A SHOCK TO THE SYSTEM

Global response to this week’s tariff announcements has been acute, with countries scrambling to respond to the aggressive policies. On Friday morning, China retaliated with a 34% tariff on U.S. goods, set to take effect on April 10 — and, going a step further, also announced the addition of two dozen American companies to “export control” and “corporate blacklists.” The EU, on the other hand, faced with a 20% tariff on U.S. exports, is readying a unified response. In many ways, it feels like beat-the-clock in terms of crafting a negotiating/retaliatory strategy, and while governments and policymakers are putting plans together there are real economic consequences that will be realized. 

Many economists have reduced expectations for global growth. That makes sense given that we will doubtless emerge from this period with meaningfully higher tariffs than the 2.5% average rate we started with. How much higher and for how long has yet to be determined; however, this period of prolonged uncertainty itself is the driver for the falling growth expectations. When faced with extreme uncertainty, the most logical path for households and companies to take is to hunker down and do nothing: slow down consumption, slow down spending and investment, slow down hiring. These activities can drive the vicious cycle of slower growth, leading to… slower growth. Global growth estimates are very vulnerable right now, and the sooner we have clarity on ultimate tariff policies, the better positioned both households and companies will be to adjust to the new conditions.

The monthly non-farm payroll report took on enhanced significance for March — would this “hard” data corroborate the loss in confidence we have seen revealed in CEO and business owner surveys? In short:  No. March nonfarm employment was stronger than consensus, rising 228K against 130K consensus (though January and February were revised down a combined 48K). The unemployment rate ticked up to 4.2% from 4.1%, and, as expected, average hourly earnings continued to grow at a 0.3% in March. While there may be some noise in the data due to the weather-impacted January/February timeframe, it is notable that there is little sign yet of DOGE impacts. Many are suggesting those will be revealed in the months to come, and recent Challenger layoff data implies a significant effect from the reduction in government jobs.

That said, most of the hard data has yet to provide enough evidence to a data-dependent Fed that there is any need to change course from the patient approach that was laid out during the March meeting.  Despite the threats of a significant global slowdown from the announced tariffs and anticipated retaliation, the resilience of the hard data in some ways ties the Fed’s hands from taking pre-emptive action — particularly as a near-term side effect of tariffs will be higher inflation. In his speech on Friday, Fed Chair Powell’s comments affirmed that the Fed is data dependent, and the data shows the “economy is still in a good place despite high uncertainty.” However, he also acknowledges that the economic impact from the super-sized tariffs is likely larger than expected. Listening to his comments, it is likely that a rate cut remains months away, and the FOMC will respond to weakening data as it comes. The challenge is that, once weakness is reflected in the hard data, the trend is difficult to reverse. Fed Chair Powell’s stance today again confirms that the Fed will respond, but likely will be late.

Many market indicators are flashing “extreme,” with market volatility as measured by the VIX “fear and greed” index hitting 45 — a decisive move up from the mid-February level of 14. Individual investors are also expressing fear, with the American Association of Individual Investors sentiment poll data reflecting the third highest bearish reading ever — and that survey was taken before April 2!

Both of these readings are at extreme levels, and at levels historically correlated closer with market bottoms than tops. It is incredibly difficult to trade markets, or stocks, during times of excessive fear and pessimism, particularly when the source of the fear could be changed or mitigated with the stroke of a pen. A good example of this is Nike, a stock that plummeted during Thursday’s selloff given the concentration of their manufacturing in Vietnam (25%) and the imposition of 46% import tariffs. The stock fell nearly 15% on Thursday; however, Friday’s trading brought a relief rally as Vietnam came to the negotiating table, offering to bring import tariffs against the U.S. to zero.

This has been a difficult week for investors, and a look at history makes it clear that volatility can instigate poor investor behavior. We are “confirming the course” with our clients: 

• Is your goal-aligned asset allocation still appropriate? The future is unknown, and we expect markets will remain volatile — so let’s make sure that your overall asset allocation correctly reflects your goals and your risk preference around funding those goals.
• Do you have the right amount of liquidity (cash and high-quality short duration fixed income)?  Having a liquid “Portfolio Reserve” is an ideal way to ride out the equity volatility storm and allows for goal funding and lifestyle spending even as risk asset markets are under stress.
• Is your risk asset portfolio appropriately diversified? U.S. equities continue to underperform their non-U.S. peer’s year to date. Do you have a globally diversified portfolio? Do you have exposure to cash flow generating risk assets like public infrastructure?

Investors should be prepared for a prolonged period of uncertainty with episodes that could break either way. For example, there may be announcements that provide some relief to broad markets or sectors/companies if the more draconian tariffs are reduced. We could see more announcements of “reshoring” that will boost investment in the U.S., and, later in 2025, we can anticipate constructive tax policy and an era of deregulation that may boost animal spirits. On the other hand, we can anticipate that corporate earnings will be revised downward and that markets will remain under pressure. The economic consequences of the combined uncertainty and tariffs could ultimately push the U.S. economy and even global economy into a recession. While this is not our base case, the risks are rising.