Sometimes the wry humor just writes itself. This week saw the House pass a tax bill going by the name “one big beautiful bill” – or “Triple-B”, as some of the Republican House staffers would refer to it in their back-and-forth messaging during the sausage-making process. Bond investors, always happy to latch onto a joke at some else’s expense, piled onto the Triple-B moniker – BBB, of course, is the lowest rung on the investment grade credit scale before descending into the funhouse of junk bond ratings. As in: that’s where American government debt – the world’s long-enduring proxy for a risk-free rate –could eventually be headed if this bill makes its way into law. Passage is not yet a foregone conclusion, as the bill will have to make its way past some potentially ornery opposition in the Senate before it gets to the president’s desk. But given the current state of Republican politics and the administration’s overweening desire to see this thing to the finish line, it’s a pretty good bet that something very close to the current plan will manage to arrive at 1600 Pennsylvania before too long.

20-year Bond? Anyone?

The latest opposing salvo from the bond market came on Wednesday this week when a $16 billion auction of 20-year Treasury bonds, in the face of weak demand, went out at a yield of 5 percent. The 20-year maturity is a relatively recent addition to the Treasury stable, introduced in 2020, and this week’s auction represented the highest yield for a new offering.

On the same day as the tepid 20-year offering, yields on the bellwether 30-year bond reached their highest level since 2007. At the same time the dollar, which had been finding some strength in recent days thanks mostly to the apparent de-escalation of the trade war, resumed falling, and conditions started to look a lot like those dark days in the immediate wake of the April 2 tariff announcements (as we are writing this on Friday morning, those kinder and gentler trade headlines of late are coming under renewed fire with a new announcement by the administration of 50 percent tariffs on products from the EU and 25 percent tariffs specifically on any Apple iPhones not made in the US. Ugh.).

Gently, then Suddenly

To be clear, the bond market’s reaction this week has been more of a gentle nudge than a violent shove. Yields on intermediate and long-dated maturities have settled back down a bit from where they were in the immediate aftermath of the 20-year auction on Wednesday. There may be some hedging going on as investors speculate on whether there might be more meaningful pushback from the Senate before the Triple-B tax act gets written into law (a sentiment we do not share, given that the main force likely to push up debt and attendant deficits will come from the extension of the 2017 tax cuts, and we see little to no likelihood of those being pulled out or tampered down by anyone in this Congress). In general, movements in the bond market tend to be more measured and gradual than the more volatile day-to-day lurches we often see in the stock market.

Our concern, though, is that at a certain tipping point things can start to unravel quickly. What might that tipping point be? Some observers think that if the 10-year breaches five percent then we could see a much more pronounced pullback, along with plummeting demand for new Treasury issues making this week’s 20-year auction seem quaint by comparison. We’re not convinced that five percent – which is only 0.5 percent away from where yields are today – would be that dramatic of a trigger. We agree, though, that there is an event horizon out there beyond which we have no desire to travel.

That famous line from Ernest Hemingway’s “The Sun Also Rises” comes to mind, when a character named Bill asks another, Mike, how he went bankrupt. Mike replies “gradually, then suddenly.” We hope that our policymakers will heed the bond market’s gentle nudges and take appropriate actions before they turn into shoves of a more sudden and unpleasant nature. Meanwhile, our bond market mantra is simple: keep your credit quality high, diversify where possible, and think shorter duration.

Every calendar quarter, we publish a survey of markets and the economy for our clients called the “State of Play.” One of the standard features of this quarterly report is a time series snapshot of four headline macroeconomic trends over the past five years. The significance of this span of time is that it was exactly five years ago when the economic shutdown forced by the global pandemic threw a spanner into our neat little set of trendlines for employment, GDP growth and the like. Suddenly, those incremental month-to-month and quarter-to-quarter changes were disrupted by the most seismic shifts on record. In the second quarter of 2020, US real GDP growth declined by 28.1 percent. In the third quarter it rose by 35.2 percent. Compare those numbers to the average real GDP growth rate for the past three years, of 2.4 percent, and you can see how those Covid-era numbers threw our orderly State of Play charts out of whack.

Incentives Now, Consequences Later

Now, we are not going to say that a month-on-month decline of 0.4 percent in the Producer Price Index, bringing the year-on-year growth rate down nearly a full point from 4.02 percent to 3.05 percent, is in any way as distortive as that 2020 freak show of data gyrations. It does stand out among its recent peers, though, as the chart below shows.

