Recession Watch (We’re Serious)
Authors: Andres Larios, Faith Spalding, Sydney Sibrian
Editors: Andres Larios, Faith Spalding, Daniel Hou
Intro:
Welcome to the Weekly BluRB, a newsletter catered to students and professionals seeking the latest news and insights on global markets. Get prepared for the week by reading four stories circulating around equity markets, macro trends, geopolitics, and new business developments. And the best part: we’ll give you an informed view about where we think prices, policy, and trends are going in the near future. The content in these writings is for informational purposes only and does not constitute financial or investing advice.
Equity Markets: Time to weather the storm
The S&P 500 gained 32 points this past week, increasing 57 basis points to snap a four week losing streak largely attributed to Department of Government Efficiency (DOGE) budget cuts and tariff news. The Dow Jones Industrial Average (DJIA) and tech-heavy Nasdaq Composite also rebounded with small gains this week, showing that as we gain more clarity into President Trump’s fiscal plans and reactions from key policymakers, investors are cautiously placing money back into equities. While we are still awaiting further clarification on tariff policy, President Trump stated this week, “I don’t change, but the word ‘flexibility’ is an important word,” hinting he will not be an absolutist tariff tsar and is open to negotiations with cooperative trading partners. We are still cautious about placing money back into equities, as we believe there is a good chance that the correction key equity indexes tracking large-cap stocks saw in the past few weeks has bottomed out.
The Russell 2000, our preferred gauge for America’s public industrial and manufacturing sectors, showed modest gains in the past week coming from the FOMC’s decision to hold rates steady on Wednesday, March 19th (More in U.S. Economy section), as consensus expectations were priced in. However, those gains were eroded during Friday’s trading session with nothing more to prop up the index. As noted in last week’s BluRB, a drop-off of 20% or more in a key stock index is perceived as a bear market. Seeing as the Russell 2000 has dropped roughly 16% from its November peak, this seems like the most likely index to falter into bear market territory, and perhaps the most telling about real economy expectations. The Russell 2000 is not over-concentrated in any sector (unlike the Mag-7 in the S&P 500), and its dynamics show key insights into America’s business health with 85% of revenues coming directly from the United States.
Figure 1: Past Year Russell 2000 Performance
A recent Goldman Sachs survey revealed that 90% of investors lowered their growth outlooks for the U.S. economy since early December, and three out of five believe tariffs are the largest policy risk ahead. This investor sentiment, paired with a confused and strained average consumer, paints a bleak outlook for small and mid cap companies, as well as American businesses in general. A prolonged high interest rate period with sticky inflation and even more uncertainty means sectors attached to the consumer are at high risk. Airlines, consumer retail names, and food companies have all highlighted these fears. Hence, we expect individual stock names to grow based on two factors: 1.) size of the company’s balance sheet or ability to weather the upcoming storm, and 2.) proximity to economic disruptions, where we anticipate poor consumer tailwinds and tariff uncertainty to be the biggest risks.
Stock Watch (by Sydney Sibrian):
Students at Berkeley jetted off to their spring break destinations faster than closing a blue book. Southwest Airlines (LUV) was a commonality for many students with domestic destinations on their itinerary. Southwest closed out last quarter with positive revenue momentum; the company followed through on promises to cut costs by pausing hiring, promotions, and internships and plans to charge for checked bags beginning May 28th. Riding this wave of efficiency, analysts switched their stance on the company. Analysts at Melius Research increased Southwest’s price target from $28 to $34, signaling a turning point. Moreover, Southwest earned a spot on billionaire Paul Singer’s Top 10 Portfolio Stocks, boasting one of the largest airplane fleets. With travel in full spring, it’s not just students making moves this spring. It seems Southwest’s performance is one to watch more bullishly than bearishly.
U.S. Economy: Is the Fed looking at the same economy as us?
The Federal Reserve held rates steady at a target rate of 4.25-4.50% on Wednesday, March 19th, highlighting a pick-up in economic uncertainty and increased risk to both sides of its dual mandate. The decision came with little to no surprise, with futures markets pricing in a nearly 100% probability of rates holding. As part of the second meeting of the year, and two mark the nearing end of the first quarter of the year, FOMC participants also released projection materials (Table 1), showcasing expectations of slower growth and higher inflation. These projections align with a higher for longer interest rate policy with most FOMC participants expecting two rate cuts in 2025, unchanged from the last dot plot release.
