“Liberation Day”
On April 2nd, President Trump announced reciprocal tariffs as a key component of his plan to reduce trade deficits, create a more even trade environment and bring manufacturing jobs back to the US. The proposed reciprocal tariffs (see table below) were in addition to a 10% baseline tariff[1]. The combination of these tariffs would significantly increase the average tariffs placed on imports from its historical 3% average. The cumulative tariffs proposed, and their scope were far worse than the worst-case scenario – much like the Mexico/Canada auto tariff announcement. Liberation Day became Liquidation Day as stocks cratered and bonds surged. Prior to this announcement, the S&P 500 was down -7.7% from its most recent high, reflecting growing concerns around the potential economic and inflation impact from tariffs. The Liberation Day announcement tanked stocks a further -12% in just two days bringing the cumulative pullback of the S&P 500 to -19% below its prior high.
On April 9th, just hours before these tariffs were set to take effect, President Trump paused them for 90 days[2], which caused a furious rally in stocks. The S&P 500 index soared 9.5% - the third biggest single day gain since World War II. This dramatic reaction to the pause should be viewed as temporary relief. Broadly speaking, the proposed tariffs are punitive and would create severe disruption to the global economy and, specifically, would be harmful to businesses. It is difficult to speculate on the complete impact of these tariffs, but we estimate that they would result in millions of jobs lost globally and thousands of business failures. Taking this ominous risk off the table even temporarily brought enormous relief.
This pause started the clock on bilateral trade deals, which expires on July 9th. There are 57 countries or economic unions specifically identified in the President’s reciprocal tariffs. Each one is now incentivized to reach a bilateral trade deal with the White House and reports suggest that many countries are already engaged in negotiations.
For investors and markets, this pause has created a wait-and-see approach. Uncertainty looms large. There have been no bilateral deals made yet and until there are several completed deals with our largest trading partners, investors may not know how to estimate the potential economic impact. Nevertheless, market sentiment remains very low until further information is received.
Proposed Tariff Schedule by Major Trading Partner
“The Art of the Deal”, Donald J. Trump, 1987[6]
To understand the current uncertain circumstances, it is useful to find a framework. The negotiation strategy set forth in “The Art of the Deal” is a good place to start. Here are some key suggestions and how they relate to the current tariff negotiations.
Start with an Aggressive Opening Offer
“The Art of the Deal” begins by recommending that a negotiation starts with an aggressive opening offer. The proposed reciprocal tariff schedule is unquestionably aggressive. As we assessed the impact of these tariffs on each major trading partner, we used descriptions ranging from “brutal” to “insane” to “irrational”. Take the 125% tariffs placed on China. Given the existing co-dependency between US businesses and Chinese production, this tariff level is unsustainable. Countries have gone to war over less. How about the 56% tariff on Vietnam’s imports? Vietnam imports mostly apparel and footwear from factories owned by companies like Nike to leverage cheap labor. Surely, this manufacturing cannot be reshored. And what about exports to Vietnam? Today, there are few US-made products imported. Why? Maybe because their GDP per capita is just $4,700[7]. They cannot afford even a monthly payment on a Ford F-150. Their obvious incompatibility as a trade partner makes punitive tariffs seem irrational.
But no matter how illogical the opening offer is, so long as it brings affected parties to the bargaining table, an important negotiation goal has been achieved. Many observers have expressed concern over this approach, as it is very disruptive to financial markets in the short run.
Use Leverage to Amplify Your Position
As the largest economy in the world, access to the US market is critical to foreign businesses. Additional points of leverage include the US military and, specifically, the US Navy’s role in securing shipping lanes. President Trump has not been shy expressing his points of leverage.
Push Hard but Stay Flexible
Where there is a stick there must be a carrot. President Trump has expressed that cooperation on trade will be rewarded. Delaying the reciprocal tariffs, for instance, was a carrot to further encourage dialogue. We expect that countries that negotiate early are likely to see other carrots (i.e., lower tariffs).
Control the Frame and Pace
President Trump has controlled the tariff agenda. The pause until July 9th created a deadline for negotiations. Is this a hard stop? Could it be pushed back? President Trump controls that decision, which is exactly what he wants.
The above negotiation framework suggests an aggressive offer followed by an opportunity to hear counterpoints and an eventual convergence to a zone of agreement. Will it work? We will have to wait and see.
How Could This Progress?
According to Press Secretary Karoline Leavitt’s media brief on April 22nd, there are 18 trade proposals on the table and 35 countries are actively negotiating trade deals with dozens more waiting. We do not have insight as to which countries are closest to reaching deals, but deals will begin to be announced in the coming weeks. We will learn a lot from each deal with respect to tariff rates, exempted products, commitment to buy US goods, etc.
