Introduction:
I watched President Trump’s tariff press conference yesterday. When the Wall Street Journal reported that the tariff level would be only 10%, the equity indexes traded up about 2% in the aftermarket. Then, the President pulled out charts that showed that in addition to the 10% baseline tariff, there would be additional reciprocal tariffs at half the rate other countries were charging on US products they import. These reciprocal rates were much higher than the market had expected and the indexes went from up approximately 2% to down 4% very quickly wiping out trillions of dollars of market cap.
The WSJ only had half the story. Immediately, commentators on X and media outlets started venting anger and frustration. While I understand their reaction, I’m not sure it’s the right one.
I’ve always been in favor of free trade, so have been a bit surprised in recent months as I’ve argued tariffs may be helpful and necessary. Over the past 50 years, the US has outsourced its manufacturing base. Seen one way, we’ve engaged in profitable trade by outsourcing the things that other countries do more cheaply and focusing on asset-light services business such as designing iPhones and Nvidia GPUs. We’ve had a dominant financial services sector and have exported trillions of dollars.
While that view is technically true, I’m not certain it’s the correct interpretation. Seen another way, we’ve slowly sold off our manufacturing capacity leaving much of the country stuck without high-quality jobs and creating a national security problem. We don’t produce PPE, pharmaceuticals, high-end semiconductors, ships, or consumer electronics. That’s been great for a small wealthy part of the country and a disaster for much of the rest. But what happens when we run out of things to outsource? What happens when the rest of the world realizes Congress is going to continue reducing the purchasing power of the dollar by overspending? What happens when the rest of the world no longer wants to accept US dollars? If we can’t keep exporting dollars on credit in exchange for goods produced by others, what happens to the United States?
For more detail on my recent thoughts on tariffs, please check out the following:
Tariffs, More Tariffs, Tariff Delays – Is it Time to Panic Yet?
Recent interview with Wall Street for Main Street
Here’s What We Don’t Know:
I’ve been noting in recent versions of the 5 Things that very few people are explaining the complicated nature of tariffs. The pro-tariff crowd only talks about all the new jobs in soon-to-be-renewed American manufacturing. The anti-tariff crowd only talks about potential future inflation. What I’m reading on a daily basis is more focused on pro-Trump and anti-Trump talking points than thoughtful economic analysis.
Even the thoughtful experts can’t agree on historical events. I’ve read lots of analysis blaming the Smoot-Hawley Tariff act for the great depression. I’ve also read compelling analysis explaining why Smoot-Hawley was actually helpful. I don’t know the right answer here, and can merely point out that the people who study these things for a living don’t know the answer either. It’s complicated.
When President Trump implemented tariffs on China during his first term, I saw lots of analysis predicting the same kinds of economic disaster that is being predicted now. While the analysis made sense, the disaster didn’t happen. We didn’t see either inflation or a worldwide economic slowdown. Some manufacturers moved out of China. Some did more work in the US. Overall, there was so little impact that when the following Presidential Administration kept the Trump tariffs in place, few actually noticed.
There’s nothing wrong with making predictions that don’t come true. Again, I’m just pointing out that the same experts who got it wrong last time are making the same predictions again. Making the whole topic more complicated is the fact that there will be lots of upcoming negotiations meaning that despite yesterday’s clarity, we still don’t know what tariff amounts will actually be implemented.
We Had to Do Something:
While I’m in alignment with the ideals of free trade, what we’re doing right now isn’t working for the country. People are complaining about all the pain we’re about to experience. They’re probably right. The analogy I’d use here is when someone has a heroin addiction, detoxing is incredibly painful, and also necessary to save their life. Continuing to use heroin means today will be more comfortable at the expense of dying from the addiction in the future.
We’ve sold off so much of our manufacturing capability. We’ve sold off our ability to make things. We export dollars and receive goods. In return for cheap goods, we’ve accumulated unpayable debt and other liabilities. We can keep putting people on public assistance and funding that with more inflation-causing debt. But that doesn’t fix the problem.
Change is often painful, and reversing 50 years of a cheap money addiction is going to be very painful. The economy, spending levels, and production we have now are not sustainable. So, we either try to fix it and accept the inevitable pain, or we hand the problem to the next generation. Maybe the tariffs don’t work, but continuing on our current path definitely isn’t working.