Table 1: FOMC Real Economy Projections
Figure 2: FOMC Member Fed Funds Rate Projections
This lack of change in monetary policy reflects the Federal Reserve’s efforts in anticipating the Donald Trump yield curve, where a neutral level would be needed to be able to react to opposing directions of inflationary pressure and growth pressure from a growing tariff threat. Even so, the Fed did slow down its rate of balance sheet treasury securities run-off from $25 billion per month to $5 billion per month. Balance sheet run-off refers to fixed income assets held by the Fed (through their quantitative easing programs) being allowed to mature without reinvestment, thus shrinking the size of the Fed’s total holdings. The Fed’s holding of assets places upward pressure on prices and downward pressure on yields. This move, while still inherently a form of monetary tightening, shows that American credit markets need a slower rate of runoff to perform at their current level of liquidity.
Figure 3: Federal Reserve Balance Sheet Size (Trillions of Dollars)
While policymakers at the Federal Reserve aren’t panicking, some of their key forecasting models are pricing in big changes to growth and inflation. The Atlanta Fed’s GDPNow Forecast, which measures the expected change in GDP for a given quarter fell from a projected 2% growth rate to almost -3% within a day, highlighting the fiscal disruptions caused by DOGE’s mass layoffs and tariff uncertainty. While CPI and PCE downward revisions have been made by the Cleveland Fed’s inflation nowcasts, these are as a result of current conditions which are marred by uncertainty. Uncertainty causes consumers to pause their spending habits, leading to these downward revisions; however, it is worth noting that as the effects of tariffs hit U.S. consumers, we do expect inflation to jump up, as projected in table 1.
Figure 4 and Figure 5: Federal Reserve GDP and Inflation Nowcasts
We also note that consumer debt has shown increasing strain following the Fed’s attempts at a soft landing circa late 2022. The share of consumers with 90+ day delinquent auto loan payments and the share of consumers with 90+ day delinquent credit card payments is near that of the great recession. Consumers who have been hit by high inflation and high interest rates for more than two years now are seeing their balance sheet increasingly strained. We note that the passthrough from higher prices does impact corporates, but they have the ability to shift the cost burden to consumers through higher prices or higher interest rates.
Figure 6: Consumer Debt 90+ Day Delinquency Rates
Hence, companies that are financed by consumer debt like credit card companies or captive financing arms of auto firms have most likely passed on these costs to consumers. With incoming tariff shocks, expect this trend to continue, and for low-income consumers to be most affected. Even so, regardless of credit score or income level, it seems everyone is beginning to feel the pain. As such, our call is similar to that for equities; we believe consumers that have larger household balance sheets and less exposure to DOGE and tariff shocks (employed by the private sector) are least susceptible to incoming price pain.
Figure 7: Auto delinquency rates are not restricted to lowest income quintile
Consumers are already reacting to the increasing uncertainty, with total retail sales increasing 0.2% in February from January, on pace with inflation. The Wall Street consensus was an increase by 0.6%, however, the real print showed that households are already pricing in uncertainty. Furthermore a decrease in auto sales over the past month shows that consumers have already learned that affected industries by tariffs see dramatic price increases. While it may be refreshing to see consumers adjust their preferences with the news, we still believe that many of President Trump’s policies are going to increase wealth inequality in this country, seeing as there has been no clear plan laid out to help the most vulnerable households.
Figure 8: Monthly Retail Sales
When merging our analysis in the Equity Markets section and the U.S. Economy section, we are officially expecting a recession, and in the worst case scenario, a short period of stagflation attributed to short-term price hikes from tariff passthrough.
Global Macro: As U.S. chaos drags on, where should investors go?
Last week, we reported on President Trump’s tariff games with both Europe and China, contributing to the overall market volatility that caused the S&P 500 to reach correction territory mid-March. Despite the subsequent wariness of investors, many still see opportunity in the face of tariff tensions. Both the E.U. and China are major players in President Trump’s tariff discourse. However, most Americans know little about these foreign markets. So what moves should investors be making? How cautious must we be when diversifying amidst market volatility?
China: Ultimate Frenemies
On February 4th, President Trump’s tariff 10% increases on Chinese goods took effect, with an additional 10% tariff imposed on top of the original tariffs in early March. During President Trump’s first term in office, he imposed 25% tariffs on Chinese goods, meaning these tariff increases are over 45% from when President Trump first took office in 2016.
