What is the correct level of fall in the stock market if the US president declares economic war on the rest of the world even at the risk of causing a recession in his own country? Does 10% capture it? Or 12%, which was roughly the S&P 500 index’s three-day decline by the time the London market closed on Monday? Or 15%? How about 20%? More? A lot more?
During three straight days of heavy falls in the share prices everywhere, a striking feature has been the absence of wise old market heads popping up to argue that the panic is perhaps a little overdone and fair value is emerging. Instead, the collective mood is stuck in bewildered mode for understandable reasons.
First, Donald Trump shows no sign of softening his language, which would be the first step towards softening his policy on tariffs. Rather, his weekend comments – “sometimes you have to take medicine to fix something” – were intransigent. Unlike others in the US administration, he didn’t choose to emphasise that the tariffs are the opening shot in a negotiation. He simply said the nasty-tasting stuff must be swallowed.
It remains hard to believe he won’t change tone if the damage to American’s 401(k) savings plans becomes substantially more severe, but one cannot be certain. For the time being, and despite the blizzard of research reports being produced by City and Wall Street analysts, the market has zero insight into whether the average US tariff rate on imports will stand at 24%-ish, which is what a full dose of Trump’s medicine would mean, or whether the practical level will be meaningfully lower.
Second, corporate America, a constituency even Trump can’t ignore entirely, hasn’t found its voice. Bill Ackman opined that Trump’s action could lead to an “economic nuclear winter”, and he may be correct. But he’s a hedge fund billionaire and one doubts he has cut through outside Wall Street. It would be a different matter if famous bosses of Apple or Nike were warning US consumers in stark terms that they would pay more for their iPhones and trainers, especially if they added that they won’t be reshoring many jobs because it still doesn’t make competitive sense to make the products in the US. But we’ve heard no plain speaking in that style.
Jamie Dimon, the chair and chief executive of JP Morgan, has argued that the tariffs will “likely increase inflation and are causing many to consider a greater probability of a recession”, but it was measured stuff. For the most part, US bosses look terrified of being labelled unpatriotic.
Third, investors’ usual source of solace during market crises is the thought that the US Federal Reserve will save the day by cutting interest rates. On this occasion, the Fed is constrained if the first effect of tariffs is higher US inflation. Slower economic growth, which could justify cheaper money, only arrives over months. The Fed surely has to wait for evidence.
Fourth, share prices were probably too high in the first place. At the start of this year, the US stock market was priced at roughly 23 times expected earnings, a rich valuation by traditional yardsticks thanks to hype around artificial intelligence and a naive faith that Trump’s rhetoric on tariffs was nine-tenths for show. So stock market investors are grappling with two valuation problems: first, the possibility of lower earnings if companies have to absorb some of the inflation by taking a hit in their profit margins; second, the worry that the base position was already too high. Amid the drama, note, the S&P 500 is still only about 4% below its level 12 months ago.
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That plays to a fifth worry that, if higher tariffs become a normalised feature of US policymaking for years, we’re barely started to assess the long-term consequences. “The quicker this issue is resolved, the better because some of the negative effects increase cumulatively over time and would be hard to reverse,” Dimon said. Quite. The fact the policy has been justified on the basis of absurdly simplistic calculations makes it even more damaging.
Investors are clearly also primed to react to anything that sounds like a softer stance from the White House – witness the brief rally on Monday on rumours (quickly denied) that a 90-day pause was on the cards. But, until something substantive arrives, the market is trading on guesswork. Another week of Trump intransigence could make the sell-off uglier yet.
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