Navigating the Markets: An Update from our Investment Committee

View the recording, here. 

General Overview

This was a conference call discussing the current state of the US economy and financial markets. [15:10] The speakers included Chief Economist John Norris, Chief Equity Strategist David McGrath, and Portfolio Manager Sam Clement.

Key Points

• The US economy is expected to see a slowdown in the first half of 2025, with potential negative GDP growth in Q1 and Q2, due to factors like consumer exhaustion, tighter monetary policy, and the impact of new tariffs.
• The Federal Reserve is expected to cut interest rates more aggressively in the second half of the year to provide support to the economy.
• The stock market has seen significant volatility recently, driven by factors like the slowdown in consumer spending, uncertainty around corporate earnings, and the impact of new tariffs.
• The speakers have been positioning their investment portfolios more defensively over the past year, reducing exposure to large-cap growth stocks and increasing cash holdings in anticipation of increased market volatility.

Notable Quotes

• “We all knew that the president was threatening tariffs. We just didn’t actually know just through the severity last week’s liberation day came as a little bit of a shot you might remember because gee whiz, markets were up nicely that day and been on a nice little roll up until Wednesday afternoon and then all of a sudden everything fell apart.”
• “Why pick a trade? The trade war with the remainder of the world, understanding that trade has again historically always been good for economic growth.”
• “The good news is the defensive areas of the market are still performing relatively well. Healthcare is down 2%, utility is down 3%. I think consumer staples down about 1% and maybe even more importantly, the bond market is actually doing their part.”

John Norris (00:35):
All right, let’s go ahead and get started. Guys, thank you all so much for joining us today — we already have 51 people on the call. That’s fantastic. Clearly, there’s a lot going on that people want to hear an opinion about, and that’s exactly what we’ll offer today.

I’m John Norris, Chief Economist and Chief Investment Officer here at Oakworth Capital Bank. Joining me today are Dave McGrath, our Chief Equity Strategist and Managing Director based in our Lower Alabama office in Mobile, and Sam Clement, Assistant Managing Director and Portfolio Manager in our Central Alabama office — also known as Birmingham.

Here’s the plan: I’ll talk about the economy for about 10 to 12 minutes. (I have a tendency to go long, so I apologize in advance for my verbosity.) Then, David will cover what’s happening in the equity markets, and Sam will wrap things up with some thoughts on asset allocation — and fill in anything David and I may have forgotten in our old age. His youthful exuberance helps keep us honest.

Afterward, we’ll leave plenty of time for Q&A. You can submit questions through the Q&A function, or if that’s not working for you, just drop them in the chat and we’ll get to them after our prepared remarks.

A quick caveat before we begin: Everything you hear today should not be considered, construed, or deemed as an offer to buy or sell investment securities. Any investment decisions made independently of Oakworth Capital Bank based on today’s discussion are made at your own discretion. Markets fluctuate, and opinions shared today reflect those of the Investment Committee at Oakworth Capital Bank as of now — they don’t necessarily reflect the views of the entire company or its shareholders, associates, or stakeholders.

Now that that’s out of the way, let’s talk about the U.S. economy.

Anyone who’s talked with me, read our newsletter, or listened to the podcast probably knows that our forecast for the beginning of this year wasn’t particularly exuberant — that’s the second time I’ve used that word today, but it fits. After a surprisingly strong 2024 and a very solid 2023, we had to ask: what’s left for the U.S. economy? What’s the encore?

Monetary policy has remained relatively restrictive, and we had to wonder how much fuel the U.S. consumer had left. Savings rates were dropping, inflation had been sticky for quite some time, and there were signs of fatigue in consumer behavior. You even heard it from consumer staples companies — talk of the “exhausted consumer.” I began to feel it in the reports too.

Then came what I’ll call a B12 shot of optimism following the election. Maybe that would be enough to carry us through the first half of the year. I wasn’t as sanguine. Politics can feel good, but at the end of the day, it’s about how much money we have to spend — and how good we feel about spending it.

Our forecast called for a slower first half in 2025 compared to the last three quarters of 2024. That wasn’t a stretch — the economy grew 3.0% in Q2, 3.1% in Q3, and still a surprisingly strong 2.3% in Q4. A little cooling off was expected. We thought the unemployment rate might tick up slightly, the labor market might soften, and inflation would begin to moderate on its own. By mid-year, we believed the Fed would have all the justification it needed to cut the overnight rate more aggressively, if it chose to do so.

