It’s time to talk about tariffs and the market. The markets have been pushed into turmoil over the past several weeks over the executive decision to implement tariffs on nearly every country all at once. These are the highest tariffs since 1904. The stated goal is to reduce the trade deficit and increase domestic production. Trade imbalances exist all around us in various forms and they are not necessarily an evil. All of us, for example, run a trade deficit with our grocer. We buy more from the grocery store than the grocer buys from us. This does not make me want to put a tax between us to encourage me to grow more food in my backyard (I do love my chicken eggs though.) In the global economy trade deficits are offset by surpluses elsewhere, just as the grocer takes his surplus from us and runs a deficit with his wholesalers. The US has a deficit with China, but we have surpluses with the UK, Australia, the Netherlands, and many others. The fact that we have a net trade deficit with the world is driven by two major factors: our budget deficit and dollar strength. We have a mammoth $2 trillion budget deficit that drives excess demand for imports, and we have a strong dollar that makes American goods expensive abroad and foreign goods cheaper domestically. In short, tariffs are likely to do little to affect the stated goals. Even if we end up buying fewer goods from China and start producing more domestically, it will come at a cost. Americans, with their already stretched budgets, are not prepared for $6,000 iPhones and $70 undershirts. Thus, the market reaction.
Economists have spoken up and they say if tariffs persist, the US will enter a recession. First quarter GDP growth is projected to be near zero, and further weakness is expected in subsequent quarters. That being said, the market is amazing at sniffing out strength or weakness much sooner than it shows up in the economy. Stocks were showing some weakness, especially domestically heading into the tariff announcements and then really sold off when the announced numbers blew through everyone’s expectations. Going from roughly a 2% average tariff to 25% was simply outrageous. But the buyers have been ready to take back control. The first glimpse of this was the other week when a fake story broke that there was a pause on tariffs and markets shot up over 3% before ending the day down 4% after it was debunked. And then we had April 9th when a real 90-day pause was officially announced and markets rallied over 10%. As crazy as Washington seems (or maybe is), they don’t want to tank the US economy and are more susceptible to market judgments than they let on.
The underlying health of the US economy is still intact. If it wasn’t for this unforced error the markets would likely still be chugging along orderly. Be wary of pundits saying the recent market strength is nothing but a “dead cat bounce.” We are about halfway through tariff mania and the worst is likely behind us. That doesn’t mean we can’t see fear pop back up and huge sell-offs take place. People are ultimately unpredictable after all, but the path of least resistance is higher lows, not lower lows from here in the market. As negotiations take place and deals start to roll in, we will see people get more comfortable owning stocks again. Sentiment indicators are very low and that points to how people are positioned. The market itself however, is holding a key support level (the highs of the last cycle.) Just as we were calling for caution in the short-term if the Dow was below 42,000 (it’s 39,600 now), we are saying below 36,000 is the line in the sand. If that were to break, then look out below. The markets kissed that level last week but have rallied back. To get the bull market fully back on track we need to see a few more positive headlines that push stocks back above those January and November lows (42,000). Global stocks are already at the equivalent January and November levels and we are looking for the US to follow suit.
We remain cautious, but optimistic that destroying the underlying economy in the name of tariffs is both harder and less politically palatable than pundits think.