The market is gauging the economic inefficiencies that may result from the US’s new tariffs and the retaliatory measures from other countries.
While tariffs alone are unlikely to end economic cycles, prolonged ambiguity can severely impact spending and investment.
Already, the market is increasing its expectations for Federal Reserve rate cuts between now and the end of the year.
Economic students are introduced early to the theory of comparative advantage. This theory posits that each country should produce goods where they have a relative efficiency and trade for other goods, thereby maximizing overall production efficiency. Deviating from this principle leads to suboptimal economic outcomes.
The US stock market has declined nearly 6% over the past eight trading days1, reflecting concerns over tariffs imposed by the Trump administration and the retaliatory measures from other countries. Essentially, the market is gauging the extent of the economic inefficiencies that may result. This observation is not meant to be political. While tariffs can be justified for national security or to protect specific industries and communities, they come at a cost. Businesses may either absorb the reduced profits or pass the costs onto consumers. Consequently, the financial market adjusts to expectations of weaker earnings growth, renewed inflation, or a combination of these factors.
The market, with US Treasury rates falling2, appears to have already concluded that the bigger risk to the economy is not inflation, but rather economic growth. The uncertainty surrounding the next steps in the current trade war compounds the problem for markets. While tariffs alone are unlikely to end economic cycles, as businesses and consumers tend to adjust, prolonged ambiguity can severely impact spending and investment.
The 2018 trade war with China serves as a prime example. Business investment collapsed3, leading to a 20% market decline from peak to trough4. In response to recession concerns, the Federal Reserve (Fed) lowered interest rates in 2019.5 Already, there has been a noticeable decline in consumer sentiment.6 Could businesses be far behind?
The culmination of the 2018 market correction coincided with a temporary truce in the US-China trade war and the Federal Reserve signaling a more dovish approach. I believe the market is likely to bottom this time amid similar circumstances. Already, the market is increasing its expectations for Fed rate cuts between now and the end of the year.7 However, an end to the trade war may not come as quickly as investors initially hoped, when they believed tariffs were a negotiating ploy rather than an actual policy.
In the short term, we hunker down, acknowledging that policy uncertainty and market drawdowns tend to go hand in hand. Investors may navigate this period by tactically favoring higher quality and defensive stocks, as well as higher quality US bonds. Lest we get too negative, we remind investors that peaks in policy uncertainty have tended to represent attractive buying opportunities.8 Here’s to hoping for greater policy clarity soon!
Source: Bloomberg, March 4, 2025. As represented by the return of the S&P 500 Index from the current peak on Feb. 19, 2025 to March 4, 2025.
Source: Bloomberg, March 4, 2025. The 10-year US Treasury rate peaked at 4.79% on Jan. 14, 2025, and had fallen to below 4.2% by the beginning of March 2025.
Source: US Census Bureau. Based on Capital Goods New Orders Nondefense Excluding Aircraft & Parts.
Source: Bloomberg, March 4, 2025. Based on the returns of the S&P 500 Index from the 2018 peak on Sept. 20 to the market bottom on Dec. 24, 2018.
Source: US Federal Reserve.
Source: University of Michigan Consumer Sentiment Index, February 2025.
Source: Bloomberg, March 4, 2025. Based on Fed Funds implied rates.
Source: Baker, Bloom and Davis. Based on the US Economic Policy Uncertainty Index and the S&P 500 Index.
A government shutdown can create short-term market volatility, but they tend to resolve quickly with little market impact for long-term investors.
We discuss the future of US inflation, the outperformance of European stocks, the potential impact of new tariffs, and the independence of the Federal Reserve in this month’s column.
The national debt keeps rising but may still be manageable in the short term despite the investment risk or pending disaster some investors fear.
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All investing involves risk, including the risk of loss.
Past performance does not guarantee future results.
Investments cannot be made directly in an index.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
The University of Michigan’s Consumer Sentiment Index is published monthly, based on a telephone survey designed to assess US consumer expectations for the economy and their personal spending.
A defensive stock is a stock whose price isn’t highly correlated with the larger economic cycle.
Dovish refers to an economic outlook that generally supports low interest rates as a means of encouraging growth within the economy.
Drawdown is the largest cumulative percentage decline in net asset value as measured on a month-end basis.
Monetary easing refers to the lowering of interest rates and deposit ratios by central banks.
The Economic Policy Uncertainty Index is compiled from three underlying components that quantify newspaper coverage of policy-related economic uncertainty, reflect the number of federal tax code provisions set to expire in future years, and use disagreement among economic forecasters as a proxy for uncertainty.
Inflation is the rate at which the general price level for goods and services is increasing.
Net asset value (NAV) is the per-share value of open-end and closed-end funds and exchange-traded funds (ETFs).
The S&P 500® Index is an unmanaged index considered representative of the US stock market.
The opinions referenced above are those of the author as of March 3, 2025. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
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