At the start of the year, the markets were pricing in two 25-basis-point cuts — 50 basis points total for 2025. Thanks to recent developments, that expectation has shifted. The CME now reflects expectations of four cuts — which is actually more in line with what we’d been projecting, though we arrived there by a different route.

We knew the president had been threatening tariffs, but we didn’t anticipate the magnitude. Last week’s “Liberation Day” caught some off guard. Oddly, the markets rallied that day — but by Wednesday afternoon, things fell apart. It wasn’t just the threat of tariffs again — it was the size and scope of what was proposed, the vagueness of the explanation, and the questionable math behind it.

Suddenly, we’re starting a trade war with the entire world — despite the fact that trade has historically supported economic growth. That doesn’t compute for many investors.

John Norris
By Thursday and Friday, the markets were unraveling. Monday wasn’t quite as bad, and David will speak more to the equity market action in a moment. But today? We gave up the ghost again in late trading.

So what does all this mean for the economy?

In my view — and in the view of Oakworth’s Investment Committee — many of these tariff threats are really just foreign policy tools in disguise. They’re economic levers meant to influence global actors into fairer trade arrangements. The U.S. is attempting to use its economic muscle to level the playing field — and it’s no secret that we’ve often traded more fairly with the world than the world has with us.

Is that necessarily bad for economic growth? That’s a good question. It’s also a debatable one. You really have to go back to the early 1990s to see when our trade deficit began to balloon — not just in absolute terms, but as a percentage of GDP.

In 1992, our trade deficit was about 55–57 basis points of GDP. Last year, it was over 3% — including services, about 3.09%. So yes, our trade deficit has grown dramatically, but since the early 2000s, it’s hovered mostly in the 2.5% to 3% range. In relative terms, it’s somewhat stable — even as the absolute number has become staggering: $1.1 trillion last year.

It’s a big number, and it’s easy to look at that and think: can’t we do something about this? That seems to be the administration’s thinking.

But what’s curious is the idea of launching a broad trade war with everyone. If you read last week’s Common Cents, you know we highlighted that just 14 countries account for virtually all of our trade deficit — with the top 10 making up the lion’s share:

• China: $279B
• Mexico: $152B
• Vietnam: $105B
• Germany: $83B
• Japan: $72B
• Ireland: $66B
• Canada: $64B
• South Korea: $51B
• Taiwan: $48B
• Italy: $44B

Add in India, Thailand, Malaysia, and Indonesia, and that’s 107% of our total trade deficit — largely concentrated in Asia.

So again — why pick a fight with the entire world?

Historically, trade has been good for growth. It’s not just the exchange of goods — it’s also the exchange of ideas, technology, and productivity gains. Over the last 30+ years, globalization has contributed to the enormous expansion of global wealth and access. Even as our trade deficit has grown, our economy has continued to benefit.

Now, if the intent is to reverse globalization, return to tariffs and protectionism — which I’m not entirely sure is the president’s true aim — then yes, the U.S. might weather the storm better than others. Why? Because our economy is less dependent on trade relative to our trading partners.

Take Mexico, for example:
In 2023, exports to the U.S. accounted for 28% of Mexico’s GDP. Imports from the U.S. were 19%. That’s 47% of their GDP tied directly to U.S. trade. Meanwhile, U.S. exports in 2023 were 6.8% of our GDP; imports were 10.4%. In total, trade made up about 17.2% of our GDP. That’s a major difference.

So a prolonged trade war would hurt our trading partners far more than it would hurt us.

That said, here’s what we expect for the remainder of the year:

• Q1 GDP could very well come in negative — but that was already expected even before last week’s tariff news.
• Q2 GDP might also be negative. Two quarters of negative growth would meet the unofficial definition of a recession.
• But the economy had decent underlying strength before all this.
• We’ll likely see consumer spending slow, and with that, prices may fall.
• Unemployment may tick up from 4.2% to around 5%, but not to alarming levels.
• The Federal Reserve is likely to step in soon. Depending on how quickly conditions weaken, we could see the Fed cut the overnight rate aggressively — possibly below 4% by the end of Q3.

If that happens — and if trade talks wrap up quickly — we’ll see a recovery sooner than later.

So here’s the bottom line: we’re in for a choppy Q2, following a choppy Q1. The official numbers from the Bureau of Economic Analysis aren’t going to look pretty in the near term. But we expect the Fed to shift policy, giving the economy some tailwinds.

