This Time, It Really Is the Tariffs

What Was

Last month, I published “Tariffs Aren’t the True Cause of the Markets Selloff.” At the time, the claim was correct. Until last week, President Donald Trump appeared unwilling to follow through on his campaign promise to impose a 60% tariff on Chinese goods, with 10%-20% levies on imports from other nations. Instead, he advocated piecemeal tariffs): 10% on China and 25% for Canada and Mexico (plus fewer exclusions for the extant steel and aluminum taxes).

Those were no big deal. Stock prices had long anticipated such actions. Investors assumed that, as with his 2016 promise to make Mexico build a wall, the president’s pledge was part bluster, part negotiating tactics—a belief strengthened by his March 5 decision to temporarily exempt automobile parts. The Atlantic voiced the consensus: “The Tariffs Were Never Real.”

The financial markets thought similarly. I made this claim without being able to read investors’ minds—although such an ability would come in handy—but rather based on the evidence that investors weren’t spooked about the possibility of recession. If they had been worried, economically sensitive stocks would have suffered. However, such securities held up well.

Risk-On, Risk-Off

Specifically, I plotted the return of four assets from late February through early March. They were: 1) intermediate-term Treasury notes, 2) US technology stocks, 3) Berkshire Hathaway BRK.B shares, and 4) bitcoin. If recession were a concern, then Treasury notes figured to rally, tech stocks and Berkshire Hathaway—each of which contain economically sensitive businesses—would fall, and bitcoin would do … something.

That is not what happened. Treasuries did eke out a small gain, while tech stocks fell. So far, according to plan. However, Berkshire Hathaway’s price rose. That wouldn’t happen if investors expected a recession. Yes, the company currently holds a great deal of cash, but most of its value comes from its businesses. After all, Berkshire Hathaway was also cash-heavy during the 2008 downturn, yet its shares lost 32%.

That’s not a portrait of a marketplace preoccupied with the effects of tariffs. It instead depicts a simpler cause: profit-taking. The most speculative assets on the list—bitcoin and tech stocks—had soared over the previous two years. Their owners were due to book some of those gains. Late February’s geopolitical chatter gave them a reason to do so, but they weren’t particularly worried about the global economy.

This was a case of Risk On, Risk Off: professional investor slang for a common stock market pattern whereby money temporarily flows from risky assets to safer securities and then back again. Such behavior occurs frequently, generating headlines that veteran investors eventually learn to ignore. No wisdom can be gleaned from those movements, any more than one learns by contemplating the ocean’s waves. (Although doing so can be calming.)

What Is

Last week’s events were something completely different. The president, it turned out, was not bluffing. On Wednesday, April 2, he announced a deep and broad set of tariffs termed “Liberation Day.” Stocks plummeted the next trading day, then fell even further on Friday, after other countries vowed retaliatory actions. The trade wars had officially begun.

Which led to different performances for those four assets. Below are their results for those two days.

This time, Berkshire Hathaway fell along with tech stocks. (If adjusted for the ballast of its cash position, Berkshire performed slightly worse than did the technology-stock index.) Given their reasonably low prices, Berkshire Hathaway’s collection of privately held businesses offers refuge when investors are avoiding speculation, as they did six weeks ago. But when the marketplace seeks economic refuge, Berkshire Hathaway no longer provides protection because many of those businesses are cyclical.

Also worth noting is that bitcoin held up better than the equities. Cryptocurrency typically declines along with stock prices, and did so again late last week, but it resisted the downturn better than not only Berkshire Hathaway but almost all other US equities. That serves as yet another signal that investors were preoccupied with the prospect of recession, which hurts corporate profits but not (of course) crypto’s nonexistent cash flows.

Although we cannot interview the marketplace, it nevertheless reveals its intention through the numbers.

A New World

My earlier article ended on a reassuring note:

Because current performances owe to the marketplace disruption that arises from risk-on, risk-off conduct, rather than a careful assessment of the economic impact of tariffs, the downturn could be brief.

I will not write the same today. President Trump’s Liberation Day tariffs are the most radical economic proposal of my lifetime. If enacted, they will reverse a 75-year trend of increasing free trade and mutual cooperation among the world’s developed nations. The global marketplace would begin a new era.

Which means that unless the president sharply reverses course, the current investment rules may no longer apply. For more than 40 years, US equity investors have benefited from buying on dips. The last time that tactic failed with any regularity was during the 1970s and early 1980s, when the previously unknown condition of stagflation confounded the marketplace.

We now face another unknown condition: high global tariffs. How that circumstance will play out is anybody’s guess. But it would be rash to assume that recent stock market history will repeat.