“What do we do now?” After yesterday’s wild ride, the question is voiced even louder. Yesterday proved that whatever people thought they knew, they didn’t. Here’s what we know, or at least can surmise. If nothing changes from where we are positioned today, with the massive “reciprocal” tariffs announced last week now in effect, the world is cascading into recession. While there is likely to be a short-term bump in retail sales in the U.S. as consumers buy what inventory is on the sales floor that is still tariff-free, once that is done, business is headed in only one direction…down.
All that can change, however, if policy changes. Bulls are counting on the likelihood that Trump will soften the tariffs sooner rather than later, especially if stocks continue to fall sharply. The House goes into recess Friday for 2+ weeks. Every representative going home will get an earful like they have never heard. The White House is flooded with calls from CEOs screaming that current policy is on the wrong path.
But will Trump listen? And, if so, when and by how much?
No one can plan under this environment. Businesses can’t make investment decisions. That means sharply lower capex. It means reshoring may be discussed but it won’t happen.
If you haven’t noticed over the past two sessions, and continuing this morning, the yield on 10-year Treasuries has spiked. What about the flight to safety that lifted bond prices and saw yields plunge in the wake of last week’s announcement? What you are seeing in the bond market isn’t a traditional flight to safety, but rather a flight of capital away from the U.S. Foreigners may fear retaliating against Trump’s tariffs will only cause an endless spiral upward. Look at what happened with China. But even Trump can’t stop foreigners from taking their money out of the U.S., nor can he stop Americans from moving money into foreign securities including foreign sovereign debt.
This all sounds scary and it is. So, what does one do? Hedge funds, by their nature, are largely short-term investors. They are paid largely based on their performance in one 12-month calendar period. If they are on the wrong side of a trade in a market this volatile, they can ruin a full year’s return in a week. Thus, many of the smartest investors have moved to the sidelines hunkering down in the safest places like cash and short-term Treasuries. They aren’t paid to guess; they are paid to invest. Today, there are simply too many unknown variables to invest wisely. So, smart money sits and waits. They know change is coming. Even Trump doesn’t want a recession. Despite his comments saying a recession wouldn’t bother him, such an event would mean lower revenues, a much larger deficit, and the need to borrow even more in a market that is losing its appetite for our debt and our currency.
Thus, there will be change. When, I don’t know. How much? I don’t know. Right now, even Trump probably doesn’t know. All over the world, individuals, businesses, and governments are using analytics to make better decisions. Trump is more instinctive than analytical. Analytics don’t work well when you rush to get everything done inside of 90 days. Instead, instinct gives way to mistakes. That’s how tariffs get imposed on uninhabited islands or on jet aircraft never subject to tariffs before. In a political world where admitting mistakes is almost unknown, making corrections requires a lot of spin. Wag the dog! But markets and voters will force change and it will likely come sooner rather than later if markets remain chaotic.
But resist the temptation to guess. Keep reserves high until there is some policy rationalization that makes sense. If Trump, for instance were to revoke the additional tariffs placed on China yesterday, markets might rally sharply. But ask yourself would such a move restore clarity or simply return us to Monday’s roadmap of confusion.
The markets’ message to the White House is clear. Skyrocketing Treasury yields, a weaker dollar, a bear market for stocks, mass demonstrations in the streets, calls from over 70 nations to negotiate toward an acceptable economic world. Trump famously said at one time that he knows more than the generals. Of course he doesn’t know more. What he really meant to say what that he thought he could make better decisions even without a complete package of facts. That’s his mindset. In his first term, smart advisors were able to achieve modification. There are some smart people in the room today including Treasury Secretary Bessett and Secretary of State Rubio. There are also smart people outside the administration offering smart advice. Eventually smart advice will win over those who speak loudest at the beginning but whose logic is faulty.
Breaking things can be done quickly. Fixing them takes time. But things will be fixed. In the meantime, don’t guess. If you have cash reserves, don’t try and guess the exact bottom. Markets could easily drop another 10% or more quickly. Or they may rally tomorrow on rational news. Invest; don’t guess. Stay calm, hunker down until the storm ends and then sift through the bargains that remain. A sell decision made out of panic is no better than a buy decision built on a guess.
James M. Meyer, CFA 610-260-2220