If that plays out, we should see a return to moderate growth by mid-Q3 and solid footing going into Q4 and 2026. That aligns with the forecast we’ve been holding since December and January. The tariff situation just makes the road bumpier — but it may also strengthen the case for action.

With that, I’ll hand it over to David to talk more about the markets.

David McGrath (15:21):
Good afternoon, everyone. It’s definitely been an eventful start to the year — and especially to the quarter. John touched on some of the points I’ll expand on, but I want to emphasize this: the stock market hates uncertainty.

And right now, many of the forces that typically drive the market — consumer strength, labor market stability, inflation expectations — have all been thrown into question. What does that mean for corporate margins? Corporate earnings? We’ll start to get a better idea very soon, as earnings season begins in earnest this Friday.

The key questions we’re watching:

• How much is the consumer slowing down?
• Will companies respond to uncertainty by cutting jobs?
• Will tariffs put a floor under inflation? And how does that affect Fed policy?

John already covered our thinking on the Federal Reserve, but questions remain about how inflation will behave under a potential new wave of tariffs.

Let me share my screen and show you a couple of charts.

In a normal environment, this would already be a challenging period. On this chart:

• The purple line shows the year-to-date performance of the S&P 500.
• The blue line is the equal-weighted S&P 500 — that’s the average performance of the companies in the index.
• And the bottom line reflects the performance of the Magnificent Seven — the mega-cap tech names that have been driving much of the market over the last couple of years.

We’ve seen three significant events affect the market so far this year:

1. The DeepSeek AI story — This was a report out of China that claimed they built a large-scale model in just 3–4 months for only $6 million. While some questioned the details, the story raised eyebrows. If you’re a company spending $10–15 billion per quarter on AI, and a competitor builds a decent model for a fraction of that, you may rethink your spend. As a result, the Magnificent Seven started to slow down — even as the broader market continued to move higher.
2. February 20 – Walmart earnings — Walmart reported a significant slowdown in consumer activity and lowered its outlook. It was late in the earnings season, and nearly every company that reported after them cut estimates, citing consumer weakness. You can see this hit the equal-weighted S&P.
3. Last Thursday – Tariff shock — Starting Thursday morning, the market took a hit. I printed this chart about an hour before today’s close, so it’s close to final. The average stock fell just over 10%. The Magnificent Seven were down about 10% too. This wasn’t just targeted selling — we’ve seen broad, indiscriminate selling over the past few days.

So, three very real headwinds are hitting the market right now.

Let’s look at earnings expectations for 2024. Here’s the outlook by quarter:

• Q1: +6.2% year-over-year
• Q2: +8.5%
• Q3: +11%
• Q4: +12%

The problem? These later estimates are very likely to be revised lower, and potentially dramatically. Companies may even stop giving guidance, like they did in 2020, due to the uncertainty.

Speaking of 2020 — when COVID hit, earnings for the S&P 500 fell 26% from where estimates had been at the start of the year. I’m not saying this situation is as severe, but even a 10–15% downward revision would take us to around $238–$248 in earnings — compared to $245 in 2023. That’s flat to slightly down year-over-year.

Let’s talk valuations:
We started the year with the S&P 500 trading at 22.3x earnings, based on a projected $268 per share. At the market high, that equated to 6,144 on the index. Now we’re down to 18.5x earnings — and if those earnings estimates come down, that multiple will effectively rise again, or prices will need to fall further.

So, what’s next? I think the next big headwind is going to be earnings revisions. How much lower are those Q2–Q4 estimates going to go?

When we look at the past 9 quarters, the average stock in the S&P 500 returned about 15%. Not bad — but not spectacular. Meanwhile, the Magnificent Seven more than doubled that return. These names have become increasingly dominant: they made up 32% of the index’s weight at the start of the year (now down to 28%). At the start of the 2022 market correction, they were about 22% of the S&P, and they fell to 16% during the drawdown.

All of this shows it’s not just about the overall market — there are multiple stories playing out beneath the surface.

Even before the tariff headlines, we were watching for signs of consumer weakness. Now it’s going to be much harder to separate what’s tariff-driven versus what was already happening.

The good news?

• Defensive sectors like healthcare, utilities, and consumer staples are holding up relatively well.
• Even more encouraging: the bond market is doing its job. Unlike 2022 — when both stocks and bonds fell — bonds are now helping balance portfolios.

