High Anxiety: Market Implications of Tariffs

Market pundits like to play the spread between greed and fear. They pick a corner and take turns amping up extreme views. I want to be the analyst with the highest target on the S&P. I want to be the one with the lowest. High anxiety.

I say that because even the most pessimistic narrative around Liberation Day was out-trumped. That’s hard to pull off. Wall Street, by its very nature, tends to lean into optimism. That is until it doesn’t. It’s where we currently find ourselves. Liberation to isolation.

Hope is circling that we see appeasement and reconciliation. We may instead see reciprocating reciprocity. China kicked things off with a 34% counter tariff on all imported U.S. goods. Away we go.

If the U.S. tariffs announced stick and we don’t see further tit-for-tat escalation, rising concern of slower growth and higher inflation may become something worse, a race to recession. Self-inflicted pain.

My back of the envelope quick calculation has tariffs as announced adding +1-2% to inflation and detracting possibly as much from growth. Stagflation tipping into recession if things escalate further.

Those are ‘wet finger in the wind’ placeholders. Keep an eye on 10-year government bond yields. The lower they go, the more the bond market is signaling concern recession risk is being pulled forward.

With earnings season upon us, no one will care about the first quarter. Earnings are baked in and will be fine. What investors care about is the outlook. I expect the 10% earnings forecast this year will quickly ratchet lower. The same for next year. Directionally, that’s an observation across global equity markets.

To cast a wide net around the S&P, if +$270 earnings this year fades from 10% to 5-6% growth, we would still be trading on a forward multiple of around 21x. Not inexpensive. Over the past 5 years, the average forward multiple was 20x, forming a baseline for the S&P of 5100-5200. Expect to see that range continue to be batted about.

There’s a quote by Maya Angelou I’ve always embraced: “When someone shows you who they are, believe them the first time.” As I’ve written before, I’ve always taken President Trump at his word; he wants to blanket the U.S. economy in ‘protective’ tariffs.

We’re watching in real time a “101-class” on negotiation. It begins with anchoring. If I’m a seller, I throw out an extreme offer to reset your expectations on what is a fair price. I’m trying to get you to overpay. I’m selling. You now need to negotiate me down from there.

The problem comes if my opening price is absurdly high. I run the risk of not being taken seriously. The buyer walks away or counters with a phenomenally lowball bid. Almost everyone likes to meet in the middle. And for the record, I’m not saying the mid-price is right. It just feels like everyone’s a winner landing there, walking away happy. Offer. Bid. Mid. Done.

No one’s happy with the tariffs announced except the President. As they stand, the U.S. will likely drag the global economy into recession. What isn’t known is the President’s threshold of pain. Also, the willingness of counterparties to negotiate. They won’t feel the U.S. is negotiating in good faith. They may choose to negotiate as trading blocs. The geopolitical ‘winner’ in this? China.

So where does that leave markets? In a high anxiety moment. One likely to remain with us a while longer. Broadly speaking, we’re neutral in our equity allocations versus core bonds. We’ve held onto a small overweight in credit for the carry. No big bets, beta is well diversified and distributed. I’m focused on risk management.

We’re locked in to ride out this part of the storm. If the optimists are right and we see rapid engagement and reconciliation from U.S. trading partners, fears of an onrushing recession will abate. Anxiety will be dialed back, investors will breathe. Hope springs eternal.

The challenge to policymakers? Inflation will move higher, with growth in retreat. Central banks are likely to err on the side of caution, starting with the Fed. They may be forced to cut rates, but I don’t believe before they have greater clarity. That means waiting until they see signs growth is weakening.

The market today expects four rate cuts from the Fed this year. That strikes me unlikely. I’m anchoring on one, the second half of this year. If growth abruptly turns lower, perhaps two. Time will tell.

I’m keeping a close eye on consumer spending patterns. They’re a bit wobbly. My sense is they can quickly go from wobbly to worse the longer this drags on. I would expect to see increased caution from companies, a pullback in stock buybacks, capital spending and hiring. Then, layoffs.

We haven’t seen a moment like this in a while. Markets were expensive; investors repriced big-tech valuations. That’s now broadening across sectors and global markets thanks to tariffs. Tit-for-tat retaliation will only add to the selling pressure.

The market narrative has shifted. Tail risk is higher, markets aren’t inexpensive, the outlook’s uncertain. I continue to believe it’s not a moment to lean heavily into risk. Anyone telling you they know what comes next doesn’t.