With Friends Like These:
I saw a lot of commentary yesterday saying President Trump ruined 80 years of relationships in one day. As above, our relationship with China isn’t working for us. Using low-cost labor, State funding, and theft of intellectual property, China has succeeded in crippling multiple US industries. US companies that produce there have to turn over their IP and soon find themselves competing with State-funded Chinese companies using that same IP. China strictly controls access to their 1.4-billion-person consumer market and has tariffs well above ours.
From the context, I suspect that most of the “ruined 80 years of relationships” commentary was focused on the EU. European countries have indeed been allies for decades. President Trump is pointing out that they’ve been able to fund a nice social safety net partly because they’ve underspent their agreed-on NATO obligations for decades. Further, they protect their own industries with tariffs that are still higher than the ones he just announced.
Many of the politicians in these countries are complaining right now, but they have two options to resolve the problem. One is to manufacture in the US. As part of last week’s 5 Things, we highlighted Hyundai’s commitment to produce steel and cars in the US. That investment, in excess of $20 billion, is expected to create 100,000 new jobs. It won’t happen next week, but reversing 50 years of decline isn’t going to happen overnight.
There was an article in today’s WSJ noting that half of German engineering businesses want to boost investment in the US. That sounds like a win/win to me. Germans can build plants here in the US, take advantage of our cheaper energy, and access our huge consumer market with no tariffs. The US gets investment, jobs, and German engineering. I hope they’re already talking with Secretary Rubio’s office.
The second way to resolve the problem is for these complaining countries to focus on the word “reciprocal”. Israel has already announced it will eliminate tariffs on US imports. I expect President Trump will adjust US tariffs on Israeli products in response. Last night, I saw that Denmark wants to enter negotiations with the US. DKI has many amazing Danes in our community, but to the best of my knowledge, none of us has access to high levels of the Danish government. Still, it’s not a big stretch to conclude that Denmark is hoping to carve itself out from the EU and work out a deal resulting in lower tariffs for US exports to their country in exchange for lower tariffs on Danish imports here. That would be a win for Denmark, the US, and the no-tariff free-trade crowd. DKI welcomes Hyundai’s new US production, potential German engineering, and beneficial reciprocal trade with Denmark.
I saw the Israeli and Danish comments last night. I would be shocked if dozens of other countries weren’t putting together offers to bring to the White House by this weekend. Either way, our friends, allies, and trading partners have options to reduce tariffs and trade barriers for both sides. Imagine if President Trump’s huge tariff announcement resulted in lower tariffs all-around should allies open their markets to US products and in turn, the US lowers tariff levels.
I’m also going to insert a comment here that countries with high tariffs on US goods complaining that they will now experience tariff rates at half their level (plus the 10% base) is the definition of chutzpah. (Chutzpah is a Yiddish word that means incredible nerve and gall.)
Hubris and the Stock Market:
Many of the early comments I saw yesterday were posts on X making fun of those who were bearish. They were celebrating the losses people with short positions would take today. Five minutes later, the President put up the charts and the market plummeted instantly. Hubris is a bad idea, and one-line posts making fun of people is neither profitable nor persuasive. In general, angry comments without reasoning aren’t persuasive. Otherwise stated, don’t spike the ball before you get to the end zone.
Others got upset when they realized the stock market was going to be down huge today. As someone who has multiple positions that were down a lot today, I can understand that. I think it’s also important to realize that the people who have had their jobs offshored over the past four decades, don’t care that the stock market is down a little bit from all-time highs.
Earlier in this piece, I commented that the countries upset with the new tariffs had multiple courses of action to fix the problem. As investors, we also have options. I hedged the portfolio heavily in early 2022. That was a great move at the time. It then produced losses in 2023 and 2024. Those hedges were again nice to have in 1Q ’25 and made a huge amount of money today and this week. I don’t think complaining about a change to an unworkable status quo is productive. Changing your exposure, or hedging out some of your market risk is a better approach. If your investment strategy depends on constantly climbing valuation multiples, you have a flawed strategy.
