Quo Vadis? Investing In The Time of Tariffs
The market rout of the past few days has been nothing short of spectacular. It is not as much the magnitude as it is the speed of the fall – it has been akin to the crash of October 1987. With the S&P500 already down about 18+% from the peak in January, we are close to a bear market territory. Having said that, at the time of writing (April 7, 2025), the index is still some 5.9% higher than its level at the beginning of 2024. So, the move has been dramatic, but not catastrophic (yet).
But we know where we have been. The real question is where we are going, or Quo Vadis? to use the famous Latin phrase. The unusually high level of uncertainty currently makes this a difficult question to answer. It is not just what the impact of the tariffs will be on the global economy, but also how long they will be in place in their current form and how they might evolve over the coming years. There is also the question of fiscal consolidation in the US and how much the DOGE actions will affect employment and growth, plus the still outstanding issue with stubborn inflation.
We can tackle the answer in two parts: in the very short term (6-12 months) and in the long run (3-5 years), assuming current policies are maintained. In the near term, we expect the tariffs to stick (more or less). President Trump seems very adamant that they are the tool needed to redesign global trade, as we have known it for 50-60 years now, in favor of the US. His view in brief is that the US can no longer be an importer of last resort to the rest of the world, while exporting back IOUs; tariffs are needed to reduce the trade account deficit and to revive manufacturing in the US, which should ultimately be positive for fiscal revenue and growth. Whether this framework will work as planned, we will not know for some time. But we can assume that it will stay in place for at least the next four years.
The Administration has also made it clear that they are concerned with the rising trajectory of the federal debt, hence they want to see fiscal consolidation and lower interest rates, with a focus on the 10-year rate. Lower yields on Treasuries help stabilize the debt/GDP ratio. Further, they want to see inflation finally come down to the 2% target level and stay low, as this could be an election winner or loser in four years. Slowing growth helps with the last two issues. That’s what President Trump means by “the medicine” that the economy needs to take now in order to improve in the future.
Tariffs and all that aside, the economy and the stock market were overdue for a healthy shake-out after the last couple of go-go years marked by fiscal largess. With fiscal deficit running at 8% of GDP, growth was artificially pumped up, and earnings and multiples were duly elevated as a result. The punchbowl would have been taken away at some point anyway, but probably not in such a drastic way as we are seeing currently.
In the very short term, we expect that growth will slow down and that the economy may come close to a recession. Whether we enter into one is a coin-toss at this point. That means that the 10% earnings growth expected for the S&P500 index is not going to pan out. Cuts to these estimates will be needed, and this will drag multiples down. The market has already priced this scenario in the past couple of days: S&P500 P/E multiple went from 26x at the peak in January 2025 to the current 18.7x, based on this year’s earnings estimate of $270 per share[1]. This is still slightly above the average P/E of 18x since 2000. Whether the market goes lower from here depends on where earnings expectations settle.
No earnings growth in 2025 would mean EPS for the S&P500 of around $243 per share. One can attach the multiple of choice to come up with an expected value for the index. During the financial crisis of 2008-2009, the P/E multiple went down to 12-13x. However, that was a severely deflationary environment driven by forced deleveraging, which does not seem to be on the horizon at this point. But we can easily see a 10-15% further downside if there should be no earnings growth this year and the P/E multiple drops to 17x or lower, the level during the 2022 bear market. So probably it’s too early to be backing up the proverbial truck and loading up on equities. Better entry points may be available later into the year.
What to do in the meantime? Avoid trading while volatility is high: the VIX index is currently at 40, which is the highest level since COVID and the European debt crisis of 2011. This means sharp moves up and down are possible. Chasing those is difficult and usually costly. Better to stick with one’s long-term asset allocation and rebalance accordingly and gradually.
There is an attractive yield to be had in the money markets, with T-Bills offering more than 4.0%. With inflation still high and tariffs likely to push it higher, the Fed will be reluctant to cut rates aggressively in the near term (watch the unemployment rate for clues that the Fed may be comfortable cutting rates). We would not chase long-term bonds after the recent rally. But if yields were to get back to 4.5% level or higher, that would make them attractive again.
What about the next 3-5 years? Unless the current US policies on tariffs and fiscal consolidation are drastically reversed, we see structural changes taking place. Growth is likely to be slower and inflation is likely to be higher, at least in the medium term. The other side of the declining trade and current account deficit (assuming this takes place) will be the rise in domestic savings. This means consumption will decline on a relative basis and interest rates likely have to stay elevated versus recent history to promote higher savings rate and to offset the higher inflation. It is possible that investments pick up because of the above as well as foreign investment flows into the US. This would be positive for growth in the long term, and possibly for the US dollar, although the dollar’s behavior is a bit uncertain in our view. Ultimately, the key variable for the long term will be the ability to arrest the increase in the debt/GDP ratio and hopefully reverse it. Failure to do that may put us all in a position where all bets will be off. Stay tuned.
[1] All financial data are from Bloomberg.
