Monthly Update
As of this writing, the S&P 500 has given back all of its post-election gains and at least for now, the stock market has spoken that it does not like a tariff war with our biggest trading partners. The market that has rallied is the US Treasury market over worries that economic growth will slow in response to the tariffs and at the same time inflation expectations remain elevated. The 10-yr yield is now down 42 basis points year to date while the 2-yr yield is lower by 40 basis points.1
Tariffs seem to be taking on four goals, some independent of each other, some intertwined. One is encouraging some of our trading partners to clamp down on something we don’t like. For Mexico and Canada, we want them to stop the flow of illegal immigrants and the flow of fentanyl. What was initially a tariff threat that many didn’t think would be carried out, I write this piece on March 4th where they are now in place totaling 25% on each country for all their exports to the US (only exemption is oil, taxed at 10%).2 A second goal is to level the so-called playing field when it comes to trade in what is being termed reciprocal tariffs where we will match whatever tariff a foreign country has on our goods. That works better on paper than practice, as there are many goods we just don’t make here and never will. The third is to use tariffs to incentivize the production of goods on US soil from overseas. The fourth, to raise money to use to partially pay for the extension of the upcoming expiration of the Trump 2017 Tax Cuts and Jobs Act.
To quantify, in 2024 the US imported about $413 billion worth of goods from Canada, $505 billion from Mexico and $440 billion from China.3 A 25% tariff on both Canada and Mexico would thus cost US importers $230 billion in an annual tax. The 20% tariff on China would be almost $90 billion.4 Also, each of these countries has lined up retaliatory tariffs on selective US exports to them.
The other big focus that has been garnering news headlines and is rather impactful for the federal government is the Elon Musk led Department of Government Efficiency, otherwise known as DOGE.
According to my friend Torsten Slok, the chief economist at Apollo Global Management, the impact on US GDP with the imposed tariffs will be a drag of about .4% while lifting CPI by .5%.5 The key to who pays the tariffs is somewhat nuanced. Logistically, US importers will pay the US Customs Bureau the tax on imported goods that the tariffs create. The question then is what the offsets are. If the US dollar strengthens vs the currencies of the tariffed countries, that will be a mitigant as it will lower the cost of the imports. But the key is having the US dollar stay strong because if it falters for whatever reason, the US consumer will end up paying the cost as companies likely try to pass on their higher costs. The other mitigant could be the exporters to us lower their price to offset the tariff but they would only do so up to a point because their profitability would be negatively impacted. The last mitigant would of course be to change suppliers to those domestically based, and that is an administration goal, but easier said than done.
The other big focus that has been garnering news headlines and is rather impactful for the federal government is the Elon Musk led Department of Government Efficiency, otherwise known as DOGE. There are two ways to view the goals of DOGE. One, to lift the hood on where our tax dollars are being spent in the context of $36 Trillion debt that is ever growing and a budget deficit that is above 6% of GDP, a level usually seen in the depths of a recession.6 The second, to shrink the size of the federal government workforce on the hopes it would cut the bureaucracy which would lead to a more effective and efficient government. For perspective, the size of the federal workforce totals about 3 million workers out of a total US workforce of about 160 million people.
Assumptions are that up to 300,000 government workers might lose their jobs across the federal workforce. 7 Also, about 2 private sector contractors are tied to each worker so there could be up to 1 million jobs lost as a result of all of this. We’ll see of course but in the context of 160 million workers it is just .6% in total. 8 We don’t mean to minimize the lost jobs or the impact on how the governmental agencies will carry out their functions but there should not be much of an economic impact from this in the short term.
With clients that are Republicans, Democrats and Independents, you’ll never hear us getting political. As investors we don’t invest your money with our politics. We cut through that and determine that whatever policy is enacted from whatever administration is in place, we do the math, try to figure out the impacts and then react accordingly. Not whether we agree or not with what policies are implemented. The markets don’t care if we like certain policies and not others, they only care about what directly impacts economic activity, earnings and interest rates.
