MW Why investors who fear a recession and the end of 'American exceptionalism' may be overreacting

By Christine Idzelis

The U.S. stock market was trading lower Monday afternoon after fresh data reflected tariff worries in the manufacturing sector

U.S. stock-market volatility is up this year amid signs of a softening economy, but that doesn't necessarily spell recession or the end of American exceptionalism.

"We continue to bet on the resilience of the American economy," Yardeni Research said in a note Monday. "We expect that pro-business policies, as they emerge, will boost longer-term confidence, allaying short-term uncertainties related to Trump 2.0."

Tariff-related worries may be behind a negative reading at the end of February on forecast first-quarter growth in the U.S. from the Federal Reserve Bank of Atlanta's GDPNow model. The model's latest estimate, on Feb. 28, points to a 1.5% contraction in real U.S. gross domestic product in the first quarter, down from the 2.3% GDP growth it forecast on Feb. 19.

"The volatile model swung in response to January's surge in imported goods ahead of [President Donald] Trump's tariffs," Yardeni said. "The bulk of this surge represented importers getting ahead of potential tariff increases."

While bearish narratives abound in the U.S. stock market, Yardeni remains bullish. The firm places both a potential recession and fiscal crisis in its 20% probability bucket of economic scenarios that could go wrong, according to its note.

"We still apply an 80% subjective probability to outcomes that are bullish for U.S. stocks," said Yardeni. "A bear market in stocks and much lower home prices likely would lead consumers and businesses to pull back some of their spending. But that would be likely only in a recession, which we see as improbable at the moment."

The S&P 500 remains up modestly so far this year, after pulling back 1.4% in February, according to FactSet data. The U.S. equities benchmark SPX was down Monday afternoon but still clinging to a year-to-date gain of around 0.4%, FactSet data show, at last check.

Meanwhile, the Cboe Volatility Index VIX, a gauge of investor anxiety in the U.S. stock market, has climbed around 19% so far this year based on Monday afternoon trading levels. The gauge was up around 5% in afternoon trading, at more than 20.

"On top of tariff threats and geopolitical ruptures, investors are having to grapple with notable signs of weakness in the recent economic data," Neil Shearing, group chief economist at Capital Economics, said in a note Monday. "With that said, while the outlook has clearly soured, we think fears that the global economy is on the cusp of a major slowdown are overdone."

U.S. economic data recently showed that retail sales and industrial production were weaker than expected in January, while consumer confidence has fallen and a flash reading on the service sector in February dropped sharply, according to Shearing's note. He also pointed to Citi's economic-surprise index, which tracks how major economic-data releases stack up against market expectations and which recently turned negative.

"All of this has led some analysts to call time on a period of U.S. macro and market exceptionalism," said Shearing. "This feels like an overreaction."

While recent data show the U.S. economy has seen a "difficult start" to the year, he said the surge in imports in January - which appeared to reflect U.S. companies trying to get ahead of tariffs - should "unwind over the coming months as higher tariffs come into force."

Consumers may be increasing their savings on worries that tariffs will raise prices, but household spending may bounce back some after it was potentially crimped by "severe winter weather" in January, according to his note. So far, consumer spending isn't signaling "impending recession," he said.

Capital Economics expects that the pace of U.S. economic growth may slow in 2025 to between 1.5% and 2%, which would be "weak by U.S. standards" but still "well above the rates of growth experienced in Europe," according to Shearing.

U.S. macroeconomic outperformance against the country's developed-market peers is likely to broadly "remain intact," even with the challenging economic outlook, he said. "And despite the recent soft patch, we continue to expect a renewed tech-led rally in the S&P 500 over the course of this year."

The S&P 500, a U.S. large-cap equities index, has lagged international stocks this year.

For example, the iShares Europe ETF IEV, an exchange-traded fund that tracks an index of European equities, ended February up more than 11% in 2025, FactSet data show. And the iShares MSCI ACWI ex US ETF ACWX, which tracks stocks globally in developed and emerging markets but excludes the U.S., was up by slightly more than 6% this year at the end of February.

"While the rally in non-U.S. stocks looks like an anomaly versus the last 2 years, our view is that they are simply making up for their terrible" fourth quarter, said Nicholas Colas, co-founder of DataTrek Research, in a note emailed Monday. "What may look like new leadership is (thus far) better explained as a beginning of the year rotation into oversold areas of the global equity market."

Colas said it is "important to remember that 'American exceptionalism' with respect to equity price performance" is a relative, longer-run concept that "does not [ensure] the S&P 500 will beat all comers over any given quarter."

The U.S. stock market was trading down Monday morning as investors weighed economic data on the manufacturing sector that reflected tariff concerns.

A reading from the Institute for Supply Management found that activity in the U.S. manufacturing sector expanded in February for a second straight month, although barely in expansion territory, as the cost of supplies jumped amid new or threatened tariffs.

See: Trump's tariff talk is raising inflation and could weaken the economy, ISM finds: 'Customers are pausing on new orders'

The Dow Jones Industrial Average DJIA was falling 0.6% Monday afternoon, while the S&P 500 SPX slid 0.8% and the technology-heavy Nasdaq Composite COMP dropped 1.3%, according to FactSet data, at last check.

"U.S. fiscal and other policy uncertainties under the new administration are clearly weighing on domestic equity markets, and we expect this to continue into March," Colas said. But, he added, "we are in the bullish camp on this point, and remain positive on domestic large cap equities."

-Christine Idzelis

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March 03, 2025 13:46 ET (18:46 GMT)

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