Tariff Man Is Back
The clouds of uncertainty have rolled in with the Trump administration set to impose tariffs on our neighbors to the north and south. The situation is fluid, so anything I pen at this moment could radically change by the time you read it. But here is what we know at this moment: all goods imported from Canada and Mexico will be subject to a 25% tariff, except Canadian energy products, which will face a 10% hike. The Trump orders also placed a 10% tariff on Chinese goods. Just moments ago, we got a tweet from Trump that Mexico has acquiesced to the degree that its tariff deadline will be postponed by a month. As I said, the situation is fluid, and spending any more time on details that could change in the blink of an eye is of little value to readers.
What I think is a useful exercise and perhaps worthy of some time is walking through a thought exercise on how I think this situation will affect asset markets. For starters, I don’t think what’s on the table now will tank a U.S. economy that continues to showcase its resilience with each passing month. Could a trade war spiral in a manner that changes that statement? For sure, but we’ll cross that bridge when we get there. We know that U.S. corporations are in strong shape to adapt and adjust. Moreover, for the companies that matter to the major indices, their elevated profit margins will act as a good shock absorber where some costs can’t be passed along or shared throughout the supply chain.
Furthermore, given that trade represents such a small piece of the U.S. economy and because the U.S. is the primary source of demand for many of the world’s manufactured goods, a trade war will likely have a more significant impact on those countries directly exposed to U.S. demand for their exports and employment. Don’t get me wrong, the economic textbooks are clear that a trade war has more losers than winners, but this administration doesn’t necessarily buy into that conventional wisdom. Understand that it’s a fine line to walk in trying to vet out this issue where the politics on both sides are very passionate about their view. To me, it’s a dynamic that needs to be analyzed and assessed from the perspective of what it means to markets and how it impacts our positioning today as well as our strategy going forward. The market constantly reminds me that it doesn’t care one iota how I feel about anything.
I do think it's crucial for everyone attempting to handicap the “game theory’ behind this administration's fortitude to use tariffs and foreign trade as a tool to carry out its campaign promises to keep the verbiage from this Trump tweet in mind:
“THIS WILL BE THE GOLDEN AGE OF AMERICA! WILL THERE BE SOME PAIN? YES, MAYBE (AND MAYBE NOT!). BUT WE WILL MAKE AMERICA GREAT AGAIN, AND IT WILL ALL BE WORTH THE PRICE THAT MUST BE PAID. WE ARE A COUNTRY THAT IS NOW BEING RUN WITH COMMON SENSE – AND THE RESULTS WILL BE SPECTACULAR!!!”
- President Trump 2/2/25
Based on investors' memories of Trump 1.0, the expectation is that Trump will use the stock market as his policy report card. Should it fall too much, Trump will spin a narrative or announce a breakthrough in the negotiation that the ‘best deal ever’ is right around the corner. But what if this Trump administration is thinking more about legacy and making a mark on history by reorienting a World Order that he believes no longer benefits the U.S. through his lens? If that’s the case, then the pain threshold in equity markets is likely much lower than where it was in Trump 1.0.
The key risk from tariffs on asset markets is less about the economic impact on resilient U.S. growth and more about the impact on global liquidity. Darius Dale of 42Macro put it best in a tweet this morning:
The US raises tariffs on economy A.
Economy A devalues its currency to offset the rising tariff rates.
Economies B, C, and D devalue their currencies to maintain competitiveness with Economy A.
The US dollar and currency volatility both strengthen materially as a result.
The US dollar and currency volatility are two of the most important variables for predicting the three-to-six-months-forward impulse of global liquidity.
US dollar strength and rising currency volatility depress global liquidity by inflating US dollar-denominated debt service costs and deflating US corporate profits growth.
Because 2025 represents a historic year of global debt refinancing demand, a too-strong US dollar, too-high currency volatility, and too-low—or negative—growth rate of global liquidity will force investors to broadly sell assets to create the balance sheet space necessary to roll all that low-cost 2020 debt issuance into a much higher interest rate regime.
Said simply, the supply of financial assets is rising rapidly amid slowing or outright negative demand for financial assets.
Foreign investors, which own a net $20 trillion of US assets will likely sell a portion of those assets to obtain the dollars they need to service their debt.