The more deals cut, particularly with larger trading partners, the better the market’s ability to assess the economic impact. The market may rally on these announcements. Initially, any deal may be received as a sign of de-escalation. Given how negative market sentiment is today, this relief alone could lift the market. As more deals are completed, we will have sufficient information to determine their economic impact and be able to pick winners and losers. As with Covid and the Great Financial Crisis, the stock market is likely to react much earlier than the fundamentals.
Are We Being Too Optimistic?
We do not think so. Both sides of these negotiations are incented to get a deal done. For affected countries, the reciprocal tariffs are a non-starter. For President Trump, he is looking to make progress on reducing trade deficits and leveling the global trade playing field. The reality is that investors have no way of assessing just how good a deal has been struck. This opaqueness provides extra negotiating room for President Trump. Some of his goals, such as reshoring manufacturing, will take years to show progress but perhaps he can extract commitments from companies to invest in a US manufacturing base to accompany trade deal announcements – much like the recent commitments from Softbank, Toyota, Nvidia, Taiwan Semiconductor and Merck to name a few.
Could There Be Some Near-Term Economic Dislocation?
Absolutely. However, the market will likely treat the impact as a one-off, extraordinary item much like it treats hurricane damage, factories fires and other events that do not impact long-term growth.
Portfolio Positioning
We think uncertainty has peaked, and the ultimate settlement of global tariffs will be better than the proposed reciprocal tariffs. This period reminds us of “green shoots” during the Global Financial Crisis and depths of the Covid sell-off. Yes, the market has not declined as much (maybe it will decline a bit more from here) but we are in a familiar spot. Market sentiment is very negative. A solution is not known but, in this case, we seem a lot closer to one. This tariff “crisis” was man-made and, therefore, the solution is man-made. This is solvable.
That said, is there a scenario where tariff deals do not get done, inflation surges, layoffs increase, and the economy falls into recession? Yes, of course. The market would decline a bit further, which means we do not have the “all clear” sign to significantly increase risk in portfolios.
Fortunately, we had already de-risked our strategies heading into this tariff chaos. When we add in our gold and fixed income holdings, our investment strategies are at the conservative end of their historical risk ranges. This gives us “dry powder” to re-risk as the uncertainty lifts from the markets. In fact, last week we started to gradually add equity exposure in certain strategies. There is a scenario where the market sees a V-shaped recovery and we need to be just as prepared for that scenario as an adverse one.
Conclusion
If you have invested long enough, you have experienced periods of uncertainty that cause significant market pullbacks. Those periods come in different forms but be assured they will come. The big difference between how we manage money versus others is that we tactically manage the risk in portfolios. Using a disciplined investment process, we try to protect wealth during periods of uncertainty and then re-risk as markets recover. Often the hardest part is not de-risking portfolios, it is knowing when to take more risk. Today, we find ourselves in a similar situation. We recently celebrated our 10-year anniversary as a firm and our track record clearly demonstrates our experience and ability to manage risk throughout the market cycle to protect and grow our clients’ irreplaceable wealth.
Disclosures
LIM is an Investment Advisor based in Dallas, Texas and registered with the Securities and Exchange Commission. Registration does not imply a certain level of skills or training. LIM is a company with purpose, dedicated to creative and unique thinking. We focus on portfolio valuation and research, along with superior client experience. We seek to identify investment opportunities by looking at economic factors, security valuation and human behavior. We start with the fundamentals of portfolio management and valuation. Then we build on these fundamentals with unique thinking and creative intelligence gathering to form a viable investment thesis. We believe this approach leads to dynamic global portfolios with increased return and managed risk. LIM utilizes Charles Schwab & Co. Inc. (“Schwab”), a FINRA-registered broker-dealer, member SIPC, as its custodian of assets. LIM is independently owned and operated and not affiliated with Schwab.
Additional disclosures:
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Definitions
The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market-value weighted index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value.
The Nasdaq Composite Index is a market cap-weighted index, representing the value of all stocks listed on the Nasdaq Stock Market. The composition of the Nasdaq Composite is a mix of long-established companies that have been on the exchange since inception, to IPO newcomers, companies that grew from OTC exchanges or switched from other exchanges.
The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.
The Bloomberg US Aggregate Index is a broad-based flagship benchmark that measures the investment grade, US dollar-dominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, mortgage-backed securities (agency fixed-rate pass throughs), asset-backed securities and commercial mortgage-backed securities.
The S&P 500 Equal Weighted Index is the equal-weight version of the S&P 500. The index includes the same constituents as the capitalization weighted S&P 500 index, but each company is allocated the same fixed weight at each quarterly rebalance.
The Russell 2000 Index is comprised of the smallest 2000 companies in the Russell 3000 Index, representing approximately 8% of the Russell 3000 Index total market capitalization.