While not as extreme, the April PPI number does share a narrative of sorts with the pandemic data in that the change, which was much larger than what economists had forecast, could be placed on one single cause. In this case, of course, the cause was the derecho storm of tariff policies announced (and revised, and revised again and again) between the March and April PPI surveys.

Think of the PPI as being “upstream” from its sister metric, the Consumer Price Index. The PPI, also called the Wholesale Price Index, tracks changes in prices that businesses receive for their goods and services. Manufacturers have choices to make in determining how much of the cost increases they face from higher input costs (raw materials, labor and the like) they pass on to consumers. What the sharp monthly decrease in the April PPI number shows is that, for now anyway, businesses are swallowing much of these input costs themselves, settling for lower profit margins as they try not to lose customers with higher end prices. Maintaining volume in sales is the incentive to refrain from passing on costs. But that strategy can only last for so long, and chances are that the coming months will look quite different.

Walmart’s Warning

How soon will those higher prices start showing up at the retail level? Pretty soon, according to Walmart. The big box behemoth released its first quarter earnings report this week, and amid what was overall a healthy outcome for Q1 was a warning that consumers will start to see higher prices on the shelf as soon as the end of this month. The company noted that it has been trying to keep prices low (for the same reason that manufacturers have been eating their higher input costs) but that, in an industry with characteristically low profit margins, they will need to offload more of that burden onto consumers.

What has been missing in much of the financial reporting this week on the “relief” resulting from the Trump administration’s abrupt decision to lower tariffs on Chinese goods to “only” 30 percent is that, well, 30 percent is only a relief in the sense that 30 is a lower number than 145. It still amounts to a sizable cost increase. After all the to-ing and fro-ing in this administration’s policy changes, the average global tariff rate on goods imported into the US is still over 17 percent, higher than at any time since 1934, when the unfortunate Smoot-Hawley tariffs were in effect. And we still have no idea what things will look like after all the various 90-day “pauses” have lapsed. Or what brilliant new ideas the engineers of the tariff program will come up with in the meantime.

Economists have been backing off some of their most dire forecasts for a recession later this year. We’ll see about that; meanwhile, however, the stagflation recipe of higher prices and lower growth remains a pretty good bet, in our opinion. We may be due for a reverse of the hard data / soft data trend of the past several months, in which consumer and business sentiment starts to improve – hey, 30 percent is pretty good by comparison! – while inflation, employment and growth data start to turn south. We’re not out of the woods yet.

We sometimes refer to productivity as “the most important macroeconomic data point that nobody pays attention to.” That’s in contrast to the holy trinity of jobs, inflation and GDP growth, the three reports that generate the most chatter among financial media types. The productivity report for the first quarter came out yesterday, but unless you were deep into the economics pages of the Financial Times or the Wall Street Journal, its coming and going would have passed you by. That’s a pity, because in the long run our economic prosperity depends on growth, and in our demographically challenged times, the only path to sustainable growth runs through productivity. The population growth rate is in decline, and with a growing ratio of deaths to births, the percentage of the population in peak working-age years is declining. Either we grow through increased productivity, or we don’t grow – it’s that simple.

With that in mind, it wasn’t great to see productivity decline in the first quarter by a greater than expected minus 0.8 percent (annualized) from last year’s fourth quarter, marking the first quarter of negative growth since 2022. Let’s take a big picture look at how we got from earlier economic cycles to where we are today.

Making More with Less

There are several technical definitions for productivity, but the underlying concept is always the same: making more stuff with less expenditure of effort, time and money. The importance of this metric was one of the key insights Adam Smith described in his seminal 1776 tract “The Wealth of Nations,” explaining how a pin factory could massively increase its daily output through the implementation of specialized labor processes. That was in the earliest years of the Industrial Revolution; one hundred years later, the manufacturing enterprises of Great Britain and the United States were achieving productivity gains at a rate commensurate with Smith’s pin factory on steroids.

Productivity in the US continued to grow at a brisk clip through much of the twentieth century. After the Second World War the Bureau of Labor Statistics started measuring productivity gains, and through the first quarter century of so after the war, the average rate of productivity growth from quarter to quarter was around 2.7 percent (annualized). US manufacturing dominated the world, and organizations learned how to optimize their production processes at a scale that would have been previously unimaginable.

Productivity growth started to fall off sharply in the early 1970s, though, and apart from a brief resurgence in the early 2000s (largely seen as the impact of Information Age innovations), it has lagged ever since. The chart below shows that from 2021 to the present, the average growth rate was just 1.09 percent. That is more than two and a half times less than that 2.7 percent growth rate from 1947 to 1973.