While holding on to that complex set of variables in the back of your mind, add to it the fiscal constraints confronting this administration. We already know that if the 2018 tax cuts are not extended come the end of this year the U.S. is set to experience the most significant tax hike in U.S. history. Extending the TCJA is a top priority for Trump. Still, given that the fiscal deficit is already running at $1.9 trillion per annum and, based on CBO estimates, is set to widen to $2.7 trillion by 2035 – the Trump administration needs offsetting revenue just to extend his prior tax cuts, let alone get new ones passed. According to estimates from some of the bean counters, Trump needs $2.5 - $3.5 trillion in additional revenue or spending cuts to placate the fiscal hawks in the GOP to extend the TCJA.
The newly formed DOGE department, while making for good theater, doesn’t have enough fat to cut from non-discretionary spending. The President already vowed to leave “entitlements” untouched, even though small changes here would lead to durable, long-lasting reductions in a bloated Federal government. That leaves tariffs as the go-to source of raising revenue and the easiest path for the executive branch to have unchecked authority, given that the President can argue they are being implemented on the grounds of national security.
Alright, enough on that, and let's get to markets. The setup for Trump 2.0 is much less forgiving than Trump 1.0, where the margin of safety, given the embedded fragility built up in the system, is going to require almost flawless execution (and probably some luck) to propel equities higher from existing levels. Consider the setup:
2025 is coming off two straight years of 20% gains.
Equity valuations are rivaling their highest readings in history.
The U.S. equity market has never been more concentrated nor as large a share of the global equity market as it is today.
After 15 years of ZIRP the U.S. economy is on the back-end of the most aggressive interest rate hiking cycle in history, which took the yield on the 10-year Treasury from 0.5% in the Spring of 2020 to 5.0% in the Fall of 2023. The full effect of this dramatic change in the cost of capital has yet to exert its full force.
Outside of the brief spasm in economic activity that occurred around the early stages of the COVID-19 pandemic, the U.S. economy hasn’t experienced a recession in almost 18 years.
Without question, U.S. financial markets have undergone some structural changes post-GFC, which have only gained momentum over time—investors' expanding embrace of passive investing, the dominance of a select group of quasi-monopolistic companies, and investors around the world using U.S. financial markets as their piggy bank. These dynamics fueled U.S. exceptionalism, where U.S. nominal GDP has increased by 50% over the past 5 years – aided and abetted by unchecked government spending rising to $7 trillion (was $4.8 trillion at the end of 2019).
Now, think about what is set to change that could upset the variables fueling these structural dynamics. For starters, fiscal restraint is coming in some form or fashion. Whether through bond market vigilantes, political choice, or inadequate liquidity, the rate of government spending is set to slow. Unless this spending is made up from the private sector then this will act as a headwind to growth. Don’t forget that the sequence of Trump's agenda this go around is a complete 180 from his first term. Previously, he led with tax cuts and then worked into tariffs. This time, it's tariffs and cost-cutting in order to find funds to keep existing tax cuts in place – a la maintain the status quo.
Immigration, which accounted for 84% of the 3.3. million rise in the U.S. population in 2024 is set to slow materially. And the recent DeepSeek shock has sent a ripple through the Teflon prism in which the A.I. narrative was previously viewed. I'm not saying the A.I. cycle is dead or won’t be revolutionary, but the psychology behind the narrative has changed with significant doubts over the size of the once believed to be inexhaustible capex cycle.
Not to mention the potential disruption to the Global World Order from this administration's agenda. Right or wrong, the policy levers being pulled to Make America Great Again represent themselves as agents of chaos. It would be a gross underestimation to think that they will be carried out and markets will not experience a significant level of volatility. Don’t get me wrong, change can be good, but the path to get there often is bumpy.
I continue to view the current setup as one where a tactical strategy can be effective. Yes, you have a core allocation that you maintain, but you carve out 10 – 15% of your capital and view that as funds that can be deployed when opportunities present themselves. Given the current backdrop, the equity market can trade as low as 5,500 and as high as 6,600. As a result, I’m neutral to marginally bearish, with the S&P 500 trading at around 6,000. A 1:1 risk reward setup is not the asymmetry you like to risk a lot of capital on. If the S&P 500 were to trade below 5,700, I’d be an opportunistic buyer of risk assets – reassessing the setup along the way. Above 6,300, I’d be a more active seller of risk, assuming that not much has fundamentally changed for the better. The risk of a deeper air pocket – a material correction of 15 – 20% for the S&P 500 – is much more probable than a 15 – 20% gain from current levels.
