You Can’t Eat A Sandwich Without Dijon
Greetings from SOUND Wealth Management Group (SWMG). We hope this Note finds
you well! Although we are only a quarter into 2025, and we believe the odds favor “tariff”
being the “word of the year.” Due to our headline driven news, people are not liking the
word, but did people love the name Blanche the first time they heard it? In this Note we
hope to provide some education on tariffs, some historical economic data, and our views on
navigating the equity market in the coming months.
The waterfall drop in the equity markets have been dramatic and for those paying attention to
the very short-term news (Availability Heuristic*) might find themselves compelled to react by
selling their ownership in companies to “stop the pain.” So, let’s look to historical statistics to
get a playbook. First, the following figures are of the S&P 500 (the ‘market’), so it represents
a very broad-based diversification of all 500 of the largest public companies - taking the
good balance sheets with the bad – so these numbers do not reflect the choice of better
balance sheets, or other metrics, over others. The market open on April 3, 2025 (“Liberation
Day” although the effective date is April 9th) opened down -3.1% (a “gap down”). This
was the 7th largest down-gap in four decades – see Chart 1. You will note that 70% of the
largest gap-downs occurred during the COVID-19 peak sell off. The median and average
forward 6 month return from the top 20 gap-downs was nearly +20%; based on the close
on April 3rd (far worse than the open) an average 6-month recovery would put the S&P
500 around 6,465 – well above the all-time high put in just 35 trading days ago. There is a
very important adage in investing: buy low and sell high. We’ll focus on the first half: “buy
low.” It is important to note in investing that the adage is not: “SELL LOW.” There is certainly a
great deal of uncertainty which leads our behavior to want to gain control of something, and
selling may feel like the situation has been triaged, but investing (not trading) requires a long-term
view. Using the past 4 decades of similarities with a 90%-win ratio leads us to believe
that, although it may be bumpy, we have a high probability of new market highs in 2025 –
could this be off by a few percentage points or months this time – perhaps, but we suspect
equities will find similar footing.
* The Availability Heuristic is a bias to believe that with mass media, and individual can
understand information based on large samples of statistics and facts when in reality and
individual is more likely to believe something is commonplace if they can find just one
example of it.
Chart 1; Source: Bloomberg
Both the COVID shutdown and the current tariff plans are global in nature. See Chart 2 that
shows the significant market drop in early 2020. Some investors chose to sell in March 2020
to stop the paper losses (among other reasons). Chart 3 shows the market for the past 10
years (which includes the 2020 selloff – looking minuscule as we broaden the view). Those
who sold good companies in the Spring of 2020 memorialized losses and missed returns
that are rarely repeated. We are not calling a bottom here (technical analysis would suggest
another low put in the coming days before a bottom, but fundamentals indicate – as Chart
3 suggests – that the upside appears much greater than the downside), but we do lean on
historical data (regardless of the reasons as there are many) to model valuations and fair
market values…
Chart 2; Source: Thomson ONE
Chart 3; Source: Thomson ONE
Following the market everyday can lead some investors to whipsaw reactions such as the
intra-day move that we saw on April 7th – and we could see more volatility like this in the
days and weeks to come. However, like we said in our SOUND Note (The Pitch), we might
want to brace ourselves for the potential for upside surprises instead of memorializing losses
at market lows only see significant rallies. Data compiled by FundStrat (Chart 4) shows that
since the inception of the formal S&P 500 there have been only 5 instances of the market
declining more than 4.5% on two consecutive days. The statistics show that there has been a
100%-win ratio after 12 months with an average forward return of 34.3% placing the S&P
500 at 6800 a year from now, or +16% on a one year and a quarter return – which would
be better than the expected forward return relative to historical averages. IF this does play
out, we are experiencing a lot of noise around textbook market undulations; a 10 – 20%
decline every 3 years (last occurred October 2022 [check]), and a market that averages a
high single digit return per year [2025: t.b.d].
Chart 4; Source: FundStrat
We do know that the market tends to demonstrate a “V” shaped recovery during market
routs – often an overreaction to the downside and a realization that (financially) things were
probably not as bad. See Chart 5 that shows the shape of the decline and recovery of every
major selloff since 1920 (which would include the most major of modern events in the equity
market).
Chart 5; Source: FactSet
The recent market selloff is rooted in the impact of tariffs on markets. If one looked at the
current balance sheet of the United States and the impact on the future taxpayer they would
clearly see something needs to change. (Chart 6).
