76report

April 7, 2025

Will Trump Pivot?

Today was only the third trading day since the Liberation Day announcement, although to many investors it may feel like an eternity has passed.

Stocks fluctuated wildly today but ended the session generally even, as investors looked for signs of hope that a tariff-induced global recession does not have to be our fate.

International trade is a complex subject. There are nuances to the topic and competing perspectives that are worth debating.

What is not really up for debate, however, is the great extent to which the global economy—including the American economy—relies on supply chains from all over the world.

Understanding the market crash

The stock market has collapsed because the tariffs that Trump announced on Liberation Day were seen as exceedingly high.

Whether or not tariffs provide a good way to conduct economic policy is an interesting question. We have in fact written and spoken positively about tariffs as a potential tool to advance American interests.

Tariffs, or the threat of tariffs, can be applied, almost like sanctions, to encourage or discourage certain behaviors.

As the largest economy in the world, not to mention the strongest military, the U.S. has a unique ability to exercise its leverage over other countries with tariffs.

There is also something to be said for using tariffs to conduct industrial policy.

To be fair, the purist free trade paradigm may not adequately address certain economic and military security concerns or issues like supply chain resilience.

There are many good reasons that a country would want to use protectionist strategies to maintain a certain level of industrial and agricultural autonomy, even if it is not the most efficient producer.

There is potentially even something to be said about countering the protectionist strategies of other countries.

But is the Trump team overdosing on tariffs?

President Trump has said of his tariff plan that “sometimes you have to take medicine to fix something.” The analogy he is drawing is that medicine can be difficult going down, but it is ultimately good for you.

The problem arises when you consume too much medicine. This can be lethal.

From the stock market’s perspective, the core problem with the tariffs as announced last Wednesday is that they are too large. Way too large.

It may be helpful to put in perspective just how large a tariff increase has been proposed by Trump. Prior to the announcement, and mainly as a result of tariffs announced in his first term, the Effective Tariff Rate was approximately 2.5%.

The Effective Tariff Rate is a simple calculation. It represents total revenue generated by tariffs divided by the total value of all imports from all countries. Essentially, it is an average tariff rate applied to all foreign goods.

Markets were actually edging up higher as soon as the Trump tariff schedule was announced last Wednesday because it initially looked like tariffs would be in the 10% range. While this meant a four-fold increase from prior levels, it was considered manageable and therefore bullish.

Stocks began to nosedive once it became clear that much higher tariff rates would be applied to many countries, including important U.S. trading partners.

The methodology used to calculate tariffs was also disconcerting since it was linked to each country’s trade deficit. This was problematic because certain countries, like South Korea, already apply very low tariffs to U.S. goods.

If their tariffs were already close to zero, what could these countries even offer Trump to reduce their tariff burden?

A massive tax hike

Following the Liberation Day announcement, the Effective Tariff Rate has been widely estimated around 22% to 23%. This is nearly a ten-fold increase.

In revenue terms, only about $80 billion of tariffs were collected in 2024. If tariff rates skyrocket as planned, this number can grow as high as $700 billion, according to Peter Navarro, Trump’s trade adviser and possibly the key official driving this whole strategy.

There are some question marks, however, around Navarro’s estimates, which are based on some $4 trillion of goods and services that are imported annually.

Actual collections would depend on the extent to which the value of imports declines as a result of the high tariffs. Like any tax, the higher the tax rate that is applied to economic activity (in this case foreign imports), the more that activity is discouraged.

While $80 billion a year in tariffs is not chump change, when it grows to $700 billion, we are talking about a significant tax hike.

And make no mistake, tariffs are indeed a tax that is paid by American consumers who purchase imported goods.

There are barely any companies that can afford to absorb tariffs of the magnitude that are being discussed. These tariffs will be almost entirely passed through in the form of higher prices to customers who still choose to purchase the foreign items affected.

$700 billion in perspective

Federal tax receipts in 2024 were approximately $4.9 trillion. About half of this came from personal income taxes. Payroll taxes are the next largest segment (around 30%). Corporate income taxes are less than $500 billion (around 10%).

If tariffs raise $700 billion, that amounts to a 20% tax hike on the American public.

It is true that Trump has announced his intention to pursue income tax cuts that would offset the revenue raised through tariffs. But in the meantime, we are looking at a substantial revenue transfer from the private sector to the public sector that will go into effect in short order.

Part of the market’s adverse reaction to the tariffs is the demand shock that this tax hike represents.

