Tariffs are taxes and taxes slow economic growth. The Trump administration’s newly announced tariff policy represents a ~$600 billion tax hike, roughly twice the size of the largest tax increase in modern U.S. history. We believe the administration’s goal is to remake the U.S. into a vertically integrated economic island, shifting from high-value sectors like tech toward lower-value ones like manufacturing. This has potential implications for U.S. equity valuation premiums relative to the rest of the world.
The “Trump put” isn’t in play for markets in the short term. The success metric is not the stock or bond market but rather a particular economic outcome – increasing median real household income. That outcome will likely take years to validate. Trump’s tariff logic is rooted in trade deficits (or, in his view, “stolen” wealth¹) rather than reciprocal tariff comparisons, making any de-escalation between the U.S. and our global trading partners unlikely in the near term.
Markets will move ahead of the economy, as they always do. While the immediate price action is ugly, the same dynamic can work in reverse and requires vigilance for upside catalysts.
Economic Impacts
We’ve focused our economic impact scope on three core areas and reviewed scenarios where we could see potential offsets from Liberation Day.
- Growth
Tariffs equal taxes, which equal a short-term growth drag. The odds of a recession in 2025 have jumped from negligible to about 50/50. Businesses and households alike are likely shifting from a “wait and see” mentality to a “hunker down” perspective, which by definition, suppresses activity. - Inflation
In the near term, tariffs are inflationary, and in the medium term, they are deflationary. The short-term inflationary impact is self-explanatory. The medium-term deflationary pressure comes from lower growth impulses and the destruction of consumer demand. Markets are pricing in higher inflation over the next year but lower thereafter. Long-term inflation expectations remain stable. We believe Fed rate cuts are on hold unless the labor market cracks. If the labor market does falter, the Fed has plenty of room to ease from the current levels. - Uncertainty
We were already in an environment of elevated uncertainty for consumers, businesses, and investors. Liberation Day doesn’t help on this front, as it injects sharply lower growth into the mix. This new growth risk, plus retaliation risk, means we haven’t hit “peak uncertainty” yet. We believe that peak is likely a prerequisite for recovery. - Offsets
- The expected tax bill and deregulation could soften the negative growth shock. The tax bill would help offset some of the tax hikes brought on by the tariffs through lower rates and other changes to the tax code. Continued deregulation could help support the environment for businesses and potentially buffer some of the near-term impacts of redirecting production to U.S. soil.
- The nature of retaliation matters: inward (e.g., other countries engaging in fiscal stimulus, tax cuts, etc) could boost global growth, while outward retaliation (e.g., new tariffs) could hamper it.
- Tariff rollback conversations by other countries have already started, and may lead to a more even playing field over the long-term. Countries that have levied tariffs against the U.S. could now consider reducing or eliminating their existing tariff positions.
- Domestic reinvestment could be a long-term tailwind for U.S. growth. Companies that have historically outsourced production could bring that business back to the U.S. and potentially foster a more active domestic economy.
What to Watch in the Markets
- Interest Rates
Rates have fallen on trade fears and are likely to keep drifting down. The Fed and the market see tariff-induced inflation as transitory. - Equities
Nominal GDP growth down equals a decrease in earnings. Also, if U.S. firms absorb higher costs, margins suffer. In the short run, the earnings per share (EPS) headwind is almost certain, the margin headwind may or may not materialize, and we will watch how firms respond to the new operating environment. - Dollar Action
Immediate dollar weakness, typically rare during market stress, is an important signal of large foreign outflows from U.S. assets. This could start a regime shift: Investors may reconsider their long-held mantra of U.S. exceptionalism.
There’s also under-the-hood action worth noting: Defensive stocks are outperforming, while high-valuation, trade-exposed names are selling off, creating a larger rotation than COVID’s blanket panic. If foreign investors continue to reduce their large holdings of U.S. tech stocks, headline indices could feel pressure.
Despite all this, U.S. consumers still have strong balance sheets. With household net worth nearing all-time highs (due in part to the strong equity markets of the past couple of years), U.S. consumer spending has remained strong in recent years. However, a sharp pullback in equities may reverse this “wealth effect” and cause the consumer to tighten their purse strings.
Closing Thoughts
We are in the midst of a policy regime shift that’s approaching economic isolation. We may also have a market regime shift if foreign investors continue selling U.S. assets. We anticipate short-term implications of lower growth and U.S. equity underperformance. Long-term implications remain uncertain as we see how other countries respond to Liberation Day.
Consumers and businesses may likely hunker down in the weeks and months to follow. Growth will slow. However, the downside is buffered by strong consumer balance sheets, resilient labor markets, low leverage, already-bearish investor sentiment, and a Fed in a position to ease if necessary.
As we have stated before, it’s imperative to stay the course during periods of market disruption – and that sentiment remains. We view the following as important reminders:
- Diversification is essential: Spreading investments across sectors, industries, and regions can help reduce concentration risk and improve portfolio resilience.
- Stay invested and avoid emotional decision-making: Market volatility can wreak havoc on investment portfolios and investor nerves. And when emotions run high, decision-making can suffer. Reminding investors not to make investment decisions that can derail a long-term financial plan is critical.
- Consider risk mitigation strategies to weather volatility: Investors with a higher aversion to investment loss may be tempted to move assets to the sidelines and weather out the storm. While each scenario is different, disciplined risk mitigation strategies can help preserve wealth, reduce anxiety, and help keep portfolios on track.
