Market drawdown vs. downturn: Watch the fundamentals

Policy uncertainty has triggered drawdowns

Consider the last two years. This elongated market advance was briefly interrupted by tariffs in 2025 and the war with Iran in 2026.² While the headlines were different, the source of the uncertainty was ultimately the same. Investors were left to assess the implications for inflation and interest rates. Would tariffs prove inflationary? Would higher oil prices keep inflation elevated? Would the Federal Reserve (Fed) need to maintain a more restrictive policy stance than previously expected?

In both cases, markets responded by repricing policy expectations.³ Markets declined.⁴ Yet those drawdowns proved short-lived as the economy remained resilient and corporate earnings remained strong. The feared deterioration in fundamentals failed to materialize.

Today, investors are once again confronting the same questions. The persistence of the conflict in Iran and renewed trade tensions have once again led markets to reassess the policy outlook. Long-term interest rates have climbed as investors grappled with a stronger nominal growth environment and the possibility that inflation may prove more persistent than expected.⁵ This occurred despite efforts by the US Treasury to mitigate the rise in the 10-year Treasury yield.⁶ The market has increasingly confronted the possibility that the Fed may ultimately need to raise interest rates and that the economy could slow as a result.

Against that backdrop, some market weakness shouldn’t be surprising. Drawdowns have generally occurred during periods of uncertainty about the path of policy.

Don’t confuse a drawdown with a downturn

What’s important, however, isn’t to confuse a drawdown with the end of a market cycle.

Although markets have gone from pricing in roughly three rate cuts at the start of the year to contemplating two or three rate hikes, credit spreads have remained historically tight.⁷ The small-cap stock and equal-weight S&P 500 indexes have remained near all-time highs.⁸ That has typically not been a characteristic of the end of a market cycle, even if the so-called broadening trade took a breather as higher rates and energy prices weighed on economic growth.

What has the potential to end the structural bull market?

In my view, the end of this structural bull market may more likely come from a break in the artificial intelligence (AI) investment cycle than from a period of Fed tightening. Inflation expectations remained reasonably contained,⁹ and the private sector hasn’t been particularly over-levered.¹⁰ Instead, I’d be watching for earnings disappointments, downward analyst revisions, deteriorating forward guidance, hyperscalers pulling back on investment spending, or signs that investment grade bond markets are struggling to absorb the issuance required to finance the AI buildout.

None of that appears to have materially happened.

Could markets experience a drawdown? Absolutely. Policy uncertainty has often created them. But drawdowns and bear markets aren’t the same thing. A drawdown has typically reflected uncertainty about what policymakers may do next. A bear market requires a meaningful deterioration in fundamentals.

For now, to me this looks much more like the former than the latter.