broadly. In our view, each of the three arguments we applied to Tesla above is echoed at the aggregate market level.
First: valuations. Despite the uncomfortable declines of recent weeks, the US equity market continues to trade at valuations seldom seen before. As measured by the forward price-to-earnings ratio, the market’s valuation was in the 99th percentile of its 20-year range – in other words, it had been cheaper 99% of the time over the past two decades. Now it is merely in the 95th percentile of that range. Other measures of valuation tell a similar story (Fig.2); despite the recent decline, the US stock market remains exceedingly highly valued. A correction that brings it even halfway towards its historic average would entail greater losses than those suffered so far.
Fig.2: Current & Recent Peak US Equity Market Valuation Ratios Relative to the 20-Year Historic Range
Secondly: earnings. The recent equity market shakedown has been driven by an abrupt change in economic expectations. Until recently, investors appeared willing to believe the Trump administration’s agenda was resolutely “pro growth” and that, under his presidency, US exceptionalism would be not just secured but enhanced. In just a few short weeks, however, his prioritisation of tariffs over tax cuts has provoked a truly dramatic decline in consumer and business sentiment, causing the IMF and the Federal Reserve (among many others) to revise down their forecasts for economic growth, while a “nowcasting” model run by the Atlanta arm of the Federal Reserve has swung from projecting annualised growth of 3.9% in the first quarter of this year to an outright contraction of 1.8%. At the same time, the realisation that tariffs are inflationary has raised questions over the extent to which interest rates could be cut in response to any slowdown in growth. Yet in spite of the economic clouds gathering on the horizon, analysts have only inched their forecasts down a fraction and continue to expect robust corporate earnings growth of 11.5% this year and 14.3% in 2026. Should depressed sentiment feed through to weaker consumption and investment, analysts may have to make more significant revisions to their calculations, making questions over heady valuations more pointed still.
Thirdly: investor sentiment. While pouring $3.2bn into Tesla stock during the second week of March, retail investors also added $1.9bn to Nvidia, $1bn to the rest of the Magnificent 7, and $4.2bn to ETFs. Clearly, a large number of retail investors view the recent setback as a buying opportunity. It seems significant that institutional investors do not share this optimism. Indeed, the latest Bank of America Fund Manager Survey revealed the sharpest retreat from US equities on record. Meanwhile, we note with more than a passing interest that Warren Buffett’s Berkshire Hathaway has been disposing of swathes of its US equity holdings and now holds more of its assets in cash and US Treasuries than ever before. Our interpretation is that those with a more analytical approach are drawing back from US equities, leaving those with a stronger behavioural influence to take up the slack and hope for a rebound. Should their hopes prove misplaced, we fear prices may yet have some way to fall.
Are there any reasonable grounds for optimism at all? We must acknowledge that Donald Trump appears to have an exceptional ability to change the prevailing narrative. It is possible that, whether through a new policy initiative or a late-night social media post, he may succeed in rekindling the investor and business confidence that has evaporated so rapidly over the first two months of his presidency. Similarly, with interest rates still at 4½%, the Federal Reserve could feasibly reduce interest rates by a meaningful amount. Meanwhile, the Magnificent 7 may discover a profitable application for AI, answering questions over the returns that can be expected from the colossal investments that have been undertaken.
We believe there are constraints on all three. Firstly, Donald Trump’s campaign pledges of lower taxes, lower deficits and lower inflation remain incompatible: something will have to give. Secondly, the Federal Reserve is walking a narrow path between stalling growth and persistent inflation: it may struggle to cut interest rates even if it wants to. Thirdly, as evidenced by the rapidly increasing number of equally capable AI models, we suspect the benefits will, at least initially, accrue to the users of AI, not to the developers or those that provided the capital. Our view is that downward revisions to AI-related revenues are much more likely than those in the opposite direction.
In summary, these remain extraordinary times. Recent events have offered some encouragement that our analysis is wellfounded, but they do not yet vindicate our long-standing caution towards US equities. However, with valuations yet to fall meaningfully, with earnings forecasts yet to reflect the deteriorating economic outlook, and with retail investors yet to unlearn the habits of the past three years’ bull market, we continue to recommend investors brace for further turbulence ahead.
Volatility should, at some point, present investors with an opportunity to buy equities at attractive valuations and in anticipation of a more positive environment for corporate earnings growth. Recent weeks have inched us fractionally towards this point but, in our view, we remain some way distant yet.