Despite the obvious tensions, many investors see promise in Chinese stocks. Louis Luo, head of multi-asset investment solutions for Greater China at Aberdeen Group, wrote in a Feb. 6th note that the country is better positioned than other emerging markets for tariff shocks. Chinese stocks have an added cushion compared to their emerging market competitors, due to their low valuations and minimal investor position — both a result of continued market uncertainty tailwinds. Furthermore, Chinese markets are set to outperform Wall Street after picking up momentum at the beginning of the year. While the S&P 500 reached correction territory last week, the MSCI China index has gained 19% since the beginning of the year. In contrast, the S&P 500 advanced 2% last week, narrowing year-to-date losses to just about 2%, still 8% down from the 52-week high reached in early October.
Hong Kong has even more promise; the HSCEI, or the Hang Seng China Enterprises Index, has had an energized start to 2025, up over 6%. Closing at 8,742 points on Friday, the HSCEI is at the highest end of anticipated price range, according to Luo. Even so, Beijing has made consecrated efforts throughout the last year to support and stimulate the Chinese Stock Market. The Chinese bank created a new swap facility, with the aim to increase market liquidity while propelling state-backed institutions to buy more stocks. According to Goldman Sachs analysts in a Feb. 4th note, these measures have put a floor on the Chinese stock market, and continued policy implementations are expected to stabilize growth and drive increased equity gains.
Chinese tech firms also play a major role in optimistic prospects for China; Chinese start-up DeepSeek launched its DeepSeek R1 model in late March, gaining international attention over the firm’s potential to rival Open-AI. Chinese venture capital has been on a decline the past three years, yet investors see DeepSeek and other firms like AI drug discovery company Insilico Medicine as a new moment of interest for global investors to invest in China. Economic stagnancy and regulatory uncertainty surrounding IPOs have been chief reasons for a stark decline in investment in Chinese capital, but with clearer regulations and renewed interest in Chinese Venture Capital, tech firms like DeepSeek have broken new ground. As such, emerging Chinese tech firms that seek to compete with major U.S. companies like OpenAI could provide new avenues of capital growth for less-weary investors.
Europe: Volatile markets, but defense sector shines through
Europe remains equally involved in President Trump’s tariff war. As of Sunday, the EU delayed retaliatory tariffs on the United States until mid-April, following President Trump’s 25% tariff increases on all aluminum and steel goods. The EU intended to impose tariffs totalling 26 billion euros ($28 billion) worth of U.S. goods in two phases, on April 1st and April 13th. The tariffs will target steel and aluminum products, along with American beef, poultry, bourbon, and more.
Despite tensions, European equity markets have had a strong start to the year. According to a March 13th article from Goldman Sachs, strong fourth-quarter earnings and increased spending are fueling optimism, alongside a lack of tariffs from the United States until March. President Trump’s trade games may tamper some European optimism, but most outlooks remain positive seeing as the E.U.’s surprising equity market optimism overcame investor expectations. A survey of over 300 attendees at Goldman Sachs’ Global Strategy Conference in January revealed that 58% of participants expected US stocks to perform best in 2025. In that same survey, only 8% of participants thought that Europe would perform best, rendering the E.U. the least favored developed market. Furthermore, because markets have already forecasted a weak growth profile this year, European markets only have to perform in line with expectations to in fact, bypass expectations.
Europe performed well from January to early March, especially Germany, marking a significant catalyst for further growth opportunities. The defense sector looks increasingly attractive for potential investors. Although volatility across European markets is certainly high, since the beginning of the year, European defense stocks have increased 67%. Additionally, as Ukraine tensions and Europe’s energy crisis drag on, investing in energy capacity could potentially bring high energy prices down.
As European defense stocks continued to surge in early March, Germany’s Rheinmetall has been a chief stand-out performer in the European defense and aerospace sector. Manufacturing combat equipment and armored vehicles, Rheinmetall’s stock price has risen 194.38% in the last 12 months. According to Morningstar analyst Loredana Muharremi, Europe is expected to “prioritize inventory replenishment, with equipment spending rising to 50% of budgets in 2025-26 and 40% from 2027-30, before declining to 25% by 2034 as personnel and research and development investments grow.” This would create a cumulative $1.8 trillion opportunity in equipment spending by 2030, with Germany leading the trend. As such, Rheinmetall is Europe’s top stock pick, down 2.32% as of market close Friday.