So yes, this is a tough environment. But once we get clarity on tariffs and policy direction, we’ll get a clearer view of earnings potential — and from there, we can reassess our positioning.

Sam Clement (24:17):
Thanks, David. Those charts were a great segue into what I want to cover — asset allocation and how we’ve been positioning portfolios.

In our last call and quarterly publication, we discussed a few key themes. One of them was “broadening out.” That applies to both up and down markets. As David pointed out, the Magnificent Seven have driven so much of the market’s performance over the last couple of years. We’ve been gradually positioning our portfolios away from that concentration.

Over the past year, we’ve trimmed exposure to large-cap growth, and specifically those mega-cap tech names — Apple, Amazon, Google, etc. Instead, we’ve rebalanced toward a more equal weighting between growth and value. This goes against the natural market movement, which has heavily favored large-cap growth, but we believe it’s the right long-term play.

Another key theme we’ve discussed is expecting volatility. John mentioned this earlier — we entered 2025 anticipating that the first half of the year would be choppy. No one could have predicted how quickly things would shift in the past few days, but volatility was on our radar well before this latest round of headlines.

And volatility, while uncomfortable, is a normal part of markets. In fact, without it, there wouldn’t be the potential for excess returns.

So how have we positioned for that?

• We’ve trimmed small-cap exposure multiple times, both last year and earlier this year.
• Small caps have underperformed significantly — down over 20% — especially alongside large-cap growth.
• We’ve reduced positions like Apple in portfolios where it could be done with minimal tax impact.

The goal has been to prepare for volatility — not after it shows up, but before it hits.

Frankly, 2024 was an unusually calm year for most investors. Outside of a brief dip mid-year, there wasn’t much visible turbulence. That kind of lull doesn’t last forever. Now that volatility has returned, we’re glad we put insurance in place ahead of time.

Now, here’s the interesting part: the speed of this recent pullback has created opportunity.

As David mentioned, market multiples have contracted quickly over just a few days. Even if earnings come down — and we think they will — prices have adjusted enough to give us room to start dipping our toes back in.

In the last couple of days, we’ve selectively added back to U.S. equity positions. We’re still cautious — our equity weight is at or near the lowest it’s been since I joined Oakworth — but we’re watching closely. If the market continues to offer opportunity at better valuations, we’re prepared to take advantage with a long-term view.

To wrap things up:

• Volatility isn’t fun, but we were prepared for it.
• We’ve already made adjustments to be more defensive — and that gave us the flexibility to respond quickly this week.
• We’re not predicting a 2008-level crisis, but we do believe tariffs — even if walked back — will have some real economic impact.
• There are signs the consumer is cracking a bit — as David mentioned, Walmart’s commentary is just one example.
• Growth may not be as strong in the next couple of quarters as it was in late 2023.

We’re not pessimistic — but we are realistic. We’re looking for opportunities, staying defensive, and thinking long-term. As the market comes to us, we’ll continue putting capital to work strategically.

That’s where we stand. John, I’ll pass it back to you.

John Norris (30:48):

Thanks, Sam — great stuff from both you and David.

To sum up everything you’ve heard: yes, we’re heading into a choppier stretch, but we were expecting 2025 to be more difficult than the last two years. Money was easy to come by in 2023 and 2024 — this year was always going to be tougher.

The tariff and trade war chatter over the past week has only amplified those headwinds. Still, I believe — with the possible exceptions of the Germans and the Chinese — most of our major trading partners will come to the negotiating table. And if that happens, any broader economic slowdown will likely be short-lived and manageable.

This is not 2008. That’s where people’s minds go when they hear the word “recession” — but we’re not talking about a financial crisis. A two-quarter, mild GDP contraction doesn’t carry the same weight.

As Sam mentioned, we’ve already made substantial adjustments over the past year. Now we’re looking for buying opportunities to reallocate some of the excess cash and short-term fixed income we’ve been holding since trimming equities.

We did get a question in the Q&A — from our friend Tom — and it’s a good one:

Tom asks: “It doesn’t seem like markets are acting according to standard metrics or sound economic principles — especially when reacting to Trump’s social media posts. So how does this worrisome downward trend reverse itself?”

Tom — great question. And honestly, I wish we had a few easier ones first!

The truth is, there’s always going to be an element of emotional trading, especially among retail investors. Headlines and social media will influence some behavior — that’s just part of the game. But the smart money — institutional investors and firms like ours — have already made many of the adjustments they’re going to make.

