April fool’s – a little late.
On Tuesday evening, we learned of the intended tariff levels to be applied to everyone. The rundown was presented to the American people and the rest of the world on a scoreboard of sorts. Notably, the administration called out the current level of tariffs that our foreign counterparts were applying on American goods imported through their borders.
The Tariffs
A tariff is not, as has been implied by tariff supporters, a tax paid by the exporter. Instead, the buyer pays a tax for the privilege of accessing foreign goods. So for example, Toyota is not getting dinged for selling a Corolla to an American importer. The importer is paying the tax, and that cost is passed on to the eventual owner. This is intended to encourage the purchase of domestic goods by making them artificially cheaper than imports.
The administrations’ approach to calculating the “tariff” we would impose starts by taking ½ of the trade deficit between our countries and then dividing it by what we import from them. This approach is not standard or accurate, and this break from the established, commonly understood calculation methods means that the US is no longer speaking the same “language” as our trade partners. This approach also lacks understanding of the unique characteristics some relationships have.
As an example, we don’t grow coffee beans in our country – we import them from Columbia. In order for Columbia to avoid a tariff, they would need to import more goods from us than we import from them. In many cases, this is not a reasonable expectation to have. Should we believe that Columbia’s population will have greater demand for our goods than our population will demand from them? We don’t manufacture enough of the stuff Columbia needs for them to import at a level to create a trade surplus for the U.S. Their population is also about 15% of ours, so it would be almost impossible for Columbia to consume our goods at a rate that would equalize imports and exports. That doesn’t make the relationship bad, unfair or imbalanced - does it?
The Market Drop
Major averages were down between 3.5% and 6% by the end of the day. As I write this, futures appear to be indicating that we face another very challenging day in the markets.
The Magnificent Seven, which to this point had been leading the market to new highs, are now all down at least 20% from their prior highs. Remember our prior comments about market concentration – these seven stocks represent roughly one third of the S&P 500’s total market capitalization. The significant fall in their prices is causing a disproportionate impact on major indices prices (S & P 500, Dow Jones, Nasdaq).
It is worth stating again, markets crave certainty, clarity, and transparency. Deutsch Bank, yesterday, suggested the concern here is that the approach to this tariff policy, ‘lacks intellectual rigor.’ If the market starts to believe that policy decisions around reordering the world economy are haphazard or ad hoc; faith and confidence can deteriorate in more significant ways moving forward. This is a very real component of what is driving the magnitude of these selloffs.
We have been writing about tariffs in our newsletters and eblasts since the election. Some would suggest that the tariffs are negotiating tools, but we struggle to understand how you can constructively negotiate against the entire world at the same time. We continue to believe that the U.S. economy is resilient enough to withstand a short period of tariff pressure. However, the level of tariffs presented are significantly higher than the worst case that Wall Street had anticipated. The daylight between expectations and reality is also amplifying the moves to the downside. Should these levels of tariff be applied for a longer duration, more than months, the potential for the U.S. to move into recession would increase dramatically.
What do we do here?
1. Maintain composure. This is a very fluid moment, no one has had ample opportunity to truly evaluate the impact of these policy changes and it must be observed that the administration has a history of moving back and forth between policy goal posts. For long-term investors, this is potentially an opportunity based on this valuation reset – however, the volatility is likely to persist.
2. Plan for liquidity. We have been working hard with our financial planning clients to anticipate your liquidity needs over the next several years. If you’ve shared your income needs with us, we have capital to rely on should difficult conditions persist.
3. Consider ways to harvest losses for tax purposes in non-IRA investments.
4. Think like an investor. There will be opportunities that emerge from this disruption. Your portfolio managers are seeking those opportunities every day. If you have been holding cash or money markets, this could be a time where you are able to buy good companies at a discount.
What has been done?
At AFS, we have an investment philosophy that includes the use of risk mitigation strategies in our clients’ portfolios. Over the last several weeks, many of those strategies have been de-risking. Beaumont’s most aggressive strategies have moved to only a 60% allocation to stock while their moderate allocation holds only 50% stock today. Hedged Equity strategies are positioned well for the current level of drawdown. Your bond allocations are providing diversification as intended – with interest rates falling over these last days, bonds are outperforming. Our clients’ portfolios are not as concentrated in their ownership as indexes are – this means you are not feeling the same pace of decline as the broad markets are at this time.
No one likes to see their account balances move in the wrong direction. We are acutely aware of that. Our work together has always sought to strike balance between market participation and the flexibility to adapt to changing conditions.
We are prepared to support you through environments like this. If you need to have a conversation about your liquidity needs, investment opportunities or anything else in your financial world, we are here for you.
Thank you for your continued confidence in our work. Please know that we are working diligently behind the scenes – feel free to make use of our scheduling link and resources on our new website: www.alliedfinancialservices.com.
We will continue to send updates during this evolving time.