Three Things That Could Ease Tariff Jitters

Summary

Thoughts on the Market: Three Things That Could Ease Tariff Jitters

Hosted by Morgan Stanley

Episode Information:

• Title: Three Things That Could Ease Tariff Jitters
• Release Date: April 8, 2025
• Description: Short, thoughtful, and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.

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Introduction

In the April 8, 2025 episode of Thoughts on the Market, Morgan Stanley's Chief Investment Officer and Chief U.S. Equity Strategist, Mike Wilson, delves into the current equity market landscape, focusing on the repercussions of recent tariff announcements and potential pathways to alleviate market anxieties surrounding these tariffs.

Market Overview and Tariff Impact

Mike Wilson opens the discussion by contextualizing the recent market reactions to tariffs, noting that last week's Liberation Day acted more as a "cherry on top for a market that had been dealing with multiple headwinds to growth all year" rather than serving as a fresh catalyst for decline. He observes that despite the tariffs being more severe than anticipated, the stock market's response seemed subdued because many equities had already been declining significantly prior to the tariff announcements.

[00:45] Mike Wilson: "While the magnitude of the tariffs turned out to be worse than our public policy team's base case expectations, the price reaction appears capitulatory to us given that many stocks were already down 30 to 40% before the announcement on Wednesday."

Wilson highlights the breach of the S&P 500's 5,500 first-half support level, which subsequently led to the consideration of new technical support levels, potentially as low as the 200-week moving average at 4700. This technical shift underscores the deeper market vulnerabilities being exposed.

Cyclical vs. Defensive Stocks Performance

A significant portion of the discussion centers on the divergent performances between cyclical and defensive stocks. Wilson points out that cyclical stocks have been underperforming since April of the previous year, now down over 40% relative to defensive counterparts. This trend, he asserts, is indicative of the market's long-standing anticipation of a slowdown in growth.

[02:15] Mike Wilson: "Markets have been telling us for almost a year that growth was going to slow and since January it's been telling us it's going to slow significantly."

He emphasizes that such underperformance mirrors conditions typically seen during a recession, aligning with Morgan Stanley's view that the private economy has been underwhelming compared to headline figures. This weakness is attributed to unprecedented fiscal spending, AI capital expenditures, and affluent consumer spending fueled by asset price gains.

US vs. Foreign Equities Outlook

Wilson discusses the implications of declining fiscal spending and its impact on global growth. He posits that while the US may experience a "diet or detox from fiscal spending," foreign stocks are unlikely to offer substantial safe haven due to similar global growth constraints.

[03:05] Mike Wilson: "Hence, foreign stocks are unlikely to provide much of a safe haven if the US goes on a diet or detox from fiscal spending."

Despite the global headwinds, Wilson maintains an optimistic view for US equities relative to foreign markets, particularly highlighting vulnerabilities in China, Europe, and Japan due to their significant current account surpluses.

[03:30] Mike Wilson: "Therefore, I remain of the view we discussed two weeks ago that US equities should trade better than foreign ones going forward."

He also critiques the inflation of employment and GDP figures, attributing them to government-related jobs and low-wage immigrant hiring, which have obscured the underlying economic weaknesses.

Equity Market Dynamics and Strategies

Wilson characterizes equity markets as "discounting machines" that often price in future events well in advance. He notes that the market correction is well advanced, suggesting that the current downturn is not the optimal time to sell equities.

[04:00] Mike Wilson: "Bottom line, Equity markets are discounting machines and they trade six months in advance of the headlines. With most stocks topping in December of last year and cyclicals relatives performance peaking almost a year ago, this correction is well advanced and this is not the time to be selling."

However, he acknowledges that the recent tariff announcements have introduced greater tail risks, including the possibility of a recession and financial contagion. This necessitates careful consideration of market levels and risk management strategies.

Three Scenarios to Ease Tariff Jitters

Concluding the episode, Wilson outlines three specific scenarios that could establish a more durable market floor and alleviate tariff-induced jitters:

1. Delay in Tariff Implementation:

   • Scenario: President Trump postpones the effective date for additional tariffs beyond the initial 10% already in effect.
   • Impact: Immediate relief for affected sectors, reducing market anxiety and allowing time for adjustment.

2. Federal Reserve Support:

   • Scenario: The Fed provides explicit or verbal support for the markets.
   • Impact: Bolstered investor confidence through assurance of liquidity and monetary policy backing.

3. International Negotiations:

   • Scenario: Multiple nations engage in negotiations to agree on unfavorable terms for the United States, potentially easing trade tensions.
   • Impact: Reduced tariff pressures and stabilization of international trade relations, enhancing market stability.

[04:10] Mike Wilson: "I see three specific scenarios that could put in a durable floor more quickly. Number one,...Number two,...and number three,..."