Is AI the Answer?

What’s the recipe for improving productivity? Opinions vary among economists. There is one school, perhaps best represented by Northwestern University economist Robert Gordon, that deems it unlikely we will ever see the kind of productivity growth we enjoyed in the middle years of the last century. In his book “The Rise and Fall of American Growth” Gordon argues that the productive power we got from the critical inventions of electricity and the internal combustion engine are unlikely to ever be repeated, and we’ve already squeezed as much as we can out of those.

Others, however, point to the observed fact that there is usually a time lag between a new invention and that invention’s translation to commercial gain. Consider electricity; it was invented in 1879, but in 1919, forty years later, only half of American houses were connected to the grid. More recently, semiconductor chips had been around for more than forty years before we saw that brief Information Age productivity surge in the early-mid 2000s.

With this in mind, perhaps it is not surprising that many of the productivity optimists among us today point to artificial intelligence. After all, it has been a scant two years since ChatGPT burst onto the scene, launching a public fascination with AI and, of course, the stock market craze that drove much of the upside in those two back-to-back 20 percent-plus years on the S&P 500 in 2023-24. We know that, despite all the excited chatter, less than ten percent of all businesses claim to have AI-driven processes deep into their business models. Perhaps it will just take a bit more time before the effects show up in the productivity numbers. It would be nice to think so, because the growth isn’t going to happen all by itself – and it isn’t going to happen from whatever is passing for economic policymaking in Washington these days.

Let’s talk about those GDP numbers. But let’s also think about how Wednesday’s report on GDP from the Bureau of Economic Analysis – in the parlance of economists a “hard data” report – relates to Tuesday’s release of the latest Consumer Confidence Index from the Conference Board. Confidence is a human sentiment, and thus survey data like the Consumer Confidence Index fall into the category of “soft data.” Up until this week, these two different macro data categories were telling two different stories about the economy. The hard data – growth, inflation, jobs – were mostly okay, reflecting continuation of the solid progress on all fronts made by the US economy in 2024. But the sentiment data, as told by the Conference Board, or the University of Michigan consumer sentiment index, or the National Federation of Independent Businesses (NFIB) survey of sentiment among small business owners, were steadily declining throughout the first four months of the year. Negative sentiment, in other words, was running ahead of the still-okay hard data.

One of These Is Not Like the Others

Eventually, of course, the sentiments that drive spending, saving and investment decisions by households and businesses are going to show up in the hard data, in the form of units of economic goods that either get sold or don’t get sold, at a higher price or a lower price, by enterprises that either are or are not running production lines at some high or low fraction of full capacity. One such “soft” sentiment showed up loud and clear in the Q1 GDP report. See if you can spot what category it influenced in the chart below.

If you guessed “imports” then you are spot on. A major surge in imports was the driving force behind the negative percentage change in real GDP. Imports, as the small print on the chart supplied by the BEA notes, are a subtraction to GDP. If “net exports” – exports minus imports – is negative, then the contribution to GDP is negative. Clearly, the miniscule amount of US exports in the first quarter was overwhelmed by the massive amount we imported, and the net result was the headline number of minus 0.3 percent growth that dominated the financial chatter on Wednesday.

The good news is that we probably won’t see another quarter of imports at this level, so the Q1 report is not a clear signpost to successive quarters of negative growth. Consumer spending remained positive (though at lower levels than 2024) and private sector business investment advanced by nearly four percent, so at least for now, the underlying picture is of a slowdown, not a collapse.

Hoard Today, Hibernate Tomorrow

The bad news is that the surge in imports can almost entirely be ascribed to the negative expectations businesses have about the economic environment for the rest of the year (expectations are a big part of the aforementioned sentiment indexes). With tariff announcements continuing to wax and wane on a near-daily basis, and the first practical signs of their effect coming into sight in the form of shipment levels and transportation prices on major trade routes between Asia and the US, businesses have been making the logical decision to front-load their purchasing needs before prices go up and supply chains break down. They are hoarding ahead of a perceived economic winter, and that carries negative implications for activity later in the year.

Can we quantify those negative implications? No, given that at this point it’s anybody’s guess what tariffs are in place today, what ones will be in effect tomorrow, and how other countries are going to respond with their own adaptive strategies. It’s a tough time for anyone trying to make economic forecasts – witness the number of companies basically scrapping their forward guidance as they report on first quarter earnings. But those “soft data” sentiment numbers carry a very clear message from households and businesses: don’t just pay attention to what we say, but watch what we do.

