Executive Summary: Q2 2025 Market Commentary

The global economic order is undergoing a profound shift. The Trump administration’s aggressive new tariff regime has reignited trade tensions, upended global supply chains, and challenged the decades-long momentum toward globalization. At the same time, financial markets are contending with heightened uncertainty, rising prices, and growing concerns over a potential U.S. recession. Amid the volatility, we believe structural shifts will create long-term opportunities for investors, but de-escalation of the trade war is a necessary first step prior to any further reassessment of the investment landscape.

Five Key Takeaways

1. The Era of Free Trade Is Over
   The introduction of a 10% universal tariff on all imports—and even steeper reciprocal tariffs on specific nations—marks a definitive shift away from the liberal trade policies that have defined the post-WWII era.
2. Markets May Be Pricing in a Recession and/or Reassessing Growth Expectations
   With U.S. equities nearing bear market territory, it's unclear whether markets are fully pricing in an impending recession or beginning to re-rate future growth and risk expectations. While a recession now appears more likely, part of the recent drawdown may reflect a broader repricing of assets in light of shifting global trade dynamics, higher input costs, and lower corporate earnings expectations. 
3. Tariffs May Be a Lasting Feature of U.S. Economic Policy
   The scale and design of the new tariff regime suggest this is more than just a negotiating tactic - it may represent a permanent shift in U.S. trade policy. Investors should prepare for a world where tariffs - and the friction they create - are no longer temporary, but a lasting feature of economic policy.
4. Expect Higher Prices
   Tariffs are likely to push prices higher in the near term, but not all industries will be affected equally. The nuanced nature of consumer demand and global sourcing makes broad inflation predictions difficult, but economic friction is certain.
5. Opportunities Lie in Structural Shifts
   As global trade routes evolve and production potentially reshuffles toward North America, countries like Mexico and Canada could benefit from nearshoring trends. The winners may be on a relative basis opposed to absolute.

A Historical Perspective on Tariffs in the U.S.

The use of tariffs as an economic policy tool contradicts the conventional understanding of good economic policy that has prevailed since WWII. All that many of us have known throughout most our lifetimes is a world that has promoted globalization and free trade as a mechanism to shared prosperity. That ideology will be put to the test moving forward, assuming the Trump administration doesn’t reverse course.  

  Looking back in history, the US wasn’t always a free trade nation. In the World War II era, goods and services made outside of America were much more novel and less commonplace than they are today. Even in modern times, the US is somewhat of an outlier compared to most other countries in terms of how many foreign goods and services can be procured domestically. The loosening of tariffs and free trade opened the US up, gradually increasing the presence of foreign companies and cultures alike.     

Tariffs were once a cornerstone of U.S. economic policy, initially serving as the federal government’s primary revenue source. Between 1798 and 1913, they accounted for 50% to 90% of total federal income, funding national infrastructure and defense. However, with the introduction of the federal income tax in 1913, reliance on tariffs for revenue declined significantly. Over the past 70 years, tariffs have contributed less than 2% to federal revenue.

The U.S. gradually transitioned away from protectionism in favor of trade liberalization, particularly through agreements such as the General Agreement on Tariffs and Trade (GATT) in 1947 and its successor, the World Trade Organization (WTO) in 1995. Until recently, approximately 70% of all goods imported into the U.S. enter duty-free, reflecting this shift. Congress historically held constitutional authority over tariff policy, but over time, Presidents have assumed greater control through laws like Section 232 of the Trade Expansion Act of 1962 and Section 301 of the Trade Act of 1974. These provisions have empowered the executive branch to impose tariffs in response to national security threats or unfair trade practices, as seen in recent tariff escalations. While generally uncontested to date, the ability of the President to leverage tariffs and the definitions of what constitutes national security threats or unfair trade practices will undoubtedly come under scrutiny given recent events. 

In general, the world as a whole has greatly benefitted from the liberalization of free trade - allowing many developing nations to experience rapid economic growth. Countries like China, Vietnam, and India leveraged access to open markets in the U.S. and Europe to build export-driven economies, attract foreign investment, and lift hundreds of millions out of poverty. China, in particular, became the world’s manufacturing hub, benefiting from low labor costs, government subsidies, and scale advantages. While American consumers gained access to cheaper goods and U.S. corporations increased profits through globalized supply chains, trade liberalization also had profound domestic consequences. For example, U.S. manufacturing was largely outsourced and the U.S. trade deficit widened. The cumulative effects, and questions surrounding whether the positives outweighed the negatives, have led American politics to where they stand today.  