Chart 6; Source: USDebtClock.org
It is estimated that only 52%** of Americans (outside of qualified plans/pensions) do not
own stocks, but almost all Americans consume everyday goods and aspire to tangible asset
ownership (e.g. a home). Harken back to Chart 6 The median income in the U.S. is
$43,561.00, the median new home is $416,854.00, and the average 30 year conforming
new mortgage rate is 6.72%; the old American Dream of home ownership is insurmountable
for the ‘averages.’ The U.S. Government owes $36T – equating to every taxpayer having an
obligation of $323,048 (and growing) – add this to your personal
“IOU.”
There are a few mechanisms to fix this situation – all of which require a difficult adjustment…
cut spending, refinance the debt interest, and increase revenues are leading solutions, and
using all of them at once expedites the resolve.
What tools might this Administration have? Pressure on the stock market leads investors to
buy risk-free assets (the U.S. 10-Year Treasury). This, in turn, leads to a drop in long-term
interest rates. Remember, the Federal Reserve only controls the short-end of the yield curve
– which does influence the long-end, but not the other way around. By having the ‘market’
do the bidding (pun intended) the 10YR yield has dropped from 4.80% (January 14, 2025)
to a low of 3.8% (April 4, 2025) – a 20.83% decline in rates. These rate declines should
influence the FED to cut the short-end, and the market is now pricing in 4 rate cuts for the
remainder of 2025 (essentially pricing in a minimum of a 100bps cut this year). These rate
cuts help borrowers who may purchase a car or home, corporations who have large capital
expenditures that are financed, and the re-financing of borrowing (e.g. resort to Chart 6
the U.S. debt at $32T – costing over $1T per year in interest payments). To put in relatable
terms: You have a job that pays $500,000 per year (far greater than the U.S. median),
you have $3,600,000 in debt, and you have $700,000 in bills each year and half of
that goes towards your minimum payment on your debt (that is compounding higher). It
is insurmountable. We are not suggesting that the current Administration intended to put
pressure on the equity markets to influence rates, but it appears that it did get that outcome.
As part of the negotiation tactic, “go big, or go home,” the current Administration as elected
to start with a much broader tariff on nearly 180 countries. Figures are ranging from 10% to
48% on these countries with the option to increase on any reciprocal tariffs. Goldman Sachs
Economic Research (Chart 7) calculated that the net weighted reciprocal is 12.6% - this is due
to many carve-outs and exclusions such as semi-conductors and energy products. The 12.6%
figure is not far off from what the 10-year average import tariff collection ratio would be if
dutiable and duty-free imports were both collected (Source U.S. Department of Commerce).
Chart 7; Source: Goldman Sachs Research
Although tariffs have existed for a long time, few recognize the extent of the divergence in
“free-and-fair” trade. Since autos have been a talking point, take the U.S. Ford Mustang.
This vehicle costs $32,000 in the United States while the exact same car cost $65,000 in
Germany. Have you ever seen a Ford in Germany – probably not due to a 105% markup.
These countries now have a few options: retaliate – which are expected to be met with equal
reciprocal tariffs, do nothing and rollover, or negotiate. The latter began as soon as April
4th with Vietnam (Chart 8) and we suspect no country wants to be the last at the negotiating
table. Where China continues to escalate, many other countries have already started with a
‘zero-for-zero’ trade deal.
Chart 8; Source: Reuters
We do not have to eat the whole horse a once (even if Jay Reimenschneider does). As of the
morning of April 8th, 2025, it has been reported that over 70 countries have reached out to
the current Administration to discuss bilateral trade agreements.
The estimated annual value of collection on tariffs (if there were fully collectable – a question
for another day) is $600B. Our best estimation is that roughly half of this figure will be
passed on to the American consumer – leading many to view this as a tax. This rudimentary
belief has led many talking heads to stoke the “recession” fear – remember, statistically, a
recession happens every four years; a 25% probability in any given year. We at SWMG do
not believe the tariffs would be a root cause of a recession for a multitude of reasons (we will
not rule one out due to a cacophony of other factors that may come into play). First, it should
be known that tariffs already existed prior to the current negotiations, and if tariffs themselves
caused recessions, then, logically, the highest offenders should support this claim. India,
Indonesia, China, EU have not indicated a recession based on the tariffs that already existed
for decades, and we have not traced any recessions to these countries due to their past tariffs.
Few have paid attention to who charges what for the parts on their Schwinn Stingray.
