April 6, 2025
Dear Clients and Friends:
April 2nd was Liberation Day in the United States, the day we were liberated from free trade and welcomed the arrival of tariffs with open arms and flowers. I grew up in Holland, where they also have a Liberation Day on May 5th, commemorating the end of Nazi occupation on May 5, 1945. That one, objectively, is more joyful. Markets were completely caught off guard, dropping north of 10% over 2 days, as measured by all major US stock market indices. It was the 4th worst 2-day stretch since World War II, after the crash of 1987, the 2008 Financial Crisis, and the Covid pandemic. Why were markets so surprised? America was promised tariffs by candidate Trump, voted him into office and then was given the tariffs, piecemeal at first, then full-blown on Liberation Day. Admittedly, I too was surprised, so it is not a fair question to ask of others, yet, we should have seen it coming.
We fired the opening shot in this tariff war, but like any war, there are opposing forces who will fire back. To suggest, as Treasury Secretary Bessent did, that other countries best not respond in kind as it is in their best interest not to, is to fundamentally misunderstand the nature of war: everyone loses, even if a winner rises from the ashes. If my word choice sounds hyperbolic, it is because I do believe this is a full-blown crisis. However, it is a manufactured one, so it is reversible. Let us hope common sense prevails, if not ours, then that of our trading partners who can offer an offramp that allows the US to claim victory. For example, the island of Diego Garcia, faced with 10% tariffs can offer to stop flooding the US market with fentanyl and reduce tariffs on US products to 0%; I am sure the 4,000 US and British forces and their civilian contractors who are stationed there, and comprise 100% of the population, would gladly oblige.
A crisis sharpens our focus and clarifies our priorities. Therefore, this newsletter will be all about tariffs. After all, tariffs are the driving force of volatility and the exogenous shock that could tip the US economy into a recession and bring the stock market down with it. Or – and I am rooting for this outcome – they can be diffused under great pressure, allowing an otherwise healthy economy to keep humming, assuming it is not DOGEd into submission.
So, three paragraphs in, what are tariffs anyway? They are a tax on consumption, and, if fully implemented, would constitute the biggest tax increase in the US since 1968. They look like a sales tax but work a little differently in that they are not added to your bill at the time of sale, unless you buy directly from a foreign seller. Typically, an importer will pay them at the port of entry if it is a physical good or if you purchase a service, it is assessed at the time of sale. Ultimately, much of it will be passed on to the consumer.
Examples will help. Your daughter’s (or son’s) weekly Temu ultra-fast fashion package from China will soon cost $80 instead of $40. There is just not enough margin for Temu to absorb the tariff hit, and there is no retailer in between her/him and the producer to absorb some of the cost. Buying from Amazon will probably not see a full pass-through of the tariff to the consumer, because Amazon can take a little hit and they can also pressure the suppliers on cost. So maybe a Chinese good on Amazon will go up “only” 20% instead of the full 50% (rounded). Buying shoes from Nike or pants from Lululemon: Here the tariffs might have a more modest impact, because much of the price is the mark up from the brand versus the input cost. But tariffs on these products are still going to push up prices for consumers, erode profit margins for the brands and squeeze suppliers in Asia. When it comes to apparel 98% is produced overseas and for footwear it is 99%. These jobs by the way, are not coming back to the US. The average footwear factory worker in Vietnam makes about $250 per month, or $10 per day, for what I assume is a bit more onerous than an 8-hour workday with a lunch break and a couple coffee breaks. That kind of manufacturing renaissance is not going to get onshored, nor would we want it to.
Speaking of Vietnam, something like 1/3rd of their economy consists of US exports. They are facing a near certain recession unless a deal is reached. Interestingly, on Friday Nike stock was up, despite the market bloodbath, on news that Vietnam (and Nike?) had a constructive call with the US administration. I suspect this path is among the more likely outcomes of this debacle: foreign governments, exporters, importers, retailers and everyone else with skin in the international trading game, will seek to strike deals. That could reduce the harmful impacts of the tariffs. However, this also opens the floodgates to rampant corruption, as all seek to curry favor, so as not to nosedive their economies or companies.
