Are Stock Vigilantes Coming to this Market?
Tariff threats on major trading partners escalated dramatically last week and far beyond most expectations as Trump sent letters dictating new tariff rates to numerous countries, including major trading partners and threatened to increase baseline tariffs on all imports to 15%- 20% from the current 10%.
Markets, however, largely ignored the significant tariff escalation because investors 1) Don’t believe that these tariff rates will come into effect on Aug. 1 and even if they do, they won’t last long and 2) Are confident that President Trump won’t enact any policies that could dramatically damage the economy. Markets believe the administration listens to markets mainly because the administration delayed reciprocal tariffs, de-escalated the trade war with China and granted key tariff exemptions in response to the stock market plunging violently in early April.
However, it appears now the opposite is happening. Late last week, when he was announcing tariff threats, Trump implied people like the tariffs and noted the stock market is at all-time highs and inferred that the performance of the market is emboldening him to escalate the global trade war and reach for higher tariffs.
While it is possible that all of the tariff moves announced this week won’t materially damage the economy and spur stagflation if actually enacted, it is unlikely. Tariff and trade policies this extreme risk all sorts of disruptions across a global economy that, for 30 years, has been calibrated to exist in the opposite environment. So, the stock market may have to remind President Trump of that reality, and if so, we may see the appearance of “stock vigilantes?”
You’ve likely heard of bond vigilantes before, as that term refers to a group of bond investors that, in the 1970s, sold U.S. Treasuries and boosted rates as a way of punishing the U.S. government for profligate spending and increasing debt and deficits. Essentially, the bond vigilantes “kept the government in line” on spending by exacting market pain on the government if its fiscal situation deteriorated too much.
So, it’s possible that stock vigilantes could appear and do the same thing with the administration on tariffs. If Trump views the new highs in stocks as a “green light” to escalate the trade war, it may well have to decline to remind the administration that, while the U.S. economy can likely stomach some tariffs (again the level that seems “ok” is around 10% aggregate tariffs), tariffs above certain levels will dramatically increase stagflation threats. The gap between what’s being threatened and what the market expects is extreme right now.
That doesn’t mean stocks will drop, but the level of apathy towards trade risks is high right now, especially considering the escalation from last week. Again, that’s not a reason to get bearish here (the market is probably right in ignoring it), but the chances of the market “caring” suddenly and stocks dropping sharply is rising, and we all need to be aware of that as we approach Aug. 1.
In addition, we need to be aware that currently earnings for the second quarter are being reported daily for the next three weeks. We will watch the markets reaction to both the earnings and the possibility of new tariffs. As a result, we will maintain with 25% bond exposure and 25% Value exposure for most of you and a 45% value exposure for those moving from mutual funds to AXIOM. Caution is the key right now, and I do not intend on chasing the market.
Enjoy the summer months, we will continue to be vigilant in managing your money.