Incentives Matter:
One reason I think much of the analysis I’ve seen in the past 24 hours is wrong is because it’s static and we live in a dynamic world. For example, when the government raises tax rates, it always assumes it will collect more tax dollars. The opposite is usually true as higher taxes incentivize people to work less, and to put more effort into tax avoidance. In extreme examples, high earners leave their States or the country.
With high tax burdens and an expensive social safety net, the US encourages many able-bodied people to avoid work. This is a loss for the economy which loses out on productive labor, for the taxpayers funding benefits programs, and for the sidelined workers who lose a sense of purpose and agency.
High tariffs in foreign countries and lower ones here encourage shifting production from the US to other locations. It results in job losses here and gains there.
One part of President Trump’s speech yesterday that I think didn’t get enough attention was his pairing tariffs with intended tax cuts. I understand why many people are saying we’ll have economic problems because tariffs are another tax. But what if tariffs produce an incentive for more investment and manufacturing in the US, and lower taxes produce an incentive for more people to work? That’s a better way to solve the labor cost problem. I don’t know the outcome here, but do think we’re aiming at a better set of incentives than the ones that were in place previously.
Some are Surprised the Dollar is Down:
Tariffs have a reputation for strengthening the currency of the country implementing the tariff. As a result, many were surprised the dollar ($DXY) was down today. I think the move makes sense. If people think tariffs will cause inflation, then that means reduced purchasing power for the dollar. That’s the definition of a weaker currency.
I also saw some analysis suggesting that tariffs will cause inflation, that inflation will slow the economy, and that economic slowdown will cause the Fed to cut rates. I’m not sure that line of thinking makes sense. For this to happen, the Fed would need to cut into higher inflation which I think is unlikely. Chairman Powell has previously mentioned that tariff inflation would be transitory, and surprisingly, I agree with him. So, it’s possible the Fed looks through tariff inflation and cuts the fed funds rate, but I wouldn’t expect that to happen at the next meeting.
What Have the Penguins Ever Done for Us:
One funny moment was when someone realized the US will have tariffs on some Antarctic islands inhabited only by penguins. Some said that this was pointless because the penguins don’t export anything so we wouldn’t be able to collect. In that case, perhaps we should increase the penguin tariff[1].
DKI FTW:
In multiple pieces recently, I’ve written that the Trump Administration is willing to see stocks decline if it means lower bond yields. Treasury Secretary, Bessent, needs to refinance $7 trillion in the next 12 months, and unless he can do so at lower rates, we’re going to have an even larger budget problem. Today, the NASDAQ was down 6% while the yield on the 10-year Treasury closed at under 4.1%. We told you they’ll kill stocks to save bonds[2] and that’s exactly what we’re seeing.
Conclusion:
I don’t actually know what’s going to happen. Not only will there be extensive negotiations by multiple countries to try to arrive at a tariff conclusion that works for everyone (and would be better for the US than the current status quo), there are so many moving parts that it’s impossible to know what happens and when. It’s clear that after half a century of overdosing on outsourcing and cheap money that the detox pain is going to come first. I don’t know how long it will take to start new manufacturing here. That could take years. The plan is short-term painful with the hope that we see positive results sooner rather than later.
Getting to the practical side of things, I’d ignore the doomsayers; particularly, the ones who don’t explain their reasoning. The experts can’t decide on the impact of 100-year-old tariff policy, and almost all of them got the analysis on the last round of tariffs wrong.
I’m watching the situation carefully and trying to keep the portfolio focused on stocks with low exposure to this situation. As disclosed in an earlier post, I used today’s volatility to increase position sizes in some names I like where I think the selling was overdone. My portfolio remains heavily hedged. And I continue to own assets like gold and Bitcoin instead of dollars.
As I recommended in last week’s piece “Everybody Hold On”, stay calm, invest for the long-term, and don’t get caught up in the negative emotions that come with endless media scrolling.
[1] I’m not actually serious, but find the idea of tariffs on penguin-inhabited islands to be funny. Also, does anyone know if penguins are on Team MAGA?
[2] Credit to Michael Gayed for that wording. The first time I saw that expression was on his X feed.
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