All things considered, it has been a relatively good week. Springtime has settled in here in the nation’s capital, and along with the pleasant weather we have seen a welcome pause in the chaos that has beset financial markets since the infamous “Liberation Day” antics of April 2. Dare we say, those market guardrails of which we spoke some time ago seem to have had some staying power. The bond market pushed back on the original tariff plan, the dire warnings of retail CEOs about empty Walmart shelves have added weight to the tariff pushback, and financial types not wanting to see their hard-earned (or inherited, or whatever) wealth collapse into a vortex of horror demonstrated some pull in getting Jerome Powell out of the administration’s crosshairs. All of which could change – uncertainty remains the number one keyword for 2025 – but for now we’ll take these manifestations of organic pushback as a win.

Meanwhile, On Capitol Hill

With the temporary reprieve from worst-case concerns about tariffs and trade, we turned our attention this week up the street from the White House to Capitol Hill, where Congress is in the process of cobbling together a remarkably irresponsible budget resolution. All talk of slashing costs and streamlining government notwithstanding, this current plan, which is on track for House and Senate approval and thus likely to come into effect, calls for $5.3 trillion in tax reductions and $517 billion in spending over the next decade. That’s a $5.8 trillion addition to the deficit, and it comes at a time when total US public debt, as a percentage of GDP, is close to decades-long highs.

A few disclaimers here. We are old enough to remember when deficits, the “crowding out effect” of paying down interest on public debt and the like were hot topics back in the 1980s (when, as the above chart shows, all that public debt accounted for just 40 percent, give or take, of GDP). The Cassandras of the time warned of chaos that never came, in no small part because the Cassandras of the 1980s did not fully grasp the implications of the globalization unfolding at the time, bringing new demand for US government debt from investors around the globe. Indeed, the ease of funding our increasing borrowing needs over the ensuing decades led to Vice President Dick Cheney’s famous (for better or worse) observation that “deficits no longer matter.”

Not Your Grandfather’s Debt Market

Cheney made those remarks in 2002, noting that while national debt had tripled during the 1980s, the US economy had grown strongly, and bond yields had fallen. He had some facts on his side, in other words. But that was then. In 2002 the “Washington Consensus” – the neoliberal framework for a globalized economy of free trade and free capital movement, centered on the primacy of the US dollar – was in full swing. The 2008 global financial crisis was still six years away, and nobody imagined that the economy of the following decade would be entirely beholden to the tireless machinations of the Federal Reserve and its fellow central banks in preventing the wheels of global growth from coming off.

Today, America’s borrowing needs continue to grow – see “irresponsible budget resolution” above – but the global appetite for American financial products, from Treasuries to the dollar itself – is not keeping pace. Where is the supply of funds going to come from as public debt grows? Just using today’s tax and spending policies as a baseline, economists estimate that federal debt will grow to around 250 percent of US GDP over the next three decades, with interest obligations eclipsing every other budget item. Already, annual interest costs are higher than Medicare, Medicaid and defense obligations. So much for all that “government efficiency” we’ve been hearing about lately.

Ghosts of 1998One likely answer to that question – where is the funding going to come from? – doesn’t give us much comfort. A long and in-depth article in the Financial Times today titled “How the Treasury market got hooked on hedge fund leverage” notes that there is around $904 billion in hedge fund investments engaged in a variety of so-called relative-value trades, which use massive amounts of leverage to exploit small differences in value between Treasury instruments and interest rate derivatives.¹ When those value discrepancies depart from the statistical predictions of the models’ algorithms, bad things can happen. We saw a (mercifully brief) example of this recently when Treasury yields shot up, and  the dollar declined, a few days after the April 2 tariff announcements.

The point here is that some of the major players in the Treasury market are institutions running strategies that are vulnerable to unpredictable shocks. These are not the boring, dependable primary dealers whose presence has been a mainstay of what for most of the last eighty years has been an orderly market with a vast pool of liquidity. Essentially, they are modern versions of the strategies employed by Long Term Capital Management before that august institution got deep-sixed by the Russian debt default in 1998.

So Dick Cheney may have been partially right about the non-consequences of debt and deficits back at the turn of the millennium. A quarter century later, though, we need to be cognizant of the potential consequences and prepared for what could be a persistent level of volatility in what is supposed to be the world’s safest asset. An in-depth review of fixed income allocation strategies and alternative scenarios is a good place to start.

