Markets Move Fast, Faster than the Economy

The market appears to be front-running the economy with the theme of sell first and sort out the questions later. Investors would do well to remember that markets and the economy are two different things. The economic impact at this point is completely uncertain. Key questions remain unanswered: How will countries respond to the ongoing tariff policies? What legal challenges will the tariffs face? No one knows the answers to these questions yet. So, how should an investor handle the current environment?

The Trump administration is interpreting bilateral trade imbalances as evidence of unfair trade practices against the U.S. (How the Trump administration seems to be calculating the “tariffs charged to the U.S.” is as the bilateral trade balance as a percent of the total amount imported.) However, we would argue there are a lot of reasons why a bilateral trade imbalance could exist, not all of which are bad. For instance, while the U.S. is a highly developed and diversified economy, many smaller economies are much more concentrated on a narrow range of products or commodities. Therefore, sometimes the U.S.’s exports don’t match up with other countries’ import needs.

We understand there is a policy agenda this administration is playing out (onshore manufacturing, deregulation, lower taxes, etc.). However, it’s our perspective that tariffs tend to hurt economic growth, distort the allocation of resources, and cause unintended consequences. It also encourages our trading partners to find alternative import partners. And given all the uncertainty around whether the next administration will dismantle them, they may have the opposite effect of what’s desired, which could be to freeze capital projects rather than bring manufacturing back to the U.S.

We believe tariffs are ultimately a tax on consumers. We do not believe they are inflationary in the sense of causing a general rise in prices like we see with excessive money printing. Instead, they cause price increases in certain areas of affected goods, which crowds out spending on other items because consumers’ overall incomes are not higher to deal with the price increases. Consequently, the actual impact is to cause slower growth and suboptimal capital allocation.

These factors contribute to rising recession risks. While we viewed the risk of recession as very low at the start of the year, it has increased substantially, given the increase in policy uncertainty. However, there is still a significant distance between the current economic state and a full-blown recession.

While concerns are valid, there are reasons for cautious optimism. The Federal Reserve has tools at its disposal to stimulate sectors like housing, potentially reigniting economic momentum. Additionally, unemployment remains relatively stable; the same goes for consumer spending. Corporate balance sheets are strong, with high profit margins that could absorb some cost increases from tariffs.

From an investment perspective, while a decline of approximately 15% in price-to-earnings ratios has been anticipated for the S&P 500 this year, the trajectory of earnings remains uncertain as they often lag market adjustments. Currently, across most of our portfolios, we’re at a lower allocation toward U.S. equities and a higher allocation to treasuries, reflecting a more defensive stance amidst market valuations and risks.

It bears remembering that fluctuating stock prices are not the same as risk for the long-term investor. In fact, volatility is the price of admission for the long-term investor. In fact, when market prices go lower, risk has usually declined on average. That’s because market prices tend to move faster than economic fundamentals. So, risk is not volatility; rather, risk is not meeting your long-term investment objectives.

Volatile times are never without very real concerns, and this time is no different. However, volatile times are also not the time to respond; instead, you should play out your investment strategy in a calculated way.

As U.S. stocks became increasingly pricier and more concentrated, we reduced exposure as portfolio limitations allowed. We believe this approach is a gradual proactive portfolio management strategy that yields dividends during transition periods like the one we’re in now. If prices continue to change substantially, we’ll look for opportunities to buy where it makes sense. However, volatile markets are not a disconcerting force that will knock us off balance. They are actually opportunities to rebalance onto a sounder footing for future returns. We remain convinced that all the investment solutions will remain on track to meet the targeted return goals.

If you would like to learn more about our investment philosophy or offerings or have specific questions about your portfolio, please contact your Blue Trust financial advisor. If you do not have a Blue Trust advisor and are interested in speaking with one, please reach out to info@bluetrust.com or call 800.841.0362.