There can be little doubt, as the dust settles on the initial reaction to the Trump tariff plans, that they are ill-conceived and reckless in the extreme. The market has spoken with a weekly fall in the S&P 500 index of 9.1%, making it the worst weekly drop since March 2020 during the Covid pandemic.
While rare (markets have only fallen greater than 10% on three occasions in the last 25 years), this magnitude of fall occurs more frequently over longer periods – there have been 60 drops of at least 10% from market peaks since 1928 according to Deutsche Bank. Perhaps more interestingly, these moves do not necessarily predict recession or worse to come. Such falls coincided with recession 44% of the time. The point here is that in the eye of the (panic) storm, rational thought goes out of the window.
Moves of this nature often occur when there is a known unknown or a total black swan event. In this case, it is a known unknown and the market has acted first, asked questions later. This is totally understandable because the method of calculation for the new tariffs is so baseless that it raises significant concerns about the competence of the new administration or, indeed, the extent to which Trump is listening to any of his advisers. Rumours were circulating late on Friday that Scott Bessant, Treasury Secretary, was weighing up his own reputational risk against that of staying in post.
We can understand why markets have reacted as they have because, if fully enacted, the tariffs have far-reaching impacts and many unintended consequences. Trump is single-handedly meting out huge cost problems on the iconic brands created in the US. For example, the Wall Street Journal has calculated that the bill of materials on an iPhone would increase from $550 to $850 – a $300 increase that would be impossible to pass onto consumers. As a result, it would severely cut the operating margins for Apple.
If we look at the impact in the simplest of terms for a company importing manufactured goods from one of the Asian countries that have been hit with 30-45% tariffs, it is stark indeed. A pure play, manufactured in a tariff-hit country and 100% sold into the US would quite possibly wipe out operating margins entirely.
Many examples of the unintended policy consequences have been written about in the last 48 hours. The Economist points out that Russia, Belarus and North Korea have no tariff levelled against them as they are effectively unable to do business with the US, yet Russia exports $3 billion of goods to the US. Starbucks will have to deal with a significant tariff on coffee imports – does Trump really want to tax the daily coffee fix that fuels the American workforce? Switzerland has attracted a tariff rate of 34% - only because the calculation was based on 2024 trade numbers; had they used 2023, the rate would have been 19%. Then there are products imported into the US that could not possibly be produced domestically, like diamonds from Botswana (38% tariff) or vanilla from Madagascar (47% tariff). The level of thoughtless insanity is boundless.
The stock market volatility is therefore a natural knee-jerk reaction. This is further evidenced by the reaction on Friday to the news that Vietnam (hit with 46% tariffs) would look to cut its tariff on US goods to zero for the same in return.
Restoration Hardware, the US home goods company, manufactures much of its furniture in Vietnam (having moved from China for fear of US repercussions!). Its shares fell from $250 on 2 April to $140 on 3 April following the announcements. It then fell to $123 early on Friday 4 April, only to recover that day’s move and more – rallying 18% from the lows to close the week at $145.
This is a microcosm of the problem that exists for markets – no one has a clue what Trump will do. One moment the tariffs are set and will not change; the next, they might change for an ‘extraordinary’ or ‘phenomenal’ offer. How can investors work out what to do? More importantly, how can companies? No company can make a multi-billion dollar investment decision to build a manufacturing facility in the US against the backdrop of Trump’s child-like vacillations.
The actions of the US administration are irrational and so therefore follows the stock market. While the risk premium of owning equities should increase, there will be great opportunities in the ashes of this destruction as there always are in volatile market moves. Friday ended the week with a significant Beta One type day. Companies that had managed to avoid the hard sell-down then got smashed as ETF and basket flows, together with margin calls and investor realignment, led to winners being used as sources of cash. This heralds the start of the opportunity to find beaten up names at cheap prices.
There are areas to remain wary of for now. Goods purchased by the American consumer and made in Asia will struggle. This importantly includes a lot of consumer electronics, apparel and household goods. It will also have a significant unintended impact on the IT sector where hard goods are manufactured or sub-assembled in Asia – think Meta buying white box servers in Asia to upscale in the US with its own software.
In the Global Equities team, we had begun to reduce exposure to potential tariff losers ahead of the Trump announcement in a risk-reward move driven by our proprietary T-Score system. Price action was already giving a good steer on the areas to be concerned about.
However, Friday’s move spread the selling to all areas of the market and this will provide an opportunity – and identifying these opportunities will define winning strategies over the next few months. We believe this places stock picking and active management at the fore.
Negative and uncertain markets will lead to greater macro-selling flows, out of over-crowded passive strategies and into parts of the market both less affected and less well owned. As we have opined since the middle of 2024, the risk-reward balance favours the active manager and this is starting to manifest itself. We would not have predicted, however, that it would be Trump and a set of totally flawed tariff policies that would be a major trigger.
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