Stagflation's Now the Baseline Scenario
Tariffs are a growing headwind for economic growth and a headache for investors; here's how I'm handling them.
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Equities started off on a promising note on Tuesday after a mixed closed on Monday. Early enthusiasm pushed the Dow up over 1,000 points Tuesday. But stocks weakened in the second half of the trading day and the relief rally went completely kaput by market close. The Dow ended up down 320 points, a huge swing for the day. The Nasdaq fell just over 2%, and the S&P 500 dropped nearly 1.6%. The trigger for the reversal was fading hopes for any progress on the tariff front.
It certainly didn’t help that the yield on the 10-Year Treasury surged to close at 4.3%. The WTI oil benchmark also dropped a further 4% to push significantly below the $60 level on increasing worries around the global economy. The markets desperately need some positive news on the trade front to break out of this increasing sense of impending doom. Whether that is the postponement of some tariffs while trade negotiations are more fully engaged on or agreement of a framework for a new trade deal with one or more trading partners is irrelevant. Investors just need something, anything, to break from the current feeling of hopelessness.
I have highlighted my view that the country looked likely to be heading toward Stagflation many times over the past few quarters in this column. With the recent deployment of new tariffs, Stagflation is now the baseline economic scenario. The only questions are how fast the economy slows in response to tariffs and what the uptick to inflation they will usher in. The economy is giving mixed signals right now. The jobs numbers on Friday came in much stronger than expected and the Inland Empire PMI reading just spiked to its highest level since early 2021. One could argue those are backward looking figures to some extent.
Investment banks like Goldman Sachs and JP Morgan have pushed up their probabilities of a U.S. recession significantly since new reciprocal tariffs were announced last Wednesday. Unless there is significant movement on the trade front in the next few weeks, I fear a recession is increasingly unavoidable. The other key question is to what extent new tariffs will boost inflation. That is a bit of a moving target to project given how fluid this situation has become.
In addition, importers might wring some concessions from their suppliers to minimize the cost hikes to their customers. They will likely eat some profit margin themselves rather than risk losing orders. The American consumer was already under considerable pressure before these new tariffs. It will be interesting to see what part of the additional tariff charges will be able to be passed on, before the consumer buckles or trades down further.
An uptick in inflation, despite rapidly slowing economic growth, really puts the Federal Reserve in a huge bind. The market was counting on some additional rate cuts later this year. If those hopes fade further, equities could easily have another significant leg down.
Given this uncertainty, I continue to slowly and incrementally put new money to work in my portfolio -- mostly via covered-call orders on stocks that have reasonable valuations. Ending on a brighter note, there are a lot more of those targets to choose from after the big pullback in the markets. That is the one caveat with getting considerably lower entry points, they always come with stipulations. Or as the saying goes "when you really should be buying stocks, you will not want to."
We are not quite at that point yet, but it feels we are getting closer as investor anxiety continues to ratchet up.
At the time of publication, Jensen had no position in any security mentioned.
