Market volatility has been extreme over the past few days. Over the previous two weeks, the $S&P 500(.SPX)$ declined more than 10% — a move that, statistically, falls outside a 3-sigma event. If we include Monday’s opening drop, it reached the magnitude of a 5-sigma event.
Yesterday, the $S&P 500(.SPX)$ saw an intraday swing of more than 7% within just 30 minutes, triggered by a false news report. Today, markets continued to whipsaw. The $Cboe Volatility Index(VIX)$ remains above 50 and has stayed above 40 for three consecutive days — itself an extreme occurrence.
Historically, such events are often followed by a short-term reversal (with a historical probability of over 70%), but investors should remain alert to tail risks — as we saw during the 2008 financial crisis or the COVID-19 shock in 2020.
In times like this, the most important thing is not to be misled by short-term swings, but to identify and focus on the key drivers of the market and build a directional view based on those fundamentals.
Currently, the three most important variables this year are:
Trump’s tariff policy — what the final structure looks like, which countries are subject to negotiation, and how much room there is to maneuver.
Whether tariffs will tip the U.S. (and possibly the global economy) into a recession.
If a recession does occur, when and how the Fed might intervene — via rate cuts or QE.
And the outlook on these are as follows.
Regarding tariffs, there are only two realistic scenarios:
Worst case: The U.S. fails to reach meaningful trade deals and continues to impose high tariffs on all trading partners.
Relatively better case: The U.S. reaches agreements with allies, and while tariffs remain in place for Canada, Mexico, and the EU, they’re reduced from last week’s proposed levels. However, tariffs on China stay elevated — so high that most Chinese exports to the U.S. become nonviable. Furthermore, during these negotiations with allies, it’s highly likely that the U.S. will pressure them to increase their own tariffs on China to crack down on transshipment. In this case, most countries aside from a few outliers will end up imposing tariffs on China.
Why? Because the U.S. accounts for less than 5% of global population but nearly 30% of global consumption. Export-driven economies — including China — are, in effect, competitors vying for access to U.S. demand. Logically, it makes more sense for most countries to side with the buyer, not the supplier.
Scenario 2 is already one of the more “positive” outcomes for U.S. equities. Seems hardly a mutually conciliatory scenario (where the U.S. and China both back down) is realistic at this point. So, Scenario 2 is more likely — the U.S. is trying to structurally remove China from its supply chain. While talks with allies may drag out, that outcome seems baked in.
Assuming Scenario 2, the next question is whether a recession will follow. And it’s likely. Even if a technical recession doesn’t occur, U.S. GDP growth is very likely to decelerate meaningfully. Even with agreements among allies, tariffs won’t disappear entirely — and China tariffs will stay high. That alone will hurt the economy. Whether or not “stagflation” happens is unclear, but the "stagnation" part looks increasingly probable. I expect real GDP growth to weaken significantly beginning in Q2, with a heightened risk of recession in Q3 and Q4.
However, because inflation may remain elevated due to tariffs, the Fed will likely be slower to act. In other words, don’t count on a Fed Put in the first half of the year. It would likely take either clearly deteriorating economic data or some kind of liquidity shock for the Fed to step in. Until then, they’re likely to remain on hold.
In summary, while U.S. equities could see a short-term rebound now that tariff risks have "landed," the medium-term outlook remains cloudy. According to FactSet consensus, 2025 EPS growth expectations for the $S&P 500(.SPX)$ have already been revised down from +14.1% at the start of the year to +10.5%. If GDP growth slows from +2.8% in 2023 to somewhere between 0% and +1% this year, then even a 10% EPS growth projection seems overly optimistic. Revisions likely aren’t done. For more cyclical sectors like discretionary, the downward revisions are already sharper — from +9.2% to -1.9% for 2025 EPS.
We’ve seen similar patterns before — such as in 2022. Though the economy didn’t technically enter a recession then, recession fears were enough to drive sharp drawdowns. The chart below shows the $S&P 500(.SPX)$ in orange and consensus 2023 EPS growth in blue. Only after markets fully priced in a potential recession did the bottom finally form.
Source：FactSet, US Tiger Securities
From a valuation perspective, the $S&P 500(.SPX)$ 's NTM P/E has fallen from 22x to 18.3x — a notable correction. But the 20-year average is around 16x, and the median is 15.5x. Even after the pullback, we’re still at the 80th percentile — not cheap. During the 2022 bear market, valuations fell below 16x.
Source：FactSet, US Tiger Securities
As for U.S. Treasuries, we recommended holding long-duration bonds to hedge recession risks. While this still holds in the medium term, given the escalating U.S.-China tensions, now take a more neutral stance.
China currently holds over $700 billion in U.S. Treasuries. In an extreme scenario, if it decides to retaliate by dumping Treasuries, yields could spike sharply. The Fed might step in to absorb supply, but until that risk clears, upside for Treasuries may be limited. If you insist on being long bonds, consider pairing it with a short position in high-yield debt.
Lastly, with Trump’s sharp tariff escalation on China, the U.S.-China conflict has entered a new phase. The global geopolitical, trade, and financial landscape is likely to undergo a reset, potentially with nonlinear effects. For investors, hedging tail risk is no longer optional — it’s a must for navigating the shift to new world order.
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