While tariffs collect headlines as they rattle markets, I would offer two additional factors that have contributed greatly to the most recent market turmoil. The first is confidence. By changing the world order, confidence has been shaken. Markets are forward-looking discount mechanisms, meaning they make assumptions about the future state of earnings and then assign a probability via a price multiple to that outcome. The greater the confidence the higher multiple. At this point, we have very little to determine what this new tariff world will look like one week from now, never mind one year from now. To what extent will earnings be impacted, in which countries and in what sectors? It’s hard to tell at the moment. As a result, the reaction is to assess this as an increase in risk, and the price needs to be lower to create a higher future return to compensate investors for that increased risk.
The second, and perhaps more important factor, is that U.S. markets are essentially priced to perfection. The consensus entering the year was for 20%+ earnings growth assigned to a CAPE ratio of ~37x, twice the historical average. In environments priced for perfection, anything less than a perfect outcome can lead to price declines. With time we will have clarity. That will lead to restored confidence and the volatility will pass. Long-term earnings will not be zero. Recessions, if there is one forthcoming, are normal parts of a business cycle. This too shall pass. Until then it looks like a bumpy Monday.
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