Today, stock markets experienced significant volatility in the wake of President Trump’s tariff roll out yesterday evening. At market close, the S&P 500 was down nearly 5% and the technology-oriented NASDAQ was down nearly 6%. Individual names such as Apple and Amazon experienced declines of more than 9%. The S&P 500 has now declined 12% off its all-time highs in February and is down 8% for the year.
The magnitude of Trump’s tariff proposal was larger than anticipated; as announced, the US’ effective global tariff rate would be approximately 25%, which is 10% higher than most experts had predicted. Today’s market action suggests that investors may be finally accepting that the President is not just negotiating, but correcting what he believes is a fundamentally unfair imbalance in global trade. As we have noted in prior market updates, our research suggests that Trump deeply believes in the efficacy of tariffs, and he views them as a key element in his strategy to raise revenue and reduce the fiscal deficit.
To this point, the stock market volatility over the past 6 weeks has not been corroborated by the bond market. Credit spreads – defined as the extra yield one receives from risky bonds over Treasuries – have barely budged in 2025. This is inconsistent with an economic environment that is deteriorating and now increasingly likely to enter a recession. Interest rates, meanwhile, have not declined to the degree one would expect if a recession was imminent. The yield on the 10 year Treasury remains at approximately the same level as when the Fed started cutting interest rates last year.
We make note of these facts because, in our opinion, it indicates the market has not yet meaningfully priced in the risk of an economic disruption. Even the stock market has behaved somewhat benignly. If one removes the performance of the Magnificent 7 stocks, which came into this year highly overvalued, the other 493 stocks in the S&P were effectively flat through the end of the first quarter. Where do these assets go if the US economy does surprise to the downside?
As of this moment, the market is trading at approximately 19.6x the expected earnings over the next 12 months (inclusive of today’s performance). This remains well above the long term average of 16.9x. However, we must also consider that corporate earnings typically fall 20% or more in recessionary periods, as is illustrated in the chart below. Even conservative downside assumptions unfortunately pencil out to further double digit declines in the market.
Compounding today’s situation is that there seems to be limited room for meaningful fiscal or monetary stimulus to “rescue” us as in years past. There have been rumblings that the GOP could deliver a larger than expected tax cut, but with a historic fiscal deficit and razor-thin margins in Congress, it is difficult to see the current governing party deliver much more than a simple extension of the current Tax Cut & Jobs Act – something that is already largely assumed.
The Federal Reserve, meanwhile, faces an inflationary backdrop that was already stubbornly above their long-term 2% target. Most economists believe that tariffs will produce an increase in consumer prices, at least temporarily, as the cost of increased import duties are passed through to end buyers. The Fed is unlikely to repeat the mistake of ignoring elevated inflation like they did in 2021; we find it hard to imagine they could reduce rates significantly if inflation started to trend higher.
The combination of these factors suggest to us that there will likely be continued volatility throughout 2025. Market declines are rarely a straight line, and typically unfold over a period of quarters (and sometimes years). Today, markets reacted sharply to news without fully understanding the consequences of the new administration’s proposed policies. The real world ramifications are a huge unknown and will take time to play out (and said policy could very well change in the interim).
As we noted in our last missive on March 10th, we have been conservatively positioned relative to clients’ standard risk targets for the better part of the past year. We felt that historically high valuations left little margin for error for financial assets. At some juncture, we will want to switch to an offensive stance to capitalize on dislocations in both the equity and credit markets. We do not believe that day is today, but are actively evaluating our “wish list” of options to buy at more attractive entry points.
Sincerely,
Andrew Hart Ryan Davis, CFA, CAIA
Chief Executive Officer Chief Investment Officer
ahart@nextcapitalmgmt.com rdavis@nextcapitalmgmt.com
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