Imagine everyone’s personal income tax burden was suddenly raised by more than 25% overnight ($700 billion relative to personal income tax collections of approximately $2.5 trillion).

Investment banks like Goldman Sachs and JPMorgan are talking about elevated recession risk in large part because of this giant tax increase on American consumers.

We also see recession risk getting priced in by participants on the online prediction platform Polymarket. Ever since tariff talk picked up in mid-February and stocks began to slide, the expected probability of a recession started to drift upwards and now sits above 60%.

Source: Polymarket

Market anxiety over tariffs—and the spike in recession expectations—is not just linked to the impact on consumer demand, however.

The other problem is the impact on businesses. For better or worse (for the most part, better), the global economy is highly interconnected.

U.S. businesses rely on imported goods in various ways—whether we are talking about a retailer selling foreign-made products, or even a domestic manufacturer that sources inputs or equipment from other countries.

American companies also operate in foreign countries and have foreign customers. Approximately 40% of revenue generated by S&P 500 companies comes from abroad. This figure is closer to 50% for the NASDAQ Composite Index.  

High tariffs have a negative effect on many companies, especially ones that operate on thin margins, because input prices will in some cases become higher and more unpredictable.

Many businesses could go under, which would have knock-on effects on other businesses, and of course drive up unemployment.

Why is Trump doing this?

People around the world are wondering why Trump is pursuing such an aggressive tariff policy—and potentially sending the U.S. into a recession.

There is some speculation that the intention is to bring down long-term interest rates on U.S. Treasuries in order to make it cheaper to refinance them.

While a decline in interest rates is undoubtedly welcome, it is hard to believe this would be the motivating factor, given the massively negative impact a recession would have on tax receipts.

The most plausible explanation is that Trump has an understanding of international trade in which trade deficits are inherently indicative of unfair trade practices.

Trump has expressed this viewpoint for decades. A high degree of concern over trade deficits has animated his political outlook since the 1980s.

Are trade deficits always bad?

Critics of Trump’s tariff policy (which arguably would include the vast majority of  businesspeople and economists on both the left and the right) contend that Trump’s outlook fundamentally misunderstands how global trade works.

The main reason the U.S. runs persistent trade deficits with the rest of the world is that the U.S. consumes more than it produces. Foreign capital is required to support this excess consumption.

In economics terms, the U.S. trade deficit is exactly equal to its capital account surplus.

The dollars that Americans send overseas must return to the U.S. in one form or another. If foreigners are not buying U.S. goods and services, they are investing in U.S. securities, buying Treasuries or otherwise providing capital to the American economy.

Trade deficit nations are net consumers. Trade surplus nations are net savers. This is a mathematical truism.

The fact that the U.S. dollar functions as the reserve currency of the world, which Trump himself has maintained as a strategic goal, means foreigners, including central banks, need to hold onto the dollars we send them as reserve assets.

If foreigners are holding onto U.S. dollars as financial reserves, they are not spending them. This is referred to as the Triffin Dilemma. You cannot always have your cake and eat it too.

A lot of moving parts

Another reality of international trade is that more than two parties are involved. This means a country may have trade deficits with one country while running a surplus with another.

Many Asian countries are energy importers. They have no choice but to buy fossil fuels from countries like Saudi Arabia, which runs enormous trade surpluses. Saudi had a trade surplus with the rest of the world in excess of $70 billion last year.

Countries like South Korea and Japan that must import energy tend to compensate by exporting more manufactured goods. When it comes to the rest of the world, they are essentially exchanging man-hours for hydrocarbons.

Another important nuance to the trade deficit issue is that on a revenue basis, the U.S. is often importing low value-added goods, like seafood or textiles from Vietnam. Meanwhile, we tend to export a lot of high margin goods and services related to technology and advanced industrial equipment.

Tariff supporters bemoan a decline in U.S. manufacturing jobs since the North American Free Trade Agreement (NAFTA) was signed, or China’s entry into the World Trade Organization (WTO). But the reality is that manufacturing employment has been trending down in the United States since World War II.

Just as hundreds of years ago almost everyone used to work on a farm, productivity gains (via automation, information technology, robotics, etc.) mean that every year fewer human beings are required to produce the same manufacturing output.

The manufacturing sector today represents something like 8% of the American work force. In our imagination, manufacturing may play an outsized role in what the real economy looks like. But it is 2025, and some 80% of American workers are employed by what are considered service sectors.

When will stocks recover?

Stocks are down primarily because of the perception that tariffs will have a negative impact on economic growth, and this will result in lower corporate earnings.