What we’re waiting on now is for the retail investor — driven by fear, FOMO, or headlines — to make their moves. When it becomes clear that panic selling has run its course, the cash sitting on the sidelines will come back into the market. You don’t want to be completely out when that happens.

So I think we’re closer to the end of the panic than the beginning — but we may still see a few more volatile sessions before things calm down.

Sam Clement (34:30):
No disagreement from me.

David McGrath (34:35):
(Chuckling) You got another question after that one, John, so you could’ve skipped Tom’s!

John Norris (34:46):
Is that right? Let’s take a look… yep, here it is — from Corey Miller. Great question, Corey:

“Ten-year yields are back above 4% — up 40 basis points in two days. Are yields pricing in higher inflation due to tariffs? Or is it China selling Treasuries? At what point do yields move lower due to a growth slowdown from tariffs? Long-duration bonds seem like decent risk/reward considering the administration’s sensitivity to rates.”

Great question, Corey. I’ll try to give you a straightforward answer.

My view is this: bond yields come down to supply and demand. That’s true for Treasuries and corporate bonds alike. When supply increases — as it inevitably will with growing deficits — demand has to keep up, or prices fall (which means rates rise). Simple economics.

Even with cost-cutting measures like DOGE (Deficit Optimization and Government Efficiency), the forecast is still for significant debt issuance in the coming decade. That has to be financed somehow.

The Federal Reserve used to soak up a lot of that issuance through quantitative easing — nearly $8 trillion from 2008 to 2022. Foreign buyers, including China, picked up another $4–5 trillion. But unless those buyers step back in, long-term rates will stay under pressure.

That said, if 10-year yields push closer to 5%, I think the Fed’s supposed independence will start to bend. We might see them re-enter the bond-buying game to cap yields — particularly given how sensitive the current administration is to borrowing costs.

Short-term, yields could move lower if growth slows rapidly — but we won’t see mortgage rates back at 4% any time soon. Realistically, I expect the 10-year to trade in a 4.3% range, plus or minus 20 basis points, for much of the summer.

Sam Clement (38:59):
Just to add — the CBO projects the deficit could run at 7.3% of GDP by 2055, which is staggering. We’re already talking about $2 trillion+ in annual deficits over the next 10 years. On top of that, the average interest rate on federal debt is still only 3.4%, so we haven’t yet felt the full weight of higher rates.

Because most Treasury debt doesn’t carry call features, we can’t just refinance it overnight. Rates would need to stay lower for a long time to materially improve the debt picture — and that’s unlikely.

John Norris (40:12):
Appreciate the backup, Sam. All right — next question, a lighter one from Benton:

“John, you seem to have forecasted this pretty accurately. Did you also forecast wearing a sweater in April in Alabama? If so, I trust anything you say.”

(Laughs) Yes, Benton — I absolutely forecasted that. When you’re trying to hide a gut, sweaters in April are part of the long-term wardrobe strategy. Depending on how the Battle of the Bulge goes, we may be forecasting sweaters in June, July, and August too!

Another question, this one from Sam BTE in the chat:

“What information out there is real, and what is not real?”

Philosophical, Sam. But I’ll say this: I have less confidence in some of the data coming out of Washington than I used to. Not necessarily because of any intentional deception — but because I think some of the methodologies are outdated. The CPI and the employment situation report are prime examples. I think the data often misses the mark in reflecting real-world prices and labor market conditions.

David McGrath (42:05):
I’d add that we’re so politically divided right now, it’s easy to find data that supports either side’s argument. That makes it even harder to filter through the noise and focus on what’s best for the economy moving forward.

John Norris (42:51):
Great point, David.

All right — we’ve got a few more minutes. If anyone has additional questions, feel free to use the Q&A function at the top of your screen and we’ll stick around for a few minutes.

…

John Norris (44:09):
All right, it looks like we’ve covered everything. We really appreciate all of you — as clients and as friends.

We don’t love having to do calls like this, because they typically mean the markets aren’t behaving the way we’d hoped. But just remember — the sun’s going to rise in the east tomorrow. This too shall pass.

A year from now — probably much sooner — we’ll be looking back at this period as a blip. Stay focused, invest wisely, think long term. It’s a marathon, not a sprint, and that mindset is what delivers superior results over time.

With that, enjoy the rest of your day — and thank you again for everything.

Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. Our opinions, as well as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.

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