The tariff announcement was not a surprise, but its magnitude was. The 10.5% decline in the S & P 500 between Wednesday’s and Friday’s closing prices is among the sharpest in a century. Declines of this magnitude over two days are exceedingly rare and typically result from significant upheaval. There have only been five market periods with two-day returns worse than what we just experienced, and each holds a notable place in market history. During the Depression-era bear market, 10 two-day declines were more significant than this week’s, as the stock market fell by more than 90% from peak to trough. On May 10, 1940, Germany invaded Belgium, Luxembourg, the Netherlands and parts of France. On May 13 and 14, 1940, the S & P 500 fell by 12.59%. “Black Monday”: On Oct. 19, 1987, the S & P 500 fell by more than 20% in a single day, marking the largest single-day percentage decline in history. The market performance over the two days ended on Oct. 19 of that year, with a drop of 24.57%. Although there was a sharp market rebound on the 20th, after accounting for the Black Monday drop, the net two-day decline remained over 16%. The Great Financial Crisis: In late 2008, after the collapse of Lehman Brothers, and as part of a larger 57% peak-to-trough decline between October 2007 and March 2009, the market experienced its worst two-day decline of 12.42% on November 19th and 20th. The Covid-19 drop: The S & P 500 fell 13.93% between March 11 and 12, 2020. The cyclically adjusted price-to-earnings ratio, or “CAPE,” which uses 10-year average earnings to help smooth out earnings through various business cycles over the past 90 years, looks like this… While this does not eliminate the substantial disruption to corporate earnings caused by financial losses during the GFC, it does demonstrate that cyclically adjusted equity valuations were (and are) significantly higher than the long-term average. Above-average valuations are acceptable and may be justified if market participants accurately anticipate a forthcoming period of above-average earnings growth. Indeed, corporate earnings growth has been exceptional over the past seven years. A 25-year earnings chart shows that earnings roughly doubled in the 17 years from late 2000 to late 2017, after which earnings growth accelerated. Earnings have more than doubled in the seven years since. Wider profit margins were a significant contributor. Over the past five years, several key have contributed to record corporate profit margins, especially in the United States. These margins, which indicate the percentage of revenue that converts into profit after accounting for costs, reached some of their highest levels since the 1950s, peaking notably in 2021 and 2022. Unprecedented fiscal interventions during the Covid-19 pandemic played a significant role. In the U.S., government subsidies such as the Paycheck Protection Program (PPP) injected approximately $1.1 trillion into the economy between 2020 and 2021, with around $800 billion directed toward small businesses. This support reduced nonlabor costs for many firms by offsetting expenses like payroll, effectively boosting profit margins. For nonfinancial corporations, margins rose sharply to about 19% in mid-2021, compared to 13% in late 2019 before the pandemic. A rapid decline in interest costs also boosted margins. Many companies refinanced their debt at historically low rates during 2020 and 2021, securing cheaper borrowing costs. For example, the interest share of value added for nonfinancial firms decreased from 2.8% in late 2019 to 1.8% by late 2022, contributing approximately one percentage point to profit margins—this strategic decision protected firms against rising operational expenses. Household demand, driven by stimulus payments and savings accumulated during lockdowns, underpinned robust sales growth. In 2021 alone, pre-tax profits for U.S. corporations surged by 25% to $2.8 trillion, far exceeding the 7% rise in consumer prices. This demand resilience instilled confidence in companies to raise prices without losing significant market share, further expanding margins. Analysts and strategists have taken what is possible, with the benefit of several tailwinds, and are now ambitiously forecasting those margins as probable . You will notice that the consensus profit margin for the S & P 500 is at the 25-year highs achieved coming out of the pandemic. The issue is that many tailwinds contributing to both revenue growth and profit margin expansion have turned into headwinds. The federal budget deficit, currently exceeding 7% of GDP, is unsustainable. Significant spending cuts and tax revenue increases are likely necessary, especially considering that federal interest expenses are expected to rise sharply. Similarly, increasing taxes and decreasing spending create substantial headwinds for economic growth and margins in an environment where the excess savings held by the bottom two-thirds of consumers from transfer payments and reduced spending during the shutdown have been exhausted. This has significant implications because it lowers the estimate for forward earnings and the multiple we should be willing to pay for it due to reduced growth. Only the decline in 10-year rates from the recent news that has affected us supports a slightly higher multiple. A lower turnover, decreasing margins, and diminished growth suggest that even after accounting for the recent market declines, the S & P 500 is hardly cheap. Therefore, sell-side strategists’ year-end price targets for the S & P 500 will decline unless the administration makes a significant shift on tariffs soon. What to do We advocated a downside SPY put spread just a few days ago, and that trade should already be monetized (consider taking profits). You may roll down to a 500/450 put spread, as the downside move was even faster and sharper than we anticipated. A VIX Index above 40 generally doesn’t persist without a snapback rally; we expect to see one within the coming days, but we suspect it’s likely a fadeable bounce. I would suggest selling upside 20 delta calls in SPX or SPY with 30-45 days until expiration if the S & P manages to catch a bid soon — which I expect, as the S & P 500 is technically oversold on several metrics, including Bollinger Bands, the Commodity Channel Index, MACD and RSI. Get Your Ticket to Pro LIVE Join us at the New York Stock Exchange! Uncertain markets? 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