The shock and awe magnitude of “Liberation Day” tariffs caught nearly all market participants off guard. The stock market has subsequently decreased trillions in value from recent highs, with politicians and pundits alike denouncing how any of this could make sense. What is most striking about the tariff decisions — that have spiraled into the worst stock market selloff since 2008 — is that the downward move was clearly predictable and likely expected by the current administration. We know this because as initial tariffs on Mexico, Canada, and China were announced and enacted in February, the stock market had a temper tantrum and immediately declined. So, it reasons that when planning to enact wide-ranging and unexpected tariffs on effectively the known world, the market reaction would be very negative. So, if we can accept this logic as highly probable and the risk was properly weighed — with realizing mid-term elections approximately 18 months away — the administration’s expected longer-term upside was presumably worth the short-term market rout. Apparently “the market” does not agree, but let’s take a deeper look.
In my 20+ years of working alongside financial markets, the current market dislocation has been the most politically centered. With that said, politicians are elected and, in turn, hire people to do very important jobs for fellow citizens. If the elected people or their hires do a bad job, one way or another, they will lose their position. So, putting politics aside, one would expect that everyone involved in recent tariff decisions would like to do what they believe is right and best for the greater good and thus retain their position.
Counting losses on the stock market is easy since we are all getting news alerts what seems like every hour. Looking beneath the surface, we realize the global trade order that has prevailed since the end of WWII is being transformed. Some like it and some do not, but it is a historical moment either way. In speaking to dozens of clients over the past week, some believe that America is losing its century-long global brand of world leadership, while others believe that America is finally making the right decisions for Americans.
Time will tell us which side is correct or if elements of both will be, but unequivocally there are two fundamental shifts underway:
1 Economic Priority:
Since the 1970s, but especially after the signing of the North American Free Trade Agreement (NAFTA) in 1994, our domestic economic North Star has been globalism, which effectively nominated our top economic priority to be lowering consumer prices. Approximately 90,000 factories have since closed, and those jobs were, by and large, shipped overseas – mainly to China. Prices on most goods did go down, which was great for those who had the means to buy goods. Data shows that the average inflation-adjusted standard of living and income share for the middle and lower class — now 80%-90% of Americans — has deteriorated over time.
While trade imbalances and misaligned trade policies are getting a lot of airtime, the U.S. economic priority has now shifted away from low consumer prices to maximizing domestic jobs by virtue of bringing factories back to U.S. shores. Some may point to a current low unemployment rate, making the shift unnecessary, but this figure only accounts for those who are unemployed and looking for a job. So, the current unemployment rate of 4% accounts for those looking but unable to find work. This data point ignores the labor force participation rate, which stands at 62.5%. Of the remaining 37.5% of people able to work, but not working, 4% of them are looking for a job.
When working for a private equity firm in the early 2000s that owned dozens of manufacturing companies, I witnessed project after project being lost to much lower-priced Chinese manufacturers with labor rates under $2/hr. This led to the laying off of swaths of shop employees. I remember wondering at that time what good lower consumer prices would be if people did not have a job to buy anything. Moving away from the priority of lower prices to now bringing factories and working-class jobs back to America is a bold move and a big bet that carries great risk. Those in charge believe it is a bet that will pay off in the longer run – likely before the November 2026 midterm elections.
2 Revenue Source:
While the United States has largely funded operations by taxing its citizens and companies, a shift is underway that is raising funds from external countries allowed to access our $30 trillion annual economy through tariffs. While the previous administration endeavored to add 80,000 IRS agents, the new administration is preparing to launch an External Revenue Service and shrink the IRS. This is a significant — nearly opposite –- shift in revenue priority. While change is rarely welcomed, if this transformation can be pulled off and leads to tax relief for U.S. citizens, most will likely applaud in the longer term.
Through this simultaneous shifting of multiple economic tectonic plates, there have been some interesting and possibly intentional consequences:
· Oil has fallen to the lowest price since the onset of Covid in 2020 with recession fears growing. Since gasoline is directly related to oil prices, this will reduce the costs of everything that needs transportation (nearly every good) and thus will have a lowering effect on inflation. With expected price increases due to tariffs, lower energy input prices will provide a near-term counterbalance.
· Interest rates – measured by the benchmark 10-year U.S. treasury – fell from 4.8% to below 4% before jumping back up to ~4.3% as of this writing. This will lower all borrowing costs, including home mortgages, and should provide a near-term economic tailwind.
· Factory Investment promised, with Apple, Softbank, TSMC, and Hyundai leading the charge, is nearing $2 trillion. As companies relocate facilities within the U.S., a presumed increase in construction and manufacturing jobs will occur. One interesting data point is that for each dollar of manufacturing revenue added to a region — as companies buy/maintain equipment, fork trucks, procure outsourced services, and the like — $3 – $4 of economic activity is gained. This is why many local Industrial Development Agencies prioritize attracting manufacturing companies to their respective areas.
With a reported 70 countries looking to negotiate new trade deals with the Trump administration, it is very difficult to project where the economy or stock market is headed. As trade war tensions escalate with China in particular — the world’s second-largest economy –- the implications could be extreme. Looking beneath the blow-by-blow headlines of this battle, the U.S. ships China ~$150B worth of goods per year relative to a ~$30T annual economy, while China ships the U.S. ~$450B worth of goods per year relative to an ~$18T annual economy. Using these measurables on percentage terms, China is ~5x more dependent on the U.S. consumer than the other way around. Math would suggest that China will aim to work with the U.S. to equalize trade agreements, but a game of chicken has begun between world powers, both with proud leaders.
As stated in my email from last week, short-term market upheavals create great and rare long-term buying opportunities. We have a team of five analysts working around the clock to determine the best way to take advantage of current volatility. We are not worried… we are putting in the work and study necessary to act with precision and make the best investment decisions possible for you and your family.
Along with adding to core positions over the past week of volatility, Arista Networks was welcomed into Concentrated Equity Alpha last month:
Arista Networks [ANET] is a leader in networking software and hardware for large data centers, campuses, and routing environments. Arista has consistently disrupted the networking market with its innovative software-defined networking (SDN) solutions and high-performance hardware. The company is poised to benefit from the continued growth of cloud computing, artificial intelligence, data center development, and the need for more agile and scalable network infrastructure. Over the past year, ANET has grown to now hold over 50% market share and stands alone as the market leader.
We have been attempting to buy the company at an attractive price for the past six months, but our first call with the company was back in 2014. Since that time, Arista has remained on our “A-List”. Arista’s strong product portfolio, continuing innovation, industry tailwind, and excellent leadership have positioned the company for long-term success. After 11 years of patience, we are very excited to add this best-in-class franchise to your portfolio.
Click here to read the main article: Historical Transformation & Arista Networks