Here’s the irony: the tariffs were in response to the rest of the world allegedly ripping us off. But quite the opposite is true: the rules-based free trade system that has prevailed for 80 years, is US made and very much to the benefit of the US economy. Now we are killing the goose that laid the golden eggs. To be sure, the working class and parts of the middle class have faced hardship as manufacturing relocated overseas. However, labor market disruption is a hallmark of an economy that is ever more productive and advanced. It is a problem that has not been successfully addressed by the US government under both parties, nor by the governments of many other Western countries for that matter. And it is a political question: how do you define and achieve a fairer distribution of the ever-growing pie. Well, it is not by cutting the pie in half.
Then there’s Economics 101. How do trade deficits – which tariffs seek to address – occur? We run large trade deficits with much of the rest of the world for two simple reasons: 1) we invest more than we save, so we don’t have the home-grown capital to make all the public and private investments that our growing economy needs. Luckily for us, foreigners are (were) happy to invest in the United States and fill the gap. We also have the world’s reserve currency, which vacuums up global savings into dollar denominated assets. 2) We consume more than we produce, so we import more than we export. It has nothing to do with tariffs. In fact, some of our largest trade deficits are with countries that have the lowest trade barriers with the US. If trade deficits do go away, it is more likely due to a recession than due to the reshoring of manufacturing. History offers an analogy: The Smoot-Hawley tariffs of the 1930s – which were actually lower than today’s tariffs – were successful at stopping imports. They also played a large role in turning a stubborn recession, stemming from the 1929 financial crisis into what became known as the Great Depression.
I am not an economist, a journalist, or a historian, so the preceding paragraphs only serve as context to my views and recommendations as an investment advisor. In other words, what does this all mean for your portfolio?
Being a successful investor is being an unemotional investor. So, the first thing to be mindful of is to avoid panic selling. The temporary relief from selling in a declining market will not make up for missing out on the reversal, which can be swift and only viewable in hindsight, given that there could be a number of false starts and given that the news cycle will not turn positive at the bottom.
Diversification is working. European stocks have outperformed US stocks this year by over 18%. US Treasuries are up year-to-date. Gold is setting records. A number of sectors are crushing tech. This will not fully offset the market mayhem, but it will protect on the downside, and open different lanes during the recovery. What I mean by that, is that if we recover into a world that is not dominated by the Magnificent Seven tech stocks and US dollar denominated assets, then diversification will reward you for having considered that the future might be different from the past.
Risk level is a dial that you control. Investment goals, time horizon and personal risk tolerance inform your portfolio’s risk level. In theory, you shouldn’t feel differently about risk in 2025 than you did in 2024. In practice, of course, people are more risk averse in a down market. However, if you have enough safe assets to meet any cash needs in the next 5 years, and typically our client portfolios do, then this period should not have to involve de-risking your portfolio.
Inflation is probably going to make at least a modest comeback this year. I rarely make economic predictions and I might end up being wrong, but tariffs are likely inflationary, as is a crackdown on immigration (cheap labor) and a projected expansion of the federal debt. The high inflation under Biden did not get anchored in people’s expectations of future inflation, and credit goes to the Federal Reserve, for convincing everyone that they were serious about fighting inflation.
This time, it will be harder to convince people that inflation will not stick, because the Fed can hardly raise rates, as it would all but guarantee a recession. When people expect inflation, it becomes a self-fulfilling prophecy and much harder to contain. Without getting into the weeds, what this means for your portfolio is that it cannot be invested on the basis that inflation goes back to 2%. So, with bonds, for example, we have to make sure that the real rates are positive (greater than inflation). Other interest rate sensitive investments like Real Estate Investment Trusts (REITs), Financial stocks, and Utility stocks, should not be made on the basis that rates will drop, but should pencil out at current interest rate levels.
There will be opportunities. Some stocks I have been eying for a while, have come down in price to where they are starting to look tempting. I don’t necessarily prescribe a buy-the-dip approach, as these are early innings in what could be a long and torturous ballgame. But, I do think it makes sense to swing at the occasional fat pitch. And there are sure to be some in the days ahead.
In summary, this too shall pass, and it is not a reason to delay retirement, panic sell, or let emotions dictate investment decisions. I plan to be the steady hand on the rudder, and we will navigate through this period of uncertainty as we have before and will probably have to do again. A silver lining is that the other three crises on my watch were systemic or pandemic: the dot.com bubble, the 2008 Financial Crisis, and Covid. This one is an unforced error that could conceivably be reversed. Time will tell, but regardless, we will prevail.
Kindly,
Jan P. Schalkwijk, CFA
JPS Global Investments