Market Thoughts April 4, 2025

In negotiations, it can be valuable to create the impression that you are willing to take bigger risks than your adversary.  Oftentimes, strategic “recklessness” can win concessions from an opposing party that is afraid to take the same risks.  In order for this to work, the other side has to believe you are really crazy enough to do it, and your own side has to believe that you are only doing it for leverage and that you haven’t actually lost your mind.  Call it “crazy like a fox” versus just plain crazy.  Up until 3pm CDT on April 2nd, most of the market felt tariff negotiations were a bit of brinksmanship that would untimely lead to positive results.  After the tariffs were announced, however, the perceptions changed.  The tariffs were both larger than expected and seemingly without any regard to how the trade deficit with any given country came about or could be easily rectified.  Thursday’s subsequent plunge in both stock prices AND the dollar were in sharp contrast to how the markets rallied back in November 2024 when tariffs were first threatened by the then President-elect.  Then – crazy like a fox.  Today – batcrap crazy.

Good negotiators need to know several things.  One is the strength of their own position.  Another is the ability for their opponent to back down.  By openly challenging China to accept a very large tariff, he was seeking a very sought-after public “win”.  Which China, playing the global public opinion game just as we are, could not afford to give him.  They came right back and matched his 34% tariff.  This morning, before the stock market opened, President Trump said he thought things were going very well.  Effectively, he was saying he thought he would win in the end.  The market thought “Oh no, this isn’t going to be over in a few days like we hoped”.   A few hours later, investors' desperate hopes for relief were dashed by Federal Reserve Chairman Powell, who said in essence, “I didn’t create this problem so it’s not mine to solve”.

Some explanation for why tariffs are such a frivolous issue is in order.

It is hard to see how the U.S. was hurt by running a trade deficit relative to our trading partners.  They largely recycled the surplus into the purchase of U.S. bonds and stocks.  Kind of a win-win.  It wasn’t even a manufacturing jobs thing; those jobs were exported in the 1980s and 1990s.  Blame Reagan, Bush I, and Clinton.

Journalist Andrew Eggar pointed out today that America doesn’t exactly want to wrestle the t-shirt market away from Honduras or Vietnam, because it would be difficult to get Americans to work at a t-shirt factory for a dollar an hour (which is what it would require for T-shirts to be sold for $5).  Selling us cheap T-shirts does not harm America unless there were a large number of unemployed Americans who could afford to live on T-shirt wages.  Unless we had a lot of semi-decent $200/month apartments available, nobody here could afford to take those jobs.  Furthermore, America has largely become a services economy, not a manufactured goods economy.  As such, we run a services surplus with almost everyone.  President Trump did not factor this at all into his formula. The lack of credibility in terms of what countries were tariffed (Heard and McDonald Islands, only inhabited by penguins) contributed to the loss of confidence in the Administration and the results decline in both the dollar and stocks.

We are winning since Inauguration Day, but not in a good way.

In any event, the stock and bond markets are both pricing in reduced confidence that the tariff war will have a positive outcome, and they are both pricing in a much higher possibility of recession.  Stocks that depend on economic growth (cyclicals) have been performing poorly, while stocks that are better positioned to ride out a recession (defensives) either gained or lost substantially less – that is, until today.  At some point in a bear market, even the leaders get sold.

Safe treasury bonds have been gaining while riskier corporate bonds are slipping.  We have been adding to our investment-grade bond positions because we think interest rates will decline as the economy continues to be harmed by the tariff war.  High-quality bonds typically provide a bit of ballast against stock declines.  We have been getting more defensive in stocks as well, but after the 9% plunge in stocks this week, it no longer makes sense to lighten up.  5100 on the S&P 500 (more or less today’s close) looks like fair value unless the tariff war drags on for months.  If we can get a credible deal and no new attacks are forthcoming, we could bounce back up to 5500.  I make no predictions.

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