Look, we’re all just reading tea leaves, as none of us can predict the future, but when it comes to the equity market and my analysis, I just see the probability of outcomes skewed to the downside rather than the upside. That wasn’t my view the last couple of years, but the setup and my view have changed. It’s not just me that lacks enthusiasm for the setup in the equity market. Vanguard, the purveyors of all things bullish and the pioneers of the passive index fund, has also turned cautious on U.S. equities. As everyone waits for the last bear to turn bullish, we have a case here where the first bull has turned bearish. Go figure that one. They are forecasting that U.S. stocks will barely keep up with inflation over the next decade. Practically no return in real terms. They are also predicting what many feel is the impossible — that the U.S. equity market will lag the Treasury market over the next ten years. Precious few are prepared for that outcome.
I can’t say I’m overly excited about the bond market either, other than parts of it offer a secure mid-single-digit return with low volatility and minimal risk of capital loss. That’s a reasonable trade-off to me – a mid-single-digit return with a capped upside and downside. You could do worse. The biggest risk (and it is a risk) to getting wed to this asset class is a resurgence of inflation that sends interest rates higher. I think the risks of a deflationary outcome are about equal with a resurgence of inflation, but both are path-dependent on policy from the administration and the Fed. Speaking of the Fed, the one big takeaway from last week’s FOMC meeting was that the Fed is definitively out of the game of easing policy to get in front of perceived downside risks to growth or the labor market. They are definitively in the camp of reacting to adverse outcomes. Said differently, they will come riding to the rescue after things have already started to breakdown, not before. So, the Fed put is much deeper than most investors are likely comfortable enduring.
The last asset class I’ll hit on is gold because I continue to think it's worthy of having an allocation in every investor's portfolio. Gold hit a new record high last week ($2,817 per ounce) and closed (very close to the peak) at $2,798 per ounce. The precious metal has turned in a near-+7% advance for the year. This was gold’s biggest monthly gain in dollar terms since August 2011 but that was a time when there was a massive flight to safety because of the S&P credit rating downgrade of U.S. Treasury debt to AA+ from AAA.
This latest leg in the secular bull market has occurred with the U.S. dollar strengthening and real interest rates rising from 1.5% in mid-September to 2.2%. This is a change of character for the barbarous relic as gold prices typically move inversely to the dollar and to real rates. That’s not the case recently, and that is because the complexion of bullion has been altered, with many pointing to the U.S. sanctioning Russian assets after it invaded Ukraine as the trigger point. Since then, the price action in gold has been more consistent with a currency than a commodity — not just that, but a currency that is no country’s liability.
Gold is a true ballast in a portfolio's asset mix and in an uncertain world — it is always uncertain, but today, it is much higher than the norm — you want to own anything that is inversely correlated with this heightened uncertainty. I’ve long held the view that gold would trade up to $3,000/oz, and we’re nearly there. I don’t want to put limitations on where it can go, but I must admit that my expectations for future gains are more restrained than when it was in the low $2,000 range. But for today’s environment and likely the near future, I do not expect the safety characteristics that gold provides to do anything else but remain on its decisive upward trajectory.
Let me end by walking you through a hypothetical thought exercise. The S&P 500 was up 2.7% in January, which is a very strong move in a month. Assuming an investor captured the gain, he/she could decide the juice wasn’t worth the squeeze for the rest of 2025 and decide to take her capital to the sidelines. She noticed that 1-year T-bills are yielding 4.2%, a portfolio of BBB bonds is yielding 5.25%, a portfolio of high-yield bonds is yielding roughly 6%, and a high-quality CLO portfolio is yielding 6.5%. She could piggyback her nearly 3% gain in the month of January with any combination of these lower-risk investment options and, by year-end 2025, be sitting on a total return of 7 – 10%. I bet most investors would take such an outcome if given the option of a 7 – 10% return coming 2025 without having to worry about navigating all the squiggles.
That is a real possibility for most investors at the moment, but I’m also willing to bet that very few will act upon it.
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