Cutting the bike down the middle, we can find ways to wash out the approximate $300B
(if no negotiations take place) “tax” on the U.S. consumer. Since the tariff talks began in
2025, crude oil has dropped nearly 30% - our ‘back of the napkin math’ translates to $150B
of annual savings. Over the same period of time, interest rates have declined 100bps –
providing $35B in corporate floating-rate interest, and $125B in consumer mortgage interest
– all equating to roughly $300B in savings to offset the tariffs, and we have yet to get the
Administration’s tax reform (no tax on social security, no tax on tips, interest deductions on
U.S. autos, corporate tax deduction) which should put more money in “Mainstreet’s” pockets.
During market volatility we expect the bond market to swing as well, and we cannot yet
bank on the long-end remaining below 4% until the FED provides their next lending rate –
expected in May.
We suggest we give the tariff negotiations some time… de-escalation can have a huge
impact on a recovery to the equity market. On April 7th we witness the potential of this with
only a rumor. The S&P 500 was down more than 4% in early trading which was quickly
reversed to be up over 4% (intra-day) on the rumor of a 90 day pause on tariffs; on a rumor
of a pause (not a full negotiation or resolution) we saw an +8% upswing in minutes! Once
the rumor was discredited, the market settled into being relatively flat on the day – we would
consider this good news as market participants recognized that they might miss out on a
rally when/if actual trade negotiations begin. The path of the trade deficits might be more
important than the outcome; the deficits do not necessarily need to reach net zero to be
considered a win for the current Administration – as we saw with NAFTA.
We had further confirmation that a turn may be on the horizon with one of our favorite
contrarian indicators, Jim Cramer (Chart 9), calling for another “Black Monday” on April
7th. (Black Monday was October 19, 1987, when the market declined 22% in a single day).
The S&P 500 closed -0.23% (not 23%; a quarter of a percent) on Monday April 7, 2025; it
wasn’t another Black Monday or #OrangeMonday. Truthfully, the longer the delay in trade
negotiations, the higher the probability of a needless recession and the fiscal stimulus required
to offset this scenario is roughly 2-3% in Government spending – negating the benefit to the
trade and budget deficit all together; we suspect this Administration would need to be avoid
this path.
Chart 9; Source: Bing.com Search
Lo and behold, as we were finishing up this SOUND Note (written between April 3rd and
April 9th, 2025) we got confirmation of the rumor for a 90 day pause on countries that have
begun to participate in trade talks. The market traded down nearly 1% around the open on
April 9th. President Trump’s Truth Social post around 10am read: “BE COOL! Everything is
going to work out well. The USA will be bigger and better than ever! THIS IS A GREAT TIME
TO BUY!!!” – apparently THEE buy signal because around 1:15pm on the same day he
“authorized a 90 PAUSE, and a substantially lowered Reciprocal Tariff during this period,
of 10%, also effective immediately.” Chart 10 shows the market reaction of a +9.52$ day
making is the best single day return in 17 years and the second best return (ever) for the
NASDAQ . Imagine stringing a few positive days like April 9th together before considering
extracting equity positions; anecdotally, we know a few who were contemplating this in the
morning. The shift was so jarring that within a one-week period Goldman Sachs Research
lifted and then lowered the recession probability (DEFCON 3 -> DEFCON 4 -> DEFCON 3).
Chart 10; Source: ThomsonOne; April 9, 2025 Intraday (1-minute)
We understand the headlines have been dramatic, and the more we look, the more we may
confirm this belief. However, we have shown that although the reasons may have been
different, good companies (and therefore the market) do recover from these market routs and
the probabilities favor another “V” shaped pattern. We do not suspect the markets will get
more regulated, so the S&P 500 should remain a free and open market to regain order and
allow cooler heads to prevail (“BE COOL”)– perhaps we are just on the cusp of a new wash
cycle. The current trade scenario is bad enough, so we suspect most of this is already baked
into the market cake. Typically, equities are pricing in 6 months into the future, so as we start
to get trade deals, we should expect the market to start pricing in better earnings than the
current revisions down and the tailwind benefits of tax reform.
We hope this SOUND Note has given you a different perspective than the prevailing
mainstream financial reporting and that you found it valuable. We put a lot of time and
research into these Notes, and we sincerely thank you for reading! We hope to always be
a voice of reason and a sounding board in a world of erratic and irrational markets. To that
end, we welcome any conversations about this Note and look forward to speaking with you
soon.
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** PEW Research Survey Source: More than half of U.S. households have investment in stock market | Pew
Research Center
The S&P 500 is an unmanaged index of 500 widely held stocks that are generally considered representative
of the U.S. stock market. Inclusion of this index is for illustrative purposes only. Keep in mind that individuals
cannot invest directly in any index, and index performance does not include costs or other fees, which will
affect actual investment performance. Individual results will vary.