It’s a time-honored ritual in global financial markets: in times of trouble, seek out the safest of safe havens until the storm passes. Treasury securities and the US dollar fit that script – at least they have, prior to the current tempest. Amid the wild volatility on a near-daily basis in the stock market since the ill-fated tariff policy announcement in the White House’s Rose Garden on April 2, the US dollar has plummeted while yields on the safest (supposedly) bond instruments have soared. This sharp reversal from the way things usually work has a number of observers wondering about the long-term fate of the dollar.

The Legacy of 1971

The last time there was a discernible transition from one financial era to another was nearly 54 years ago. On August 15, 1971, then-President Nixon removed the gold exchange standard that pegged the US dollar to $35 per ounce of gold, the exchange rate framework set at the Bretton Woods conference in New Hampshire near the end of the Second World War. Gone for good was the relationship between gold and national currencies that had prevailed for most of the time since the advent of the Industrial Revolution.

Nixon’s closing of the gold window – the “Nixon Shock” in the parlance of the day – had many observers convinced that the days of dollar supremacy were over. The early 1970s was a period in which the hitherto uncontested economic leadership of the United States was challenged, particularly by the rapid rise of Japan and West Germany as viable competitors on the world stage. Inflation had started to tick up in the US by the late 1960s, and a recession in 1970 presaged an even deeper downturn in 1973. Eventually, the 1970s would earn its place in economic history as the decade of stagflation, where anemic growth and persistently high inflation conspired to make life miserable for average households trying to make ends meet and for central bankers trying to implement an effective monetary policy.

The dollar did fluctuate wildly over the course of this decade. But it remained the linchpin of foreign trade, the preferred asset for central banks’ stores of foreign exchange reserves, and the most sought-after currency for black market traders on the streets of Buenos Aires, Jakarta and other emerging markets in their earliest stages of growth. The dollar’s role as the world’s reserve currency was solidified as the 1970s gave way to the Global Age, when finance became the world’s most important industry and US financial institutions bestrode the globe with their dealmaking knowhow and endless pipeline of capital markets innovations. The US trade deficit grew over this time, but a ready supply of foreigners willing to hold US dollar-denominated assets to fund the deficits minimized the potential economic pain.

A Quandary for the Fed

By our reckoning, the Global Age ended for all intents and purposes with the global financial crisis of 2008. That crisis hit the US harder than many other countries, and the dollar index hit its lowest point since the Nixon Shock during the crisis. But the dollar soon regained its footing, losing nothing of its importance to the world economy, as the post-2008 environment came to be dominated by the Federal Reserve. The US central bank was arguably the most important economic entity of the 2010s, with its program of quantitative easing alongside ZIRP – zero interest rate policy – shoring up financial markets and (again, arguably) keeping the economy from tipping back into recession. The Fed reprised its role as the sun around which all else revolves during the Covid pandemic, unleashing a flood of bond-buying at the peak of panic during March 2020 that in turn made the world safe for speculators in any imaginable form of asset, wisely or less so, throughout the pandemic period.

Jay Powell’s Fed broke decisively with this pattern in 2022, when the central bank responded to the highest inflation since the 1970s with a resolute policy of monetary tightening that took interest rates from zero to a high (for the Fed funds rate) of 5.5 percent in just two years. The Fed defied the ceaseless expectations of the bond market that it would throw in the towel and pause or cut rates every time something went sideways somewhere in financial markets. Bringing inflation back down to two percent was, and remains, the central bank’s number one priority.

Which brings us to the difficult moment the Fed finds itself in today. Not only are there serious questions about what is going to happen to inflation given the ongoing chaotic quasi-implementation of tariffs by the administration, but there are even more fundamental questions about the ongoing role of the US dollar and, by extension, the traditional safe haven of the Treasury market. Last week, as we noted in our commentary last Friday, the Treasury market appeared close to having another March 2020 moment before the administration blinked and “paused” most of the April 2 tariffs.

Conditions since then have been somewhat more stable for stocks, bonds and currencies, but volatility and the potential for disruption hang over edgy market sentiment. Will the Fed have to intervene again to facilitate liquidity if the Treasury market goes pear-shaped again? What should the Fed’s policy be (if any) vis a vis a possible dollar retreat from its centrality as the world’s reserve currency? These are questions without clear answers. Sadly the Fed’s independence, which should not be an issue for discussion, is also in the mix. While we do not see a worst-case scenario here as a high probability outcome (that would be a nightmare for market sentiment), we can’t ignore it entirely. Strange times, these.