Therefore, to the extent Trump dials back his position on tariffs and signals to the market that we may be headed for a lower Effective Tariff Rate, we would expect stocks to respond positively.

Just this morning, major stock indices temporarily popped several percentage points after a false report that Trump was considering a 90-day freeze on tariffs. Having sold off so viciously, the market is like a coiled spring waiting for good news.

Trump has always signaled a willingness to negotiate. At the same time, he has repeatedly expressed a rather serious fondness for tariffs, so we expect tariffs to remain with us at substantial levels.

The key question is whether tariffs at the end of the day will be at high enough levels to drive the American/global economy into a recession and continue to cause investors to approach stocks with extreme skepticism.

Political calculations

Tariffs on this scale have not been attempted for over 100 years. In many respects, investors find themselves in uncharted waters, as does the Trump administration. The question of how much is too much is something we are all feeling out.

The administration has spoken about not being beholden to the gyrations of the S&P 500 and has drawn a (perhaps overstated) distinction between Main Street and Wall Street. At the same time, Trump has always taken pride in how well the stock market performed in his first term.

Trump’s ultimate goal in implementing tariffs is to strengthen the U.S. economy. He obviously wants to avoid a recession and set the stage for strong stock market performance.

One might assume he also wants the Republicans to perform well in mid-term elections and for his successor to win in 2028 (without getting into recent speculation about “methods” that could provide him with a third term).

While Trump sees much more value in his tariff strategy than others might, he will need to take into consideration the potential damage that pushing the envelope on tariffs could do to the broader MAGA agenda and his legacy.

It is nearly impossible to imagine Republican electoral success in the context of a Trump-induced recession and bear market. Anyone with a shred of political sense realizes this.  

Signs of hope

While administration figures like Peter Navarro and Commerce Secretary Howard Lutnick seem to be strong advocates for aggressive tariffs, Treasury Secretary Scott Bessent may have a more moderate angle.

Bessent appears to be more sensitive to the legitimate concerns of investors as to the impact on growth.

Earlier today, Secretary Bessent posted on social media his intention to engage in high level discussions with the Government of Japan, which we see as a very encouraging announcement. Japan is important as both a trading partner and strategic ally.

Rob will coincidentally be traveling to Japan later this week and meeting with investment industry contacts there. More to come from 76research on the Japan front!

China is key

President Trump’s focus on China is important to note. When it comes to unfair trade practices, China should be the starting point of all discussions.

China above all has pursued a mercantilist trade policy that makes investment in the country extremely difficult.

Americans are free to buy Chinese goods, but it is difficult to put money to work as an investor in China, which is critical to understanding why China has by far the largest trade deficit with the U.S. (around $270 billion).

China is also the country that has rather sneakily reorganized supply chains through countries like Vietnam and Mexico.

Final assembly of many imported products takes place in these countries, even as most of the content originates in China. But the products may receive Made in Vietnam or Made in Mexico labeling for tariff purposes.

China also has by far the largest manufacturing output in the world (around $5.1 trillion). This is nearly twice as large as the manufacturing output of the United States (around $2.6 trillion). Japan is a distant third (around $1.1 trillion), followed by Germany, India and South Korea.

To stave off recession, Effective Tariff Rates clearly need to come down.

Trump may want to continue to put the screws to China as our most significant economic competitor and geopolitical adversary.

But to bring the overall level of tariffs down, it would make a great deal of strategic sense to prioritize getting to better trade terms with allies like Japan, Germany and South Korea.

It also makes sense to focus on further strengthening America’s economic and political links to India.

India is the most populous country in the world and one of the most strategically important ones. While India may have a trade surplus with the U.S., it is a major energy importer and has a net trade deficit with the world as a whole.

Putting money to work

Despite fears of another Black Monday, the market stabilized today. However, the S&P 500 and the NASDAQ Composite are down 17% and 22% respectively from their February 2025 peaks.

From a long-term perspective, we continue to view a severe valuation adjustment like this as a buying opportunity, especially considering the self-imposed nature of the problem that the market is facing.

After potentially underestimating the severity of the market’s reaction to the Liberation Day tariff schedule, the administration has significant incentives to fix the situation.

We are optimistic that the administration will in the coming weeks negotiate its way towards country by country tariff arrangements that in totality will be seen as less harmful to corporate earnings growth.

As we saw today, any good news on this front could get priced in very quickly.

Click HERE to learn more about our Model Portfolio subscription plans.

Disclaimer

FOR SUBSCRIBER USE ONLY. DO NOT FORWARD OR SHARE.