Is a US market correction coming?

A Goldman Sachs model on February 28 showed that the probability of a market correction in the US stock market is increasing significantly before mid-2025. This assessment marks a shift from the bank’s previous outlook, reinforcing concerns among cautious investors who warn of a potential market downturn or correction in the near future.

Warnings about a potential correction or market pullback in the US are not new. They began alongside the rise of artificial intelligence (AI) stocks, particularly as inexperienced investors entered the market in large numbers. With the S&P 500 surpassing 6,000 points for the first time, concerns have grown about an overheated market.

The First Variable

The most important US stock index has soared over 100% in the past five years. This surge can be attributed to several factors—beyond the AI revolution—including the strength of the US dollar, the influx of substantial foreign capital into the market, the continued bullish sentiment among the majority of investors, and the solid performance of the US economy, which recorded a growth rate of 2.9% in 2023 and 2.8% in 2024.

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All these factors, along with generally positive reports on employment and consumer intentions, have driven the market to explode in recent times. But can we say that this trend will continue? What has changed—or could change—that might alter the situation?

Perhaps the first and most important variable to watch is the future of AI investments. The market anticipated growth in this sector due to significant investments, leading to a surge in related stocks. However, the largest stock drop in history occurred on January 27, 2025, when Nvidia lost nearly 17% of its value, wiping out almost $600 billion from its market capitalization in a single day. This was a clear sign that the rally, despite its strength, was "fragile."

The decline was triggered by the emergence of a Chinese AI model that is more cost-effective than its American counterparts and does not rely on the same high-powered processors used by models like ChatGPT. This development signals a potential major drop in Nvidia’s sales in the coming period and raises doubts about its market valuation.

What iI Fears Are Confirmed?

Despite the fact that shares of tech giant Nvidia recovered some of their losses after a continuous decline for several days following January 27, they still dropped by 18% overall from that day until early March 2025—just over a month.

What helped prevent a "free fall" for the stock was US campaigns supporting the $500 billion investment initiative announced by the US administration to secure AI leadership. This move was driven by American concerns over strong Chinese competition, which eased fears and provided support for the sector. Additionally, there were other campaigns questioning the accuracy of Chinese data regarding AI model costs, claiming they were misleading.

Although the S&P 500 index rose by more than 1% in the first two months of 2025, the tech-heavy Nasdaq declined by 2.25% over the same period—an unprecedented drop in the past decade. This suggests a certain degree of "relative pessimism" about the leading tech stocks that have been driving U.S. market growth over the last five years.

But the key question remains: what if it turns out that Chinese AI models are indeed significantly cheaper than their American counterparts? This will likely become evident with the emergence of more open-source AI models, leading to a continuous decline in the value of AI-related stocks—including the so-called "Magnificent Seven": Nvidia, Microsoft, Meta, Amazon, Alphabet, Tesla, and Apple.

The possible exception could be Apple, which has not made massive investments in AI and might actually benefit from cheaper models to enhance its products. However, in general, the recent decline in tech stocks would then be seen as merely a "wait-and-see" phase rather than a definitive downturn. Predicting the full extent of pessimism replacing the previous optimism about AI companies remains difficult.

If such a decline occurs, it won’t be limited to these companies alone—it will likely trigger a broader market correction in many sectors that have grown in recent years due to their direct or indirect ties to AI. This includes industries like telecommunications, energy, and mining, as part of their valuations are based on the potential expansion of their businesses in response to the AI revolution.

AI Is Not the Only Factor

Beyond AI, another major concern is the ongoing economic tensions fueled by persistent US threats to impose tariffs on both allies and rivals. The primary targets include China, the European Union, Canada, and Mexico—America’s largest trading partners. If trade wars break out—regardless of their scale—they could jeopardize a portion of America’s export gains, which reached $3.2 trillion in 2024.

Although Washington might save some of the more than $4.1 trillion worth of imports, the resulting disruption in production, distribution, and storage structures would have a devastating effect on the economy. This could threaten to push growth below 2%—a rate that experts consider healthy for maintaining an inflation level that allows the economy to expand without putting excessive pressure on resources. (This is specific to the U.S. as a developed economy, whereas developing economies require different growth rates due to factors like infrastructure investment needs.)

Although discussions about trade wars only began in the first quarter of 2025, warning signs had already emerged following Donald Trump’s victory in the November 2024 presidential election. His statements on the matter, along with general economic uncertainty, contributed to a GDP growth rate of just 2.3% in the last quarter of 2024.

Moreover, assessments of US economic growth in the first quarter of 2025 have painted a pessimistic picture. The Federal Reserve Bank of Atlanta projected a -1.5% growth rate. If this negative number materializes—or any negative GDP figure—it would mark the first economic contraction since the first quarter of 2022. What makes this potential contraction even more concerning is that it follows earlier central bank forecasts of a 2.3% growth rate for the same period.

This pessimistic outlook is primarily due to two factors:

1. A record surge in imports compared to exports.

2. A decline in personal consumption, which dropped by 0.2% in January, with further declines expected in February and March (though official figures have yet to be released).

Is It Time for a Defensive Strategy?

A significant portion of the U.S. dollar’s strength is tied to the strong performance of the American economy, while another key factor is the relatively high returns on U.S. bonds. However, if the U.S. administration achieves its goal of lowering interest rates throughout the year, this could also lead to a reduction in bond yields—potentially weakening the dollar. A weaker dollar has been one of the factors supporting the stock market rally in recent months.

That said, interest rate cuts could have another positive effect by encouraging business investment and making borrowing easier, which would stimulate economic activity. Additionally, lower interest rates could help revive personal consumption, which has been relatively weak.

Finally, it remains difficult to predict whether the net impact of interest rate cuts will be positive or negative for the economy. The final outcome will depend on how various market players respond, which will, in turn, shape the broader effects on the economy and the stock market.

These repeated warnings have led many US -based brokerage firms to advise their clients to shift towards so-called defensive stocks—those that involve less risk and often offer dividend payouts. Additionally, many large investors have been holding significant portions of their portfolios in cash, preparing to capitalize on potential opportunities if the market declines.

In an analysis of the current US stock market, Barron’s magazine concluded that "it’s time to play defense"—and the reasons are numerous. After reviewing the state of the market, including potentially overvalued AI stocks, the looming risks of trade wars (regardless of their scale), slowing economic growth, and the potential relative weakening of the US dollar, one thing is clear: storm clouds are gathering over a corrective market. Whether these clouds will lead to a downpour or simply pass remains uncertain, but the sky is undeniably overcast.

Sources: Argaam, WSJ, Barron's, The New York Times