The thrills and spills of the new world order (such as it is or may be) continued this week with some of the wildest swings in equity markets since 2008. As much as those gyrations in the Dow and the S&P 500 dominated the financial news shows, though, the real action was taking place in the bond market. It was there, in what is often called the plumbing of the global financial system, that a sudden spike in Treasury yields midweek led to the temporary “pause” on the novel and ill-considered tariff program announced last week.

Vigilantes, Of a Sort

A few weeks ago, we made reference in this space to the “bond vigilantes” of a few decades ago – the likes of Salomon Brothers economist Henry Kaufman and his ilk, who bet against bonds (sending yields higher) in reaction to what they considered irresponsible fiscal chicanery coming out of Washington. What we saw this week in the bond market was a bit of vigilante-ism, giving a thumbs-down to the budding trade war, but also something potentially even more concerning.

Because Treasury securities are highly liquid, they are relatively easy to dispose of in the market when you need to raise cash quickly. This week, a number of institutional investors needed to do just that. Plummeting stock prices hastened margin calls, leading financial players highly exposed to short-term market disruptions to unload Treasuries. The spike in yields, shown in the chart above, caused a break in the normally stable fabric between spot yields and Treasury futures for commensurate maturities. Hedge funds are a major player in arcane strategies that aim to profit from the relative value movements between spot and futures prices. When those movements go wonky, as they did earlier this week, bad things happen. The mechanics are complex, but the net outcome is that more Treasuries get sold, and then yields keep going up, and then more needs to get sold in what can turn into a very nasty doom loop.

Shades of 2020

The last time things got this bad in the Treasury market was in March 2020, at the height of the Covid panic. The S&P 500 had fallen by 34 percent from its recent high on March 23 of that year, when the Fed stepped in with a fire hose of liquidity to stabilize markets. But the Fed wasn’t there because of the equity market plunge. It was there because the Treasury market was about to blow up, and the consequences of that would be far, far worse than any damage stock prices could cause. It worked – both stocks and bonds stabilized after the Fed’s intervention, and the “everything rally” in risk assets began.

This time around, though, the root cause of the market disruption was not an exogenous event like a health pandemic. It was a policy decision that had the potential to severely damage the global trading system – a decision of human construction that could be reversed as easily as it was put in place. The “pause” announced Wednesday wasn’t great – it did not include China (and the problem with that is a story in and of itself), it is only for 90 days, and it still leaves us with a much higher average rate of tariffs than we had at the beginning of the year. But it was enough, for the moment at least, to reduce tension in the bond market to a manageable level.

A Lesson About Short-Term Market Moves

You have heard us say over and over again that short-term movements in the market are unknowable. In times of unusually high volatility, like now, the big intraday swings can be either up or down. When the S&P 500 racked up more than twelve percent in losses in the four trading days after the April 2 tariff announcement, the limbic brain was urging sell, sell, sell! But then came the backtrack on April 9, and whoosh – up goes the index by 9.5 percent in less than four hours of trading. The point is – things are going to happen, and we aren’t going to know what those things are until they happen, and they are going to move prices both up and down, often instantaneously. Trying to outguess any of this is a futile exercise. Stay disciplined. As for us we will, to paraphrase Metallica, sleep with one eye open…on the bond market.

So here we are. The Wall Street Journal – not a publication known for any kind of a liberal bias – calls it the “dumbest trade war in history.” And that’s saying something, because there have been some epically dumb trade wars in the past. Take the infamous Smoot-Hawley Tariff Act, signed on June 17, 1930, just eight months after the Crash of ’29, which was supposed to help US manufacturing “bounce back” by creating a wall of protection around domestic industries but instead added more fuel to the conflagration that became the Great Depression. If the tariffs announced on April 2 all go into effect as stated, the average rate this time around will actually be higher than those of Smoot-Hawley.

But from an economic perspective, the Journal is right – these are even dumber, because they aren’t actually “reciprocal” tariffs as advertised by the administration. Cambodia, a poor country, has factories where workers make less than a dollar an hour to stitch together running shoes for export to the US, but Cambodia doesn’t buy a bunch of expensive Nvidia GPU semiconductors from us in return, so according to the blinkered trade logic of this administration, Cambodia deserves a whopping tariff rate of 45 percent because of this bilateral trade deficit. This completely unnecessary trade war is bad for Cambodia, bad for the US and bad for the rest of the world (though we assume the penguins on Heard and McDonald Islands, off the coast of Antarctica, are largely indifferent to the 10 percent tariffs now slapped on them).

