Global trade. Tariffs. Protectionism. Concepts many of us studied in Economics 101. President Trump campaigned on increasing tariffs, but none of us, including the financial markets, believed that he was intent on reengineering the entire global trading system. Prior to the announcement last week, most market participants thought this was a negotiating tactic to gain an edge in individual negotiations with other countries. But the speed, scope, and magnitude of the tariffs laid out on our trading partners on April 2, 2025, or “Liberation Day”, was far worse than expected. A 10% baseline tariff was imposed on all trading partners and another set of tariffs (as high as 50%) on countries that the administration identified for US trade deficits. Further adding to the complexity, the administration is calculating the individualized tariff rates based on the size of the US goods trade deficit with the specific country relative to the US imports from that country. This makes the potential de-escalation harder since, in theory, other countries cannot simply reduce tariffs on the US. Countries will have to decrease their own trade surplus with the US to see a relief, which can take considerable time. We use as an example the country of Vietnam, that the administration proposes enacting a 46% tariff in hopes of balancing our trade deficit. Vietnam is a small relatively poor country. It is almost inconceivable that it will ever purchase as many goods from the United States as we can purchase from them. This is a misguided policy goal in our opinion. While economists, corporate executives, business owners, and investors all scramble to understand the far-reaching implications, one thing is clear…these tariffs are proving more than a negotiating tactic, and the global free trade system that emerged following World War II has been upended seemingly overnight.
Before we discuss the implications of these policies, we think it is important to respond to some of the rhetoric coming from the current administration. It can certainly be argued that some of the tariffs on US goods are unfair and should be renegotiated. Having said that, the administration continues to emphasize the unfairness and “cheating” in the global trading system, without any mention of the benefits that the world’s economies, including the US, have enjoyed over the last 80 years. The global trading system has allowed countries to specialize in products and services that they are most effective in producing, increased productivity and economic efficiency, and has raised the standard of living of billions of people globally. Over this time, America transitioned from a manufacturing-based economy to a services-based economy.
Even if these policies are softened, changed, or reversed in the near to intermediate term, they are damaging the economy as businesses and consumers put off investment and consumption decisions until they have a clearer picture of the rules that they will be playing by. Further, the “process” that was used to arrive at and announce these tariffs have led countries across the globe to question whether the US can be trusted as a trading partner (and more). In our opinion, the actions of the administration have significantly increased the likelihood that we will have a recession in the US and global economy. We believe they will negatively impact corporate earnings. We will start to get more information on this later this week as companies report their first quarter earnings and their outlook for the coming year.
As we write this Outlook, the S&P 500 is now in bear market territory, falling ~20% from its mid-February highs. The NASDAQ, Russell 2000 and other market indicators are off even further. We find it helpful when we experience these types of declines to reflect on when this has happened in the past, including the stock market crash of 1987, the tech bubble of 2000, the Global Financial Crisis of 2007, and the Covid pandemic of 2020. In each situation, new information at first caused a decline in equity prices as markets correctly discounted a decline in short and intermediate-term earnings for corporations. The situation then evolved into panic as investors continued to sell equities. Bear markets are typically exacerbated by “forced” sellers: investors that have money in equities that they need in the short-term, investors who are leveraged or on margin, investors that don’t understand the short-term risk of equities, etc. History never repeats itself, but it usually rhymes. The chart below shows every bear market in the S&P 500 since World War II. The average decline was 34% and ranged from 22% to 57% during the Global Financial Crisis.
While we certainly cannot predict when and at what level this bear market will bottom, we do not believe that the problems facing the global economy are as foundational as they were during the Global Financial Crisis of 2007 or the Covid shut down in 2020. Today, a mere modification in the administration’s policies could quickly lead to a turnaround for an otherwise healthy global economy. In many ways this is the most frustrating thing about this current downturn. As a result, we have moved to a slight Underweight to US Large Cap Equities in our asset allocation models. US Mid Cap (S&P 400) and Small Cap (S&P 600) Equities have both also entered a bear market following recent declines. These companies are typically more domestically focused as compared to their larger counterparts and were trading at relatively cheaper valuations going into the trade war. We remain Neutral weight US Mid Cap Equities and US Small Cap Equities in our asset allocation models.
After years of US equity markets being the “only game in town”, Non–US Equity markets have provided investors with positive diversification benefits this year. Non–US Developed Equities, as measured by the MSCI EAFE Index, returned +7% in the first quarter and Non–US Emerging Market Equities, as measured by the MSCI EM Index, returned +3%. Although these markets have given back most of these gains over the last few trading days. While the tariffs will undoubtedly affect these companies, we believe there are several factors for this relative outperformance which can be sustainable. Valuations remain historically low on both an absolute and relative basis, providing support amidst these tumultuous times. And economic and corporate earnings trends are improving, particularly as fiscal and monetary policy turn into tailwinds in many economies. We remain Neutral weight Non–US Developed Equities and slightly Overweight Non-US Emerging Market Equities in our models.
The Federal Reserve held short-term interest rates steady at 4.25 – 4.50% in the first quarter, after lowering three times in 2024. Fed Chairman Jerome Powell was already walking a tight rope to ensure the job market doesn’t slow too dramatically and inflation doesn’t increase. The tariff announcement brings a hurricane into the forecast, with gusts of higher inflation, lower growth and weaker employment. Markets are currently pricing in several cuts to short-term interest rates this year, which we worry may be too optimistic. The Fed remains very wary of “getting behind” inflation, again. Long-term interest rates moved lower in the “flight to quality” trade we typically see in times of market stress. The 10 year Treasury is back under 4% for the first time since October 2024 and has room to move further if economic growth materially declines. We continue to purchase high quality bonds to lock in income for client portfolios, while being wary of undue duration (interest rate) risk. We remain Overweight US Investment Grade Bonds. We also increased our allocation to shorter duration Treasury Inflation Protected Securities (TIPs), which will help protect against a rise in inflation from tariffs and now are Neutral weight in our models. Non-Investment Grade bonds enjoyed another quarter of positive returns (+1% as measured by the Barclays High Yield index) and credit spreads tightened to historically narrow levels. We have been reducing our allocations even through the income is attractive on an absolute basis, because we do not believe investors are being adequately compensated for taking excessive credit risk. We remain Neutral to Strategic Bonds.
In our fourth quarter 2024 market outlook, we cautioned that we should be prepared to see more volatility “whether from central bank policy, the upcoming US presidential election, geopolitical tensions, or something else unexpected, we cannot be sure. But volatility is a price investors must pay to benefit from the long-term equity premium that investing in stocks has provided.” Well, the April 2nd tariff announcement was certainly unexpected, and is particularly painful given it is a seemingly self-inflicted wound. But capital markets adjust…and eventually recover. We continue to monitor, rebalance and tax-loss harvest our clients’ long term portfolios as appropriate
We leave you with a 19th century quote which Warren Buffett recently reminded his investors to observe during a significant market decline…. “If you can keep your head when all about you are losing theirs … If you can wait and not be tired by waiting … If you can think — and not make thoughts your aim … If you can trust yourself when all men doubt you … Yours is the Earth and everything that’s in it.”
