The Silver Lining in Trump’s Tariff War

Roger Montgomery | Montgomery Investments

Trump’s first hundred days have been defined by a bombardment of declared emergencies, liberation days and disconcerting and apparently chaotic executive orders, perhaps designed to overwhelm and distract the media and opposition but certainly destabilising for investors.

Bypassing Congress, Trump has imposed unprecedented tariffs on the world and his neighbours, Mexico and Canada.  He deported suspected illegal migrants without due process by first deploying the Alien Enemies Act of 1798.  He gave an unelected billionaire authority to sack vast swathes of government employees and officials, and perhaps more destabilising than anything else he has attempted, to turn the old-world order on its head by embracing Russia’s Vladimir Putin, withdrawing support for Ukraine, offering to redevelop the Gaza Strip and inspiring a global trade war.

Right on cue, the S&P500 fell 19 per cent in one of the fastest declines since the 1950s. It's enough to make any investor’s head spin, and we have seen a consequent flurry of applications for our private credit funds by those seeking to avoid stock market volatility altogether.

But this is not a crisis, financial or otherwise.  It is a short-term shock driven by uncertainty.  Importantly, such shocks usually reverse when the peak of that uncertainty has passed. While the tariffs haven’t been repealed, I currently believe the final picture is unlikely to be as bad as the worst-case scenario envisaged initially. That can be enough for equity markets to recover quickly and meaningfully.

So, let’s look at the data—the same data Trump is conceivably being shown, and that might inspire a decision by him to step back from the precipice.

There’s no question the U.S. economy faces a critical juncture as Trump’s tariffs, particularly the 135% levy on Chinese imports, threaten to push it into a stagflationary spiral. Most investors are now focused on the dangers, and if they haven’t sold already, they will use the recent bounce as an opportunity to exit. We have seen clients doing exactly that.

However, a contrarian approach may prove more rewarding, as compellingly weak economic indicators might force President Trump to retreat from the most extreme versions of his tariff policies. This recalibration could stabilise markets and pave the way for a robust rally in equities, as investors find relief in the passing of the worst-case scenario.

Current economic indicators paint a stark picture of the tariffs’ impact. Goldman Sachs forecasts U.S. GDP growth at a mere 0.5% for 2025 if tariffs rise by 15 percentage points, but the 20-point increase already in place points to a mild recession akin to 2001. Loomis Sayles predicts zero growth, underscoring the economy’s vulnerability. Of course, any such contraction would erode political capital, pushing Trump to soften his stance to avoid being blamed for a downturn.

Meanwhile, former Deutsche Bank Chief Economist Torsten Slok, now chief economist at Apollo Global Management, warns of a 90% chance of a “Voluntary Trade Reset Recession,” characterised by stagnant growth and rising inflation. He places the U.S. economy in a period of stagflation, where few assets thrive. With inflation expectations surging to 6.7%, Trump may face pressure to curb tariffs to tame price pressures and restore economic stability.

Elsewhere, S&P 500 earnings expectations are seeing their sharpest downward revision since 2020. Industry leaders like Southwest Airlines’ CEO Robert Jordan describe conditions as recessionary, while Chipotle and PepsiCo report consumers cutting back to save money. Plummeting new orders, collapsing container ship traffic, and a projected halt in China-U.S. trade by mid-May signal a corporate crisis. These red flags could also compel Trump to ease tariffs to prevent widespread layoffs and bankruptcies, especially among small businesses that employ over 80% of the workforce.

The University of Michigan’s consumer confidence survey reported an 11% plunge in early April, with sentiment at pandemic-era lows. Fears of job losses and deteriorating business conditions are universal across demographics, with a record-high share expecting worse economic conditions. Rising credit card delinquencies and minimum payments also reflect financial strain amongst consumers. Trump is nothing if not extremely sensitive to public sentiment, and the devolving consumer picture may prompt him to scale back tariffs to restore consumer optimism and avoid political backlash.

According to the Federal Reserve’s Manufacturing Prices Paid survey, input costs are spiking while new orders are contracting. U.S. heavy truck sales hit their lowest level since the pandemic, and container ship traffic from China is expected to “come to a stop” by mid-May, with haulage demand collapsing by late May. These disruptions threaten small businesses, which lack the resources to absorb the tariff costs. Again, Trump’s economic advisors may highlight these risks, pushing for a phased tariff approach to avert supply chain chaos.

