Looking beyond the first quarter, the scale and scope of the worldwide tariffs that Donald Trump announced on April 2 took investors by surprise, and the market reaction has been powerful, with the S&P 500 falling 12.1%+ over the following four trading days for the 12^th largest 4-day decline since 1950. Those index declines are additive to the first quarter drop, leaving the benchmark for large cap US stocks down over 15% year-to-date through April 8.

There are two popular ways of viewing the tariff policies that the administration announced last week, the first being the textbook global macroeconomic view of long-term tariffs for revenue generation as well as an attempt to balance trade flows or even erase trade deficits. Reciprocal tariffs leading to ‘trade wars’ are a possibility, and that concern has been validated by China’s reactionary counter-tariffs. At the end of this macroeconomic chain of logic lies the future of the US dollar as a reserve currency, which requires trade deficits to distribute dollars abroad which are then recycled to finance the home country debt created by the trade deficit. If the Trump administration’s intention is to dissolve this long-term construct, then investors should brace for a significant period of volatility and reconstruction of the familiar pillars of the financial system and investment landscape that US investors have benefited from since the Berlin wall came down. This permanent macroeconomic shift scenario with extended trade-war-oriented tariff implementation is the viewpoint that has investors most concerned.

The other way to view the Trump Administration’s tariff announcement is that this is a complex approach to softening up the battlefield prior to negotiation; the ‘Art of the Deal’ at the presidential level, in which Trump gets to use US global trade policy to anchor terms ahead of a negotiation between major trading partners that potentially enshrines advantageous US terms for the next half decade. The discussion with China involves more than just trade policy, as within this negotiation lies a play for the future of the Panama Canal as well as TikTok, both of which require Chinese acquiescence that, in Trump’s mind, is better obtained if the communists start the conversation on their back foot. This path is centered on China’s current economic weakness and implies quicker results as well as less long-term structural change and is one that the market can become comfortable with if the administration can quickly demonstrate negotiated results with a large group of trading partners.

“It is worth acknowledging that doing nothing, while attractive in the short term, is not an option.”
– Trey Willerson

These are two different extremes in terms of what US trade policy becomes, and the ultimate result will fall somewhere between them. It is worth acknowledging that doing nothing, while attractive in the short term, is not an option. The current direction of deficit spending and debt accumulation is unsustainable for the United States, as we have written about previously (Yields, the Fed, & Fiscal Uncertainty). The current level of US interest payments alone has risen to nearly $1 trillion, and the US borrows to pay that interest, leading to further debt and higher interest payments in a cycle that is the definition of a debt spiral. Give credit to this administration for separating themselves from generations of politicians who have ignored fiscal reality while focusing campaigns, presidential administrations, policy, and spending on the shiny object of the moment because near-sighted policy made for easier short-term governance and better short-term results than would addressing the ever-growing fiscal disaster.

Political realities should be factored in. In gauging the President’s plan, it makes sense to keep in mind that President Trump is unlikely to be able to stomach protracted economic malaise. He needs to show economic progress in order to hold the votes for the tax plan that his administration is trying to work through congress, and if he goes into the mid-term elections with the country focused on economic and stock market turmoil, then majorities in congress are at risk and so is his agenda. All of this, and everything we have come to know about President Trump, argues toward seeing the recent policy changes in the light of short to intermediate-term negotiation along with whatever positive structural changes that he can make stick in a context of near-term US economic gains and global economic health.

Summary

Great long-term investors look forward to periods of market dislocation such as we’ve seen over the past quarter, and particularly over the days following the administration’s announcement of new tariff policy. If it is possible to buy a strong, fast-growing company at a significant discount and an attractive cash flow yield because of a market panic that temporarily drops the stock price by half, then sign us up for shopping in the sale aisle. With a ten to twenty-year hold-period, the problems that markets are focused on today are likely to fade to irrelevance while earnings power and future cash flow distribution compounds relative to our entry price. At the right valuation, the same is true for other investments, including many of the funds and ETFs that dominate most investors’ portfolios.

Unfortunately, investing is, in part, an emotional exercise. The reason the aforementioned stock dropped was profit taking and fear, which leads to second-order effects like margin calls and forced selling, which shows up in lower prices and even more fear, more selling and even lower prices. The reality is that most human beings are simply not wired to be great investors because, by definition, lows are created at moments where the perception is of much more bad news to come, and the fear induced by this process creates a desire for action, the desire to escape, and the easiest action of all is simply to sell, to step aside until the facts are more clear and the markets more stable. Unfortunately, when that stability returns and the fear subsides, the price of the stock or fund will also have recovered, and to re-enter the trade, the investor gives up long-term returns for that soothing feeling of comfort. Warren Buffett’s advice is to “be fearful when others are greedy and greedy when others are fearful,” something that is easy to say, but hard to do when the stocks on the screen are all red, and a ridiculous talking-head on CNBC is pulling at his hair, blowing air horns, and screaming about the1987 crash while mumbling vaguely-understood economic theory. At those moments, the whole long-term investing idea seems different than it did when planning it out in your advisors’ tranquil office and stopping the pain becomes emotionally easier than considering the less immediate concepts implicit in valuation, long-term outlooks and compounding. It has been a while since we got a taste of that kind of panic, but we’ve seen it in markets again over the last few days.

“Be fearful when others are greedy and greedy when others are fearful.”
– Warren Buffett

Investors do best when they use periods of strength and high expectations to trim holdings and adjust portfolio exposures, and when they use weakness like we have seen over recent days to allocate cash into measurable value. Valuation and entry points matter, and markets entered this phase of volatility at very high valuations, leaving room for a healthy correction in prices. Current values are most attractive in value-oriented stocks, certain international markets, and in smaller capitalization stocks. US large cap stocks, while much more attractive than they were 100 days ago, are ‘cheaper’ but not yet ‘cheap’. This is a good time for a thoughtful conversation with your Wealth Advisor to discuss the ways your portfolio can take advantage of the turmoil and, in some cases, the discounts.

It is reasonable to expect continued volatility ahead relative to investors’ experience of the previous two years. A Presidential Administration that is trying to reset long-term economic relationships, a Federal Reserve whose hands may be tied by inflation to a degree that the Federal Reserve prior to 2020 was not, interest rate levels that have compelling reasons to adjust higher due to growing US borrowing needs, and elevated valuation ranges for large cap stocks will all be contributing factors to a regime of higher uncertainty and wider trading ranges. The good news is that volatility creates opportunity, and well-advised investors can position themselves to take advantage. We have a strong and growing team of Wealth Advisors through the state of Texas. Each of them is prepared to have a detailed conversation about your portfolio and the current balance of risks and opportunities.

 

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