The Current Tariff Environment

Last week, the Trump administration launched the most sweeping overhaul of U.S. trade policy in decades. On April 2, President Trump announced a universal 10% baseline tariff on all imported goods, effective April 5. In addition, the administration introduced unexpectedly aggressive "reciprocal tariffs" targeting approximately 60 countries, which begin taking effect on April 9. These tariffs are layered on top of the 10% baseline and vary in magnitude.

The methodology, designed by the Office of the U.S. Trade Representative (USTR), behind the reciprocal tariffs has come under great scrutiny. According to the Trump administration, they analyzed each country’s average tariff rates and non-tariff trade barriers - including quotas, subsidies, licensing requirements, and intellectual property enforcement - against U.S. exports. The idea is to impose a U.S. tariff that matches the effective barrier that American goods face abroad. While the calculation appears to be complex, economists state that the formula is simply goods trade deficit divided by goods trade exports. In other words, the actual dollar equivalent to even the trade deficit out with every country affected. 

The most prominent targets include the European Union, which now faces a 20% tariff, and China, which is subject to an additional 34% tariff, creating a cumulative 54% tariff when combined with preexisting duties from earlier trade actions. In response to an immediate 34% retaliatory tariff from China on US goods, Trump announced that an additional 50% tariff on top of the cumulative 54% could go into effect as soon as April 9^th. The administration has also levied 15% - 25% tariffs on other major trading partners including Japan, South Korea, Mexico, and Brazil. Meanwhile, the EU is preparing countermeasures targeting sensitive U.S. exports such as agriculture and autos. 

Asian and African countries have absorbed the greatest impact under the new tariff framework. Given the massive amount of goods manufactured in Asia and exported to the US, adjustments may be necessary on both sides.  China, Taiwan, South Korea, and Vietnam - all of which maintain significant trade surpluses with the U.S. - face elevated tariffs on goods ranging from electronics to steel and consumer products. The long-term effects may include a structural realignment of global manufacturing. U.S. importers are already seeking alternatives to China, but many lower-cost Asian countries that would normally benefit from diversion are now themselves targets of reciprocal tariffs. 

Despite all the headlines related to Canada and Mexico prior to April 2^nd, they may have ended up as relative winners as no additional tariffs were imposed. The U.S. had imposed a 25% tariff on general imports from both countries, with Canadian energy products facing a reduced 10% rate. However, under USMCA provisions, 50% of Canadian imports and 38% of Mexican imports remain tariff-exempt, mitigating some of the economic disruption. While tensions and anti-US sentiment are high in both countries, negotiations between all parties remain ongoing. A further rerouting of global trade and acceleration of the broader trend of reshoring and nearshoring production to the Americas could theoretically benefit both countries.

Tariff Market Implications Moving Forward

There is still so much to work out, but the baseline has been set. The era of global free trade is over. As we continue to stress, the details matter. The primary focus for the foreseeable future will be on the risk of further tariff escalation, with trading partners considering more retaliatory measures. So far, the biggest retaliation came from China as previously stated. Alternatively, the White House has communicated that over 70 countries have already reached out to negotiate. While we won’t take that at face value, reports have indicated specific concessions from certain countries like Vietnam, Cambodia, and the UK. Negotiations with India were active prior to April 2^nd. Reports indicate a bilateral trade agreement with US has been in the works. India could be a relative “winner” if trade and manufacturing reroutes further from China. 

To be clear, the U.S. is at a full-blown global trade war. Some countries will stay firm, while others can’t afford to. From a market perspective, our hope is for a net de-escalation of the trade war. In other words, we hope the worst potential economic damage was announced on April 2^nd. This would likely mean that more countries would come to an agreement with the US to reduce reciprocal tariffs compared to those who slap retaliatory tariffs on the US. However, the elephant in the room is how it ends with China because the US imports about 3 times more goods from China than what it exports to China. The cost increases to US consumers from China alone could be enough to upend the global economy.

