Tariffs & Fear

Markets unraveled this week after the release of reciprocal tariffs. Was the response justified or perhaps the opportunistic behavior of institutional investors?

This week's musings is inspired by the 1994 surprise hit movie, "Dumb & Dumber." Here’s some trivia about the movie:

• This movie was a slapstick production with a meager budget of only $17 million. The movie made enough money to cover the film's budget in the opening weekend. It finished with more than $247 million at the box office.

• Jeff Daniels, known as a dramatic actor, wasn't initially considered by for the film by the Farrelly brothers. However, Jim Carrey wanted him as his sidekick in the film. The Farrelly brothers wanted to insure Daniels would say no, so they offered him a paltry $50,000 for the role. Daniels accepted the role without hesitation.

• The famous scene with where Lloyd asks Harry, "Hey, wanna hear the most annoying sound in the world?" was not in the original script. You can tell when Carrey starts yelling by looking at Daniel's face.

• Daniel's agents begged him the night before not to go to the initial dress fitting for his costumes, claiming the film would destroy his career. By 1994, "Dumb & Dumber" was the most commercially successful film of his career.

• The hotel, bar, and Lamborghini scenes in Aspen were shot at the Historical Stanley Hotel in Estes Park, CO. The Stanley was the inspiration for the film, "The Shining."

Here's what we've seen so far this week..

Our Pets Heads Are Falling Off! The "chicken littles" of the world think that the sky is falling. As in "Dumb & Dumber," when everything seems to be going wrong, Lloyd convinces Harry to head to Colorado with him with this speech: "We got no food, we got no jobs...our PETS' HEADS ARE FALLING OFF!"

As we often highlight in our blog posts, let's start with the facts and not the grandiose claims of the financial media. Reminder, they are motivated to keep your eyes on their content so they can generate advertising revenue - not necessarily focusing on objective information. A couple of important items in the release of reciprocal tariffs announced on Wednesday are the exemptions and the non-US content of goods. First, semiconductors are one of the products that is exempt from the new tariffs, and yet, the SOX Semiconductor Index was down more than 9% the day after the tariffs were announced.

Is this type of price action reasonable? It would be understandable for the investors to take some long-term profits with the idea that other related products subject to tariffs could affect semiconductors, but 9% in one day? The reality is this is probably the result of a knee-jerk reaction - similar to COVID in 2020. Second, goods that have non-US content are exempt from the new tariffs so long as at least 20% of the product is made in the U.S. Ford, GM, & Chrysler all operate assembly plants in the U.S., but certain parts (for instance engines, transmissions, & electronics) are made outside the U.S. Speaking of Ford & GM, Ford announced yesterday that it will be offering "employee pricing" to U.S. consumers for the next three months and GM has announced that it will be increasing plant production in Indiana, offering more overtime pay, and hiring new employees. Perhaps not all is bad for the U.S. consumer in the global trade market.

The U.S. consumer makes up 34% of global household spending, or $18.2 trillion of global consumption.

That means that Europe, China, and Japan are going to find it very difficult to replace U.S. consumers in the global market if they choose to engage in a long, drawn-out trade war. Coincidentally, this is exactly what the market priced in with Thursday's reaction. What if, like COVID in 2020, the market has over-reacted to initial news about tariffs? It has been reported that India, Mexico, Australia, Canada, Vietnam, Singapore, and yes, even China, have all expressed interest in coming to the negotiation table to avoid a trade war. Perhaps letting Wednesday's news marinate a little is the better investment strategy.

So You're Saying There's A Chance? When we get anchored to our beliefs, without accepting other contrary information, we can get blinded by what we want reality to be - just like Lloyd in "Dumb & Dumber." When he finally gets the nerve to ask Mary if they can have a relationship, she seemingly drowns his hopes by saying the odds are "more like one in a million." Lloyd, the eternal optimist/denier of reality responds, "So you're telling me there's a chance. YEAH!"

Until we get more data that indicates recession is imminent, our view will remain that recent market action has been a recalibration of valuations, and most recently, a knee-jerk reaction to tariffs. Both the Fed's National Financial Conditions Index and Financial Stress Index are firmly in negative territory, meaning financial conditions are favorable. Prior to recessions, these two indices will turn positive, meaning troubled times are ahead. We'll see how these two indices report next week, post-tariffs.

The futures market has not shifted from the view that the Fed won't get involved in the trade war. The current probability remains greater than 70% that the Fed will leave rates unchanged at the May meeting. This would indicate that there is not an emergency warranting a cut in rates before next month's meeting.

Goldman Sachs admitted in research notes released after the tariff announcement that the expected increase was lower than their initial projections. Goldman has estimated the White House would announce a 15% increase in tariffs. However, while the top-line number was an increase of 18.3%, when exemptions are accounted for, the number is actually a 12.6% increase. The jobs report may show a worse-than-expected number due to changes in government payrolls, however, the private sector is showing job growth. The ADP report came in with 155,000 new jobs versus the 118,000 expected. Initial Jobless Claims came in lower than expected and both Initial & Continuing Claims remain well below recessionary levels. Investors should take a pause and relay on agreed upon investment strategies instead of reacting to one day's worth of action in the markets.

There's always a chance for those who believe...

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