Tariff tantrums
The front-of-mind topic for investors, now that reporting season is over, is what Trump’s trade wars and tariffs, the potential of an end to AI-related stock leadership, and general volatility mean for the stock market’s outlook. Today we touch on one of the bullish arguments I came across in my readings.
The bullish view is that equity markets are now extremely oversold, a popular take given the rising tide of references to the American Association of Independent Investors (AAII) survey. I wrote in a recent article ‘Should you always be greedy when others are fearful’ that this extreme bearish reading is a sign that markets are about to surge as they have in past episodes of extreme bearishness.
Bullish investors are understandably searching for evidence the market could return to its bullish posture for the remainder of 2025. Notwithstanding the two most recent years’ greater-than-20 per cent gains and the S&P 500’s history revealing only one example of three successive double-digit returning years. Let’s explore some of the arguments being put forward by the optimists, which does not imply we are bearish.
As many readers know, we began the year with the view that provided disinflation, positive economic growth, and ample liquidity were present, which would point toward 2025 being another positive one for investors, albeit not a high double-digit returning year.
If you’ve been watching the markets’ reactions to the latest Trump-inspired-global-order-reconfiguring headlines (also known as doom-scrolling) you might begin to notice this year is remarkably similar to the market’s response during the beginning of Trump’s first term.
Back then, tariffs also sparked short, sharp spikes in market volatility. As investors appear to be doing now, they would respond negatively, digest the news, absorb it, and then move on.
Acknowledging that past years are not a reliable predictor of the future, what are the bulls saying about Trump’s second term and its influence on equity markets?
You may recall, during Trump’s first term, the S&P 500 rose 67.8 per cent on January 20, 2021, noting that period also included the COVID-19 disruption to markets. There were three reasonable pull backs in the S&P 500 during that first term. The first was a little over eight per cent ending in February 2018, the second, a decline of just over 15 per cent ending in December 2018 and the third, a decline of almost 35 per cent upon the outbreak of the global pandemic.
What some may not realise is that every new tariff announcement had the same effect on equities as a tossed pebble into a pond – the ripples were noticeable initially but faded fast. The market also weathered all the noise about inflation and economic doom. Those worst-case scenarios didn’t materialise and the dips became golden buying opportunities. Investors who remained calm picked up stocks at bargain prices.
As Figure 1., reveals, the VIX (Volatility Index) – an index of option implied volatility – you can see that the volatility spikes coincided with tariff announcements during trumps first term.
Figure 1., Trump 2017-2019
Source: RIA, Real Investment Advice
When equity prices drop meaningfully, the sell-off initially appears chaotic, but something useful occurs.
Imagine the S&P 500 is sitting at 6144 points, and investors are expecting one-year forward earnings per share of $306. That produces a market valuation (Price to Earnings) of about 20 times earnings.
Then tariffs roll in, with the net effect of one-year forecast earnings falling to $287 a share. To keep that same 20-times valuation, the market needs to fall to, say, 5,700. That’s repricing in action.
And if that’s all that happens, the bulls argue, the recent selloff this year might have already adjusted prices enough to tempt bargain hunters.
However, those bulls need to acknowledge that tariffs produce geopolitical uncertainty, raise the spectre of sabre rattling, and the consequent fear may also produce a decline in price-to-earnings (P/E) ratios. In that case, not only do earnings per share decline, but investors’ willingness to pay 20 times earnings also fades.
The other thing to remember is that when Trump took office for his first term, earnings expectations were below the long-term trend and inflation was a non-issue. That’s not the case today, which leaves the market vulnerable to disappointment.
A question for the bulls is: how much will tariffs actually hurt corporate earnings this time around? And to what extent does a trade war inspire a recession?
Tariffs are like a tax on imports, and for companies relying on global supply chains, that means higher costs, especially for companies that can’t pivot to alternative suppliers. In Trump’s first term, inflation didn’t spike, and the bearish predictions fizzled out. But today is different. This time, with higher interest rates, businesses might try to pass on rising costs, but inflation-sensitive consumers might result in weaker sales. Earnings could take a hit if companies can’t offset those tariff costs. And don’t forget how blunt tool tariffs are.
Meanwhile, expectations for earnings growth through 2026 are optimistic and above the long-term trend. This is in stark contrast to when Trump took office in 2017. Earnings expectations then were below the long-term growth trend, and market valuations were cheaper – around 18 times forward earnings.
Fast forward to now, and even the rosiest estimates put us at nearly 22 times forward earnings – one of the highest levels since the mid-80s. That’s a lot of optimism vulnerable to tariff-related disappointment.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