Conclusion and Forward-Looking Optimism

Despite the current headwinds, Wilson maintains an optimistic outlook for the second half of the year. He anticipates that growth-negative policies may transition into growth-positive ones through measures such as deregulation, improved fiscal trajectories, lower interest rates, reduced taxes, and potentially higher wages for American consumers.

[04:20] Mike Wilson: "I remain optimistic that the second half will be better than the first as these growth negative policies morph into growth positive ones via deregulation, a better fiscal trajectory, lower interest rates and taxes, and maybe even higher wages for the American consumer."

He advises investors to brace for continued market volatility while keeping an eye on long-term positive shifts that could underpin market recovery.

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Key Takeaways:

• Market Sentiment: Tariff announcements have exacerbated existing market vulnerabilities, but the overall correction is advanced, suggesting less urgency to sell.
• Stock Performance: Cyclical stocks' significant underperformance signals anticipated economic slowdowns, while defensive stocks offer relative stability.
• US vs Foreign Equities: US equities are expected to outperform foreign counterparts due to unique domestic advantages amidst declining global fiscal spending.
• Risk Management: Investors should consider scenarios that could stabilize the market, including tariff delays, Fed support, and international negotiations.
• Optimistic Outlook: Potential policy shifts in the latter half of the year may foster a more favorable growth environment.

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Transcript

[A]

Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley CIO and chief U.S. equity strategist. Today on the podcast I'll be discussing equity market reactions to the tariffs and what to expect from here. It's Tuesday, April 8th at 11:30am in New York, so let's get after it from our perspective, last week's Liberation Day was more like the cherry on top for a market that had been dealing with multiple headwinds to growth all year, rather than the beginning. While the magnitude of the tariffs turned out to be worse than our public policy team's base case expectations, the price reaction appears capitulatory to us given that many stocks were already down 30 to 40% before the announcement on Wednesday. As discussed in last Week's podcast, our 5,500 first half support level on the S&P 500 quickly gave way given this worse than expected outcome for tariffs. The price action since then has forced us to consider new technical support levels which could be as low as the 200 week moving average and that would be 4700 on the S&P 500. I think it's worth highlighting that cyclical stocks started underperforming in April of last year and are now down more than 40% relative to defensive stocks. In other words, markets have been telling us for almost a year that growth was going to slow and since January it's been telling us it's going to slow significantly. In fact, cyclicals have underperformed defenses to a degree only seen during a recession, not prior to them. This fits very nicely with our long standing view that most of the private economy has been much weaker than the headline numbers suggest, thanks to unprecedented fiscal spending, AI Capex and wealthy consumers spending their gains from asset prices. With the exceptional fourth quarter surge in US fiscal spending likely to decline even without Doge's efforts, global growth impulses will suffer too. Hence, foreign stocks are unlikely to provide much of a safe haven if the US goes on a diet or detox from fiscal spending. Markets began to contemplate such an outcome with last week's announcements. Therefore, I remain of the view we discussed two weeks ago that US equities should trade better than foreign ones going forward. That's especially the case with China, Europe and Japan, all which run big current account surpluses and are more vulnerable to weaker trade. Meanwhile, the headline numbers on employment and GDP have been flattered by government related jobs and the hiring of immigrants at below market wages. This is one reason the Fed has kept rates higher than many businesses and consumers need and why we remain in an economy of haves and have nots. Our long standing thesis is that the government has been crowding out much of the economy since COVID and arguably since the great financial Crisis. It's also why large cap quality has been such a consistent outperformer since the end of 2021, and why we have continued to have high conviction in our recommendation to overweight these factors despite short periods of outperformance by low quality cyclicals or small caps like last fall when the Fed was cutting interest rates and we pivoted briefly to a more pro cyclical recommendation. Bottom line, Equity markets are discounting machines and they trade six months in advance of the headlines. With most stocks topping in December of last year and cyclicals relatives performance peaking almost a year ago, this correction is well advanced and this is not the time to be selling. However, it's fair to say that the tariff announcements last week have taken us to an area with greater tail risk that includes a recession and financial contagion, and that must be taken into consideration when thinking about levels and adding risk. I see three specific scenarios that could put in a durable floor more quickly. Number one, President Trump delays the effective date for the implementation of the additional tariffs beyond the initial 10% that went into effect this weekend. Number two, the Fed offers support for markets either explicitly or verbally. And number three, a number of nations come to the table and negotiate unfavorable terms to the United States. In short, get ready for another bumpy week and remember markets are looking much further ahead than today's headline. I remain optimistic that the second half will be better than the first as these growth negative policies morph into growth positive ones via deregulation, a better fiscal trajectory, lower interest rates and taxes, and maybe even higher wages for the American consumer. Thanks for listening. If you enjoy the podcast, leave us a review wherever you listen and share thoughts on the market with a friend or colleague today.

[B]

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