Markets in motion: making sense of the administration’s trade policy

Key Takeaways

• Given the significant volatility the last few months and near uniform sour sentiment, we believe markets may have been too eager to price in the worst-case scenario, creating a potential bullish asymmetry.
• Potential outcomes of the administration’s tariff policy strategy range from a best-case scenario of reduced U.S. debt and increased domestic manufacturing to a worst-case scenario of stagflation and recession, with the reality potentially falling somewhere in between.
• We continue to like the major themes expressed in our current investment positioning, with exposure to gold as a portfolio shock-absorber and potential meaningful upside from beaten-down AI, tech, and momentum stocks.

The new U.S. administration’s sweeping tariff policy agenda has rattled global markets from stocks to bonds to currencies and caused some to question the sustainability of US exceptionalism.

The uncertainty of the policy itself – both in terms of scope and magnitude – has understandably given rise to questions and stoked fear among American investors. Reasoned and thoughtful investment analysis is especially important at this moment of uncertainty, when major economic decisions and drivers hang in the balance.

As fiduciaries, our team has an obligation to do our best to decode the potential rationale behind these latest developments and their implications to markets. If we can better understand the intended direction, rationale and objectives, we put ourselves in a more favorable position to map out and evaluate the most probable downstream economic outcomes and prepare portfolios accordingly. So, using our best judgment and applying a long-term view of the latest administrative moves, what is the opportunity, what are the risks, and why do we as investors remain relatively constructive on the U.S. and risk assets?

First, we try to understand the potential aim of the tariff policies themselves.

We can think about the administration’s strategy as potentially serving two primary macro purposes: 1. pushing investment toward American manufacturing while cushioning consumer impact with strategic tax cuts and 2. geopolitically functioning as leverage to extract concessions from nations with whom we have large trade deficits.

For a U.S.-based investor, in the optimal policy scenario, the gambit redefines America's trajectory for the better, lowers net effective trade barriers for the U.S., and rewires global trade power dynamics. This could disproportionately benefit the U.S. economy and further enhance the premium on U.S. risk assets, which would align with our structural portfolio tilts towards the U.S. equity market.

However, the risk remains, failing negotiations may create adversaries, domestic supply chains can’t scale to compensate for international retaliations, another pesky bout of inflation is stoked, and the Fed is stuck in an impossible “stagflation”-esque situation. This very likely results in a recession.

The final resting place for all this could likely be somewhere in between. The timeframe for reaching this destination could, in our view, be determined more so by behavior in U.S. interest rates rather than major equity indices, given the larger asset base (both domestically and internationally) that is anchored to the bond market, rather than U.S. stocks.

So how are we thinking about managing portfolio risk in this environment, given the highly uncertain distribution of these possible outcomes?

Well, over the last few months, it appears as though stock and bond markets have already digested, evaluated, and priced in at least a fair amount of the possible worst-case scenario discussed above. Therefore, we believe the balance of risks could be to the upside from here – a bullish asymmetry made even more compelling given our view that the best-case scenario deserves at least some non-zero weight, which we believe is more than many market participants appreciate and are currently pricing, and coincides with our current portfolio-level overweight to stocks over bonds.

Given we introduced gold as a potential volatility absorber in November, proactively reduced exposure to stocks in February, and realized negative equity drift due to the selloff that had the intrinsic effect of further de-risking portfolios, we have been reasonably well-positioned to patiently weather the recent stormy market conditions. We also continue to like our exposure to what we believe are the most attractive sources of potential upside through beaten down U.S. tech and momentum stocks. The structural long-term themes supporting these investment narratives may have been dinged but not derailed, in our view.

Our patience not to make hasty decisions in the middle of extreme market volatility appears to have paid off, as evidenced by the significant bounce in equities seen since the mid-April lows through to the first few weeks of May. While impressive, the sharp recovery in stocks has come amidst still meaningfully elevated uncertainty. This admittedly warrants a bit of caution at least over the short-term as conditions are ripe for a potential market consolidation, in our view.

Moving forward, we will be most closely monitoring the evolution of ongoing trade negotiations and upcoming data releases describing growth, corporate profitability and domestic labor markets conditions. We expect these factors will be the most influential drivers of financial market performance over the coming quarters.