What seems to be obvious in the short run is higher prices and slowing economic growth. We use the term “higher prices” intentionally opposed to “inflationary”. That is because biggest impact from tariffs is generally absorbed initially. For example, a 10% tariff on avocados could be expected to increase the price to consumers by 10% but would not necessarily lead to further increases in future years.  In addition, goods with elastic demand may not become less desired by consumers if the price increases by a certain margin, leading to the possibility of lower demand and price discounting. Tariffs will affect the price of goods in different ways so it's incredibly difficult to model out the actual impacts on consumers and businesses.

Reuters did some analysis on specific goods affected by tariffs in recent memory. In 2018, Trump placed a 50% tariff on imported washing machines. While the data is messy due to the pandemic, the actual impact of the tariff was felt immediately but not at the 50% level.

A separate example was in 2009 during the Obama administration when tire tariffs were introduced. The tariff rate was initially set at 35%, reduced to 30% in 2010, reduced further to 25% in 2011, and allowed to fully expire in 2012. While prices rose, not nearly to the level of the total tariffs imposed. 

These examples aren’t meant to downplay the potential for higher prices. They simply serve as a reminder that things don’t always end as expected. The full impact of the tariffs will unfold in the coming months as trade flows adjust, retaliatory measures escalate, and businesses respond to rising input costs and shifting sourcing strategies. 

As for the high likelihood of slowing economic growth, the Trump administration has signaled willingness to risk a recession as the economy "transitions." While not yet in a recession (e.g., Non-farm payrolls rose 228k in March, well above expectations), the probability has undoubtedly increased. There was initial "cushion" entering the year due to strong corporate earnings and economic growth to absorb some impact. However, the administration risks crossing a point of no return. With a large cohort of consumers still struggling from inflation, further price increases could reduce consumption and strain company margins, leading to a downturn.

Understanding the Big Picture

We often get asked whether we agree with the tactics being deployed. What many people are really asking is if we agree with the ideology that led us here. However, what matters most to us as investors is grasping some form of understanding as to how far the administration is willing to go. While we can’t say for sure as to why specific policies are being utilized, we can provide our thoughts as to what we think the underlying motivations of the administration are. Since Trump’s first Presidential term, his rhetoric and alignment of individuals within his inner circle have been fairly consistent. Attempting to understand the motivations of the administration is a valuable exercise to extrapolate how far this can go and where the best long-term investment opportunities ahead lie. 

In recent years, US economic policy has begun to shift away from decades of globalization and toward a more self-reliant, strategically focused model. The Trump administration has focused on the concept of economic sovereignty, challenging the long-standing consensus that global integration is an unquestioned good. At the heart of this approach is a belief that American prosperity over the long term requires more control over supply chains, trade relationships, and industrial capacity.

This philosophy is likely the basis of current foreign policy aimed at reducing the US’s reliance on foreign countries. Dating back to Trump’s first Presidential term, there has been a clear push to rebuild domestic manufacturing and bring strategic industries to the US. For example, the US has become a leader in innovative technology but relies on other countries to supply the components (e.g., semiconductors) necessary to use such technology. The COVID-19 pandemic reinforced this thinking, as supply chain disruptions revealed just how dependent the US has become on foreign countries for essential goods (e.g., medical supplies and pharmaceutical drugs). 

Enter tariffs. As stated above, a tool that the executive branch theoretically has the power to leverage without congressional approval. Even more so, a way to upend global order without the use of military force. Tariffs are being utilized not just as a negotiating tool, but as a deliberate mechanism to reset trade imbalances and bolster domestic sectors deemed to be critical by the administration. While tariffs are clearly causing chaos in the financial markets and creating friction with key allies, the administration likely believes that US self-sufficiency outweigh those costs.

US energy production is also a key variable to consider. It had been almost 70 years since the US produced more energy than it consumed. We find it highly unlikely that the Trump administration would have been emboldened to the same level if the US still relied heavily on international sources of energy. Trump’s policy stance on opening up federal lands for “drilling” is not coincidental. Neither is his infatuation with other mineral rights such as those sought after in Ukraine, Greenland, and natural resource rich Canada. 