When Fear Takes Over

This ill-conceived trade war has put financial markets back into a mode of fear, which means it is time for us to trot out the chart we always come back to in times like these.

Yep, it’s the long-term price performance history of the US stock market since 1929, showing all the good times and bad times along the way. We highlight the five most prominent bear markets – two during the years of the Great Depression, one in the tumultuous decade of the 1970s, and the two bursting asset bubbles of the 21^st century’s first decade. We then list the nine other bear markets – defined as a peak to trough reversal of more than 20 percent – that happened throughout this 96 year span of time.

There are really two main reasons why we think this chart is important for our clients in navigating through times of fear. The first is to show that, even when it has looked like the world was coming apart at the seams, sooner or later things always recovered. How soon? Well, in the case of the Covid-19 pandemic, the S&P 500 fell by 33.9 percent from its high point of February 19, 2020, to the low mark of March 23. It took only five months, though, to regain that high point, which it did on August 18 of the same year.

By contrast, the S&P 500 did not recoup its record high close of 31.86 on September 16, 1929, until 25 years later, on September 22, 1954. That was a quarter-century of depression, war and the early years of postwar reconstruction. Everything else falls somewhere in between those two endpoints. For example, it took about four years after the 2008 global financial crisis for the S&P 500 to regain all the ground it lost during that event.

Getting Back In Is Harder Than Getting Out

The second reason why we think this long-term chart is helpful is because it shows you what happens after the market hits its low point for the cycle – namely, that it starts to go back up, and in a manner typically characterized by large bursts of intraday gains. Here’s the key: being in the market when those post-trough gains happen is incredibly important for preserving your capital over the long term. The problem, of course, is that you never know in advance when that worst day will happen. Fear will keep you tentative and afraid of another shoe dropping – which, to be perfectly honest – often happens. False dawns are a regular feature of these bear cycles. The math is brutal: by the time you decide that things are bad enough to sell out, the market is presumably already down quite a bit from its last high point. But even that decision is easier than figuring out when it’s time to get back in. In the long run, you lose.

Nobody knows how this, the dumbest trade war in history, is going to play out. Much is going to depend on how other countries react. China, for example, has already made a first retaliatory move by matching the 34 percent tariffs on it announced Wednesday with the same level on all products it imports from the US. French president Macron has called for a cessation of investment into the US by his fellow Europeans. The idea that other countries are simply going to bend the knee in appeasement seems unlikely. More likely, we are probably in the early stages of a structural global realignment. There will be opportunities here as well as risks, and we will be looking to take advantage of those wherever possible.

In the meantime, though, we believe that the most prudent action we can take is to remain disciplined and avoid the temptation to give into fear. We will not be shy in communicating with you our views and specific courses of action we are taking as we assimilate more data from the shifting tectonic plates taking place in the global economy. Our commitment to discipline, with an eye always on the specific long-term growth objectives, risk tolerance and income needs of each one of you, will guide these actions.

As the current corporate earnings season winds down, the last companies to report are giving us a preview of what to expect when the Q1 numbers start coming out next month; notably, that consumers are increasingly unhappy with the current state of things and even less happy with what they imagine the state of things will be later on this year. The less happy the consumer is, the less likely she will be to shell out $100 for a pair of yoga pants, a message delivered loud and clear by upscale athleisure wear maker Lululemon in the company’s Q4 earnings report yesterday.

Sour Lemons

Lululemon joins a bevy of consumer-facing companies that have been guiding future sales and earnings lower amid the never-ending uncertainty around tariffs and prices. Nike, one of its main rivals in the athletic wear segment, saw its share price hit a five-year low last week as the company forecast an unexpectedly large drop in revenue, citing tariffs and the potential for a global trade war as distinctly unhelpful to efforts to increase sales. FedEx, widely seen as a proxy for consumer activity (those goods have to get to your house somehow), also flagged consumer caution and general macro uncertainty in its most recent earnings release. Macy’s, Kohl’s and other brick-and-mortar department stores are closing hundreds of locations while others, including of late Party City and fabric & crafts emporium Joann’s have called it quits for good.

Consumer sentiment surveys validate this recent stream of dour reports. The University of Michigan Consumer Sentiment index was revised lower in its final version today, the third monthly decline in a row and the lowest since July 2022, roughly the time when inflation hit a high of nine percent. Of perhaps greater concern is the rise in long-run inflation expectations, which jumped to 4.1 percent in the revised report. Meanwhile, the Conference Board’s Consumer Confidence index, released earlier this week, touched its lowest level in 12 years for the expectations category. Say what you will about how well-informed the average American consumer is, but he or she appears to have a clear understanding about the relationship between tariffs and consumer prices.