I’ve said in past monthly letters that the US GDP growth performance of about 2.5% has mostly rested on three pillars. One, upper income consumers that have prioritized recent spending on travel, restaurants, etc. and that are also benefiting from the wealth effect of high stock and home prices. Second, anything tied into the AI capital spending ecosystem. Third, anything touching government spending/incentives, including the Inflation Reduction Act, Chips Act, infrastructure spending bill, healthcare via Medicare, Medicaid and transfer payments. With DOGE and a greater focus on government spending, the last pillar is obviously now in big focus and any faltering in the stock market could negatively impact upper income spending.
The other important thing I want to point out here is that we are witnessing the possible end to the stock market dominance of the AI tech trade that anointed the 7 biggest market cap stocks, “The Magnificent Seven”. These 7 stocks make up about 35% of the S&P 500 and contributed about half of the 2024 stock market returns for this index.9 I think there are two main things that have unfolded over the past few quarters after the magnificent rally seen since late 2022. One, the revenue drivers of Generative AI have been modest so far, thus putting into question the massive amount of money being spent as to its return on investment benefits for the spenders. Two, the Chinese company DeepSeek has created its own AI model at a fraction of the cost of its US competitors by utilizing in part the data of these US models. What this proved is that the GenAI models being built are becoming commoditized and at the end of the day, it will be the users that will most likely be the biggest beneficiaries. At some point too, the enormous level of capital spending on GenAI will slow and the providers of that AI infrastructure will be negatively impacted.
What’s noteworthy is that in contrast, finally international stock markets have picked up the baton from the US. As I write this, on another down day for markets, European markets are solidly positive year to date. The German DAX is up 12.6%, the French CAC 40 is higher by 9% and the UK FTSE 100 has rallied by 7.4%. Interestingly too, the Hang Seng is higher by 14% year to date. 10 What all have in common is they’ve been left for dead over the past decade, have gotten cheap and are now possibly rallying in anticipation of change. For Europe, change is coming via likely a massive increase in defense spending, along with the realization that overregulation via too many rules, red tape and bureaucracy has smothered economic growth. For China, the DeepSeek news has reinvigorated their tech sector and even Xi Jinping is embracing its top tech CEOs by meeting with many of them in February. Also, the big strain in their economy has been distress in the housing market and while there is more pain to come, it seems that home prices are beginning to show signs of bottoming.
Conclusion
We are possibly in the midst of some major change, both in the global economy and markets and the playbook that worked so well over the past 15 years might not be applicable anymore. A cliché on Wall Street is that ‘markets don’t like uncertainty’ but life is always uncertain, and it does feel now more uncertain than we’ve seen in a long while and that will likely impact the multiples that investors are willing to pay for their investments. We are thinking everyday of what this possible new economic and investing landscape will look like.
Whatever comes our way though, it remains vital that investors have adequate short-term liquidity over the next 2-3 years. Knowing that period is covered can help separate the balance of one’s portfolio from the ups and downs of the market. Time horizon is always crucial and is always the best friend of any investor. We are not just in the asset management business but also in the risk management business and always believe that by watching our back and focusing on the risks, the upside should take care of itself.
Disclaimer
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The market and economic data is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The information in this report has been prepared from data believed to be reliable, but no representation is being made as to its accuracy and completeness.
Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index.
The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.
The Stoxx Europe 600 index also called the STOXX 600 is an indicator of the performance of the European stock market. It measures the performance of large mid and small-cap companies across 17 countries in Europe. The number of constituents is fixed at 600.
The Hang Seng Index is a freefloat-adjusted market-capitalization-weighted stock-market index in Hong Kong. It is used to record and monitor daily changes of the largest companies of the Hong Kong stock market and is the main indicator of the overall market performance in Hong Kong. These 82 constituent companies represent about 58% of the capitalization of the Hong Kong Stock Exchange.
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The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index.
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1-4, 6-10 Bloomberg
5 Apollo Global Management