For less wary investors, European defense stocks seem to be more consistent than Chinese markets. However, the E.U. is incredibly intertwined with the United States, and trade tensions have the potential to turn the international economy on its head. China has always been less of an ally and more of a competitor with the United States, especially as the world’s second largest economy. As such, while U.S./China trade tensions are also significant, the relationship between the two superpowers has always been mercantilist, not assimilatory. As such, one could argue that Chinese markets, and in particular their tech stocks may be inherently less affected by President Trump’s trade games, and as such, make for better investment opportunities, even in a volatile landscape.
Story of the Week: The Department of Education gets educated (by Faith Spalding)
Last week, we reported on Elon Musk’s decimation of key federal regulatory institutions, generating national outrage. We now want to turn our focus on the gutting of the Department of Education (DOE) by the Department of Government Efficiency (DOGE).
The Department of Education is a cabinet-level department of the federal government, beginning operations in 1980. Established in Congress in 1979 under the “Department of Education Organization Act,” the department has become the main institution charged with facilitating educational funding and ensuring equal access to education. Yet on Thursday, President Trump signed an Executive Order entitled “Improving Education Outcomes by Empowering Parents, States, and Communities,” essentially dismantling the DOE as the White House looks to “return authority over education to States and local communities,” according to newly-instated Education Secretary Linda McMahon.
In September of 2024, the Department of Education employed 4,200 people, accounting for 0.2% of federal employment, a signal of agencies already limited capacity and manpower. As of March 11th, the DOE announced that 50% of its employees were to be laid off. But with President Trump’s newest executive order, it’s certain the majority of the DOE’s employees will find themselves on administrative leave. With the agency’s wide variety of responsibilities, how will states adjust to these changes?
The Department of Education has typically governed over offices including Federal Student Aid (FSA), Institute of Education Sciences (IES), and the Office for Civil Rights (OCR). That’s why this overhaul is particularly jarring. The FSA is the largest facilitator of the student loan balance, managing over $1.693 trillion in student loans, facilitating Federal Pell grant programs and university work study programs. In 2024, the FSA provided roughly $120.8 billion in federal grants, loans, and work-study funds to more than. 9.9 million students. Dismantling the key program that students from all tax-brackets depend on to continue college is one of the biggest consequences of President Trump’s newest target for downsizing.
The DOE’s remit is broad. In addition to managing student loans for 40 million Americans along with pell grants and work study, it also oversees $18 billion in Title One funding for elementary and secondary education in low-income areas and the FAFSA application, which many Cal students depend on. As such, with the lack of resources to manage these assets and ambiguities on state’s plans for adoption, students may expect delays in funding and loan applications or processing. While the DOE will still ‘retain oversight’ over Pell grants and student loans for now, according to White House press secretary Karoline Leavitt, the incredible amount of uncertainty in the past weeks means that anything is on the table. The White House is still unable to fully decimate the DOE as doing so would require 60 filibuster-proof votes to pass in Congress.
However, congressmen and women across the country have come under fire by their constituents, as widespread-anger at Conservative policy makers manifests in town halls across the country. From Wyoming to Arkansas, GOP congressmen have faced angry, mocking crowds, some in heavily conservative districts. These meetings have become so hectic that Republican lawmakers have begun to hold “empty-chair” town halls, unwilling to show up and face their constituents. It’s clear that the drastic gutting of federal agencies and institutions has gone ‘too far,’ even in conservative’s minds. Not only does the White House not have a plan for the transition of the DOE’s responsibilities to states, but the overall logic being used to argue the Department of Education’s lack of efficiency is flawed. In fact, states have always played a role in managing education, allocating federal funds to target issues. Dismantling the DOE has clear consequences, not far from those reaped by the destruction of other agencies like the Consumer Financial Protection Bureau (CFPB). Federal programs and funding will be increasingly divided up between states, or some agencies’ responsibilities will shift to other deferral programs, disrupting standardized procedures and routine. What’s clear is that voter outrage is coming from the lack of clarity in what comes next.
How will students continue to get federal loan funding if the very programs allocating funds are stuck in limbo? The answers are unfortunately unknown. It’s clear that DOGE and the Trump Administration are willing to make the boldest policy moves. But we don’t know whether the Trump Administration’s bold moves will actually streamline government operations, currently seeming that the chaos created by the gutting of former institutions will create major delays inhibiting student access to funding as the transition of the Department’s responsibilities becomes more complicated. As the Department of Education is reduced to a mere shell of itself, this year will be the ultimate test for DOGE, and for the resolve of U.S. students.