Parsing the 4/2 Tea Leaves

At this point, all that chronically confused investors are hoping for next week is some clarity. April 2 is supposed to be the day when all the tariff pieces fall into place; the reality is likely to be far different. Tariffs on automotive vehicles and component parts appear to be the category on which analysts can most confidently hang their hats – 2.5 percent initially then increasing to 25 percent, supposedly with no exceptions (but there is almost never an instance where “no exceptions” apply, so…). Mexico, the EU and Japan top the list of countries most affected by this measure, each with more than $40 billion in completed vehicle exports to the US annually, and another $50-odd billion in components from Mexico alone. But then there are the broad-based reciprocal tariffs, which will vary by country and product type, and probably a separate tariff regime for lumber and pharmaceutical products, and maybe copper, and possibly some kind of a break for China if something good happens with the TikTok situation, whatever that means. So yes, the “fog of war” continues to apply to the trade war.

We expect the growth environment is going to be challenged for some time to come. There are still pockets of relative attractiveness among certain defensive sectors in the market, and prudent diversification among appropriate asset class exposures remains, in our opinion, a better strategy than a knee-jerk retreat into cash. But there is no doubt that these are trying times, for investors, consumers and businesses alike – and they could be so much less trying with just a little more thoughtfulness and discretion from our government policymakers.

At Wednesday afternoon’s press conference following the two-day conclave of the Federal Open Market Committee (FOMC), Fed chair Powell repeatedly invoked two words. Those words were: uncertainty, and transitory. Uncertainty, as it pertains to the inability to make informed decisions about anything when variables like tariff policy change on a near-daily basis. Transitory, as in the likely trajectory of higher inflation resulting from those tariffs. If we could try to distill this all into one statement it might look something like this: We still don’t understand the actual timing or magnitude of the proposed tariffs well enough to make detailed forecasts about their impact – but in principle, the inflationary impact of any such tariffs should be a one-off, short-term phenomenon that will increase prices in the near term but not have long-lasting effects thereafter.

2021 Flashbacks

Powell’s specific use of the word “transitory” awakened the collective muscle memory of the assembled journalists who, like survivors of a bad acid trip, experienced a sudden flashback to 2021. That was the year inflation kicked in from the twin stimulants of pandemic-era fiscal stimulus on the demand side and manufacturing and logistics bottlenecks on the supply side. At the end of 2020 the Consumer Price Index stood at 1.3 percent (year-on-year growth); one year later it was at 7.2 percent on its way to a peak of 9.0 percent by June 2022. Throughout most of 2021 the Fed insisted that higher inflation would be a transitory shock, a brief response to those one-off demand-side and supply-side factors. It was no such thing, of course. Four years later, inflation remains stubbornly above the Fed’s two percent target. Even if the additional inflation created by higher tariffs is transitory – according to the FOMC’s own economic projections released on Wednesday – that two percent target is unlikely to be reached before 2027.

The Uncertainty Is the Problem

The stock market’s hot take from the Wednesday afternoon press conference leaned dovish, meaning more attention paid to “transitory” and less to “uncertainty.” But, as is often the case when investors sleep on it and then reconsider, sentiment in the days since seems to have pivoted back to uncertainty. Observers of corporate earnings reports are hearing the word come up more and more on the quarterly analyst calls. FedEx, a bellwether proxy for general economic sentiment, noted a “very challenging” macro environment and lowered its forward revenue and earnings guidance on – you guessed it – uncertainty during its management call after the market close on Thursday (FedEx stock is down more than 10 percent since this morning’s opening bell as we write this).

It is important to note, as Powell himself did on Wednesday, that the uncertainty is not due to any organic changes in the underlying economy. Yes, consumer spending would probably be slowing somewhat anyway, from the fast pace of recent years but, generally speaking, the US economy started the year in strong shape and is still, based on most current variables, healthy. No, the uncertainty is the product of human hands, and those same hands could choose to take away the uncertainty tomorrow, if they were to so choose (we are of course under no illusion that they will). If you take away the tariffs, you take away the uncertainty and also the resulting threat of higher inflation, transitory or otherwise. In which case Powell could spend his next press conference on other more salutary topics, without the need to invoke on repeat loop those two words.