Goldman Sachs believes the U.S. Federal Reserve will be forced to cut rates by 200 basis points in 2025 to counter an economic slowdown, but persistent inflation from tariffs could limit the Fed’s ability to act. Notwithstanding the war of words between Trump and the Fed’s Chair, Jerome Powell, this constraint may force Trump to moderate tariffs to avoid a scenario where monetary policy cannot offset economic damage, preserving his administration’s growth narrative.

Beyond economic data, political and policy dynamics further suggest Trump may back off. Trump’s recent 90-day freeze on reciprocal tariffs and overtures toward trade deals with multiple countries indicate flexibility, if not a chaotic or bipolar approach to negotiation. While China has responded by raising its own tariffs, negotiating with Mexico, Canada, and others could lead to lower barriers. A zero-tariff agreement within North America, for example, could be enough to reduce economic strain, aligning with Trump’s deal-making instincts, and inspire risk-on sentiment that would stabilise markets.

And I haven’t even addressed the possibility the U.S. Supreme Court and Congress could theoretically challenge the tariffs’ legality. While no concrete steps have emerged, the threat of intervention, legal entanglements or loss of congressional support may pressure Trump to adopt a less aggressive stance.

The headlines influence most investors, and they let share prices inform their decisions.  However, it’s worth remembering that this is not a financial, macroeconomic, or liquidity crisis, well, not yet anyway.  History shows that improving fundamentals can lead to rapid market gains when they coalesce with liberated sentiment. Equity market investors typically find solace when the worst-case scenario fades. The S&P 500 has weathered tariff uncertainty but now faces downward pressure from earnings revisions and economic slowdown fears.

Despite that, a rally is entirely possible, if not likely, if Trump scales back tariffs because investors crave predictability. Any retreat from the 135% China tariffs or a shift to phased implementation would reduce uncertainty and provide businesses with time to adjust, boosting corporate investment intentions and consumer spending. Historical data, including after 2018, when tariffs stabilised, shows the S&P 500 rallying after trade tensions ease.

And don’t forget, despite current gloom, the U.S. economy entered this period with just four per cent unemployment and robust job growth (228,000 jobs added in March). Any tariff policy rollback would provide relief, certainty and stability, allowing corporations to resume capital expenditure and hiring.

Finally, markets tend to rally from the lowest economic ebb of a recession, and I would expect the same if a recession ensues in 2025.   

Make no mistake, the economic indicators are dire—stagnant GDP, corporate distress, consumer panic, and supply chain chaos paint a gloomy backdrop for equity investors.  But the same backdrop will likely compel Trump to retreat from the most extreme tariffs. His negotiation signals, political pressure, and pragmatic options such as a phased approach to Tariff implementation, increase the odds of a policy shift. For equity investors, this would mark the passing of the worst, unleashing optimism. Provided Trump relents, I would expect the S&P 500 to rally as investors price in a brighter outlook, reduced uncertainty and economic resilience.

That would mean our policy of buying only high-quality businesses when PE compression delivers good value will work yet again, and investors will then only need to worry about the next issue.

All prices and analysis at 1 May 2025.  This information has been prepared by Montgomery Investment Management Pty Ltd ABN 73 139 161 701 AFSL 354 564. The content is distributed by WealthHub Securities Limited (WSL) (ABN 83 089 718 249)(AFSL No. 230704). WSL is a Market Participant under the ASIC Market Integrity Rules and a wholly owned subsidiary of National Australia Bank Limited (ABN 12 004 044 937)(AFSL No. 230686) (NAB). NAB doesn’t guarantee its subsidiaries’ obligations or performance, or the products or services its subsidiaries offer.  This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice.  Past performance is not a reliable indicator of future performance.  Any comments, suggestions or views presented do not reflect the views of WSL and/or NAB.  Subject to any terms implied by law and which cannot be excluded, neither WSL nor NAB shall be liable for any errors, omissions, defects or misrepresentations in the information or general advice including any third party sourced data (including by reasons of negligence, negligent misstatement or otherwise) or for any loss or damage (whether direct or indirect) suffered by persons who use or rely on the general advice or information. If any law prohibits the exclusion of such liability, WSL and NAB limit its liability to the re-supply of the information, provided that such limitation is permitted by law and is fair and reasonable. For more information, please click here.