U.S. equities struggled during the first quarter and the selloff intensified April 3 rd following the announcement of President Trump’s expansive new tariffs on April 2nd. The new tariffs represent a significant escalation of a burgeoning trade war.
The main contentious issue is that other countries do not agree on the calculation of tariffs applied to them. Rather than using an estimate of tariffs and other trade barriers, the Trump administration took each country’s trade deficit divided by its exports to the United States multiplied by one-half. In most circumstances, tariffs are most effective when used to protect particular industries or national security versus the broad application of these tariffs. For example, many Asian countries were hit with high tariffs in part because of the large amount of inexpensive goods (clothing and shoes for example) that they export to the U.S. However, it would be difficult if not impossible to produce these goods in the U.S., given higher labor costs and an older and generally wealthier population. Further, a trade deficit with some smaller countries is a near certainty, as they lack the wealth and population to purchase the import the same amount of goods as they export.
The chart below shows just how high the currently announced tariffs are. The average rate of these new tariffs is higher than the Smoot-Hawley Tariffs that were enacted in 1930 and are often cited as an exacerbating factor of the Great Depression.
Increased Risks
1) The likelihood of a recession is higher. In 2024, U.S. real Gross Domestic Product (GDP) grew at 2.8%, but the impact of tariffs and lower sentiment make it seem like GDP will be lower in 2025 than in 2024.
- Consumption makes up 68% of nominal US GDP, so any slowdown in consumer expenditures would lead to an outsized hit to GDP.
- Market consensus GDP forecasts for the first quarter of 2025 range from 0.5% to 2.5%, but the Atlanta FED GDP Now real GDP forecast is down to -2.8% for the first quarter.
- As a reminder, a recession is commonly defined as two consecutive quarters of negative real GDP growth.
2) It seems likely that non-U.S. investors view investments in the U.S. as riskier than they did last year.
- Foreign direct investment in the U.S. was $5.4 trillion in 2023; for context, U.S. GDP was $27.7 trillion in 2023. This was an increase of $227 billion over 2022 – European countries and Canada were responsible for most of this increase.
- There are already signs of a reduction in economic activity of foreign citizens with the U.S., such as a noticeable decrease in travel to the U.S.
3) The U.S. has benefited from the U.S. dollar being the world’s reserve currency. However, perceived risks in the U.S. could lead to a further decline in the value of the dollar. The U.S. dollar index has fallen about 5.5% so far this year.
4) Volatility continues to move higher. The CBOE Volatility Index (VIX) is now above 30, up from about 16 at the beginning of 2025.
5) It is possible that the tariffs announced on April 2nd could be reduced in the coming weeks after negotiations with other countries. A lowering of the currently communicated tariffs could cause markets to rally. However, it is also possible that the U.S. could apply additional tariffs to countries who apply retaliatory tariffs on the U.S.
Perspective
1) The 4.3% decline in the S&P 500 during the first quarter was not unexpected given that the index had gained over 20% each of the last two calendar years and become expensive based on their price-to-earnings ratio.
2) The 4.8% decline in the S&P 500 on April 3rd was the largest decline since June of 2022 and was less expected. Between 1990 and 2024, the S&P 500 only fell 5% or more on 20 trading days, or about 0.2% of the time.
3) While lower stock prices should mean more attractive valuations, high tariff costs and lower expected trade are also expected to lower the earnings of both U.S. and international corporations.
4) Diversified portfolios have benefited from low correlations between asset classes so far this year. For example, in the first quarter, US taxable bonds (Bloomberg US Aggregate Bond Index) benefited from risk-off sentiment and returned 2.8%. International developed equities (MSCI EAFE) were up 7% in U.S. dollar terms and infrastructure (S&P Global Infrastructure) was up 4.6%, helping smooth the ride for diversified investors.
5) The most recent Federal Reserve projections anticipated three rate cuts during 2025. However, inflation remains closer to 3% than their 2% target. The inflationary pressures of tariffs and deglobalization could make it more difficult for the Fed to justify interest rate cuts, but any economic weakness because of tariffs would make Fed action more likely.
Conclusion
Sunpointe continues to advocate diversification across asset classes, sectors, market capitalizations, and styles, and a rebalancing plan that adheres to long-term strategic objectives. We also recommend investors hold 6-12 months of expected spending in less risky assets to avoid being forced to sell equities should the current selloff intensify. Investors should exercise patience and remember the importance of diversification, particularly in times of turmoil. Today’s volatile market conditions argue for employing active management, especially in international equities, as sustained tariffs should create dispersion between companies that are more affected and less affected by these new tariffs.
While we recognize that it is difficult not to dwell on daily equity market moves, investors should ensure that their long-term strategic investment portfolios are properly aligned with their goals and commensurate level of risk. We will continue to monitor the rapidly changing market environment and adjust asset allocation recommendations as needed. Please reach out to us if you have any questions or concerns.
