Recession Fears, Yet Again
After finally dispelling lingering fears of recession evident in an inverted yield curve for almost three years, tariffs quickly revived those concerns. Even so, the economy continues to motor along and many governments are trying to negotiate deals to avert large tariff increases. No government wants to precipitate a recession intentionally or damage their economy’s growth prospects, even if they wish to exude bravado in the hopes of extracting a “good” deal. It may take several weeks or even some months to work out the new arrangements, but it is timely for investors to take advantage of the mispricing of some securities created by the carnage.
First, let’s consider the likely damage to the economy. Imports surged artificially before the tariffs took effect, as was evident from the 41% rise in imports that produced a 0.3% decline in Q1 GDP. (Imports enter GDP calculations with a negative sign.) But final sales rose more than 3%. Q2 GDP is likely to produce a mirror-like surge as imports plunge. If imports remain depressed because of tariffs, U.S. consumers will need to find alternative sources for some products, which may not exist. Even so, I have the utmost faith that U.S. consumers will find other items to purchase with their unused buying power. That buying power will be reinforced by the decline in energy prices with crude below $60. Some kids may be disappointed they do not find plush toys under their Christmas trees this year, but that will hurt the Chinese economy far more than our economy. More seriously, higher cost imported car parts will drive up vehicle prices. But keep in mind that labor costs are the largest component of building a car, so the retail car price rise will be somewhat muted and more domestic models will be sold, helping the domestic economy. The increase in tariffs will act like a tax increase, slowing growth, but the substitution of domestic goods for imported products will provide a meaningful, but now indeterminant, offset. The net effect will be a headwind to growth, but likely only a muted one. So, growth is likely to continue, even if it is a bit slower.
As long as the economy doesn’t lapse into recession, which still seems unlikely, it is still timely to think about how to take advantage of the turmoil. Precipitous market declines always create price mistakes. All of the citations of the damage wrought by the Smoot Hawley tariffs of the 1930s exacerbated or promoted fear, which never leads to good investment decision making. Fearful investors rushed for the exits and sold what they owned regardless of the prices. Stocks are volatile, so investors are always nervous and it doesn’t take much to scare people. So, such downdrafts occur incredibly often. There’s always an excuse or triggering event, but such behavior persists anyway. Expensive stocks may (or may not) get cheap, but cheap stocks commonly get either somewhat cheaper or silly cheap and perceived safe havens become relatively expensive. And those safe havens become relatively overvalued unless the market’s worst fears are realized, which rarely happens. The market has already come to recognize that its worst fears are unlikely to be realized, so much of the tariff plunge has already been reversed. But while the averages have reversed from the sell-off following the tariff announcements, the rebound is uneven, as was the decline. And stock prices are still well off their Q1 highs. So, there are still opportunities to be uncovered, which we have been seeking since the tariff announcements.
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