All of this is happening against the backdrop of America’s “twin deficits”- a persistent trade deficit and a growing budget deficit. We have written extensively about our concerns regarding the budget deficit post-pandemic. The rising budget deficit and seemingly annual government shutdown possibility related to the debt ceiling led to the US losing it’s AAA credit rating status, while being put on watch for further downgrades. None of the potential outcomes are good if the US continues along that path. In the worst-case scenarios, the US dollar loses its reserve currency status or US Treasury demand from foreign buyers dries up. Both are underappreciated catastrophic events. While the deficit issue remains a big risk, our assumption was that the US would eventually need to raise taxes and cut social programs such as Medicare and Social Security. Rather than focusing on austerity, the Trump administration may be attempting to grow (and inflate) out of the problem through the combination of smaller government, deregulation, reshoring manufacturing, tariffs, and tax reform.  

With that said, this isn’t solely about the deficit or mitigating the US’s reliance on foreign goods. We suspect the administration views them as intertwined. We also include the rise of China as a common thread amongst all the theories speculated in the media and the Street. After all, one could argue that the federal budget deficit is in part a byproduct of the trade deficit (as is excessive government spending). China, in particularly, contributes the most of any country to the total US trade deficit, equating to a comparable figure of the next two countries (i.e., Mexico and Vietnam) combined. We also note that China was the primary target of Trump’s first foray into tariffs. Recent comments from Commerce Secretary Howard Lutnick suggested the need to place tariffs on every country to close potential loopholes, specifically calling out China exporting goods through other countries to circumvent US tariffs the first time around. Perhaps part of this is an attempt to ensure what “didn’t work” last time “works” this time.

Current State of the Economy and Markets

The long-term implications remain unclear, but the immediate impact is already being felt as the economic and market response has been swift. U.S. equity markets have declined sharply, with almost all of the major US equity indices at or near bear market territory. Interestingly, foreign equities have faired better year to date despite entering the year with lower economic growth and greater susceptibility to US tariffs. Lower valuations in combination with the potential for fiscal and monetary stimulus are likely buffering the fall. However, if negotiations fail or extend out, we suspect recent outperformance to dissipate rapidly. 

With heightened fear and uncertainty in the markets as highlighted by the VIX (the market’s so-called fear gauge) spiking rapidly, it’s important to point out that through every crisis, growth scare, recession, and depression, markets have rallied to hit new all-time highs 100% of the time. Of course, bounce backs vary in time and recent drawdowns have conditioned many investors to believe bounce backs happen swiftly. There are several plausible end game scenarios where a fast market recovery is possible. However, there are also several that could imply further down drafts and ongoing economic disruption. 

Recently, market strategists and forecasters have rushed to update their price targets and recession calls. Much of Wall Street has raised the odds of a US recession from 20% - 25% to 50% or higher. With the likelihood of the trade war persisting and tariffs creating economic damage, lower economic growth is effectively a certainty. Strategists suggest US inflation could rise 5% or more this year. Higher prices, falling corporate profits, and fear lead us to assume a recession of some form may be more likely than not if this continues. However, an important understanding is the potential length and depth of a given recession. The markets are forward looking and at the current price drop, markets may already be pricing in an “average recession” in the coming months. 

For context, the S&P 500 is down nearly 20% from its highs earlier this year. In Trump’s first term, many have forgotten the panic that set into the markets when tariffs were placed on China in 2018. That year, the S&P 500 fell 19.8%. Additionally, according to Goldman Sachs, the median recessionary decline in US equities has been 24% and the average has been 30% during recessions. 

Whether we are in for an “average” recession is questionable. The magnitude and depth (or possibly lack thereof) are important questions we need to consider with regards to whether or not now is the time to buy equities. While getting that as right as possible is important, a separate consideration is assessing what fair value is moving forward. Aside from the possibility of the market pricing in a recession, it’s also possible the market is fundamentally repricing risk and future corporate profitability. If we examine the average forward price to earnings multiple on the S&P 500 over the last 20 years,16x forward earnings was the average. Over the past 10 years, the average was 18.28x. That is compared to the current forward multiple sitting at 18.25x. In other words, following the recent market carnage, the S&P 500 is trading at its 10-year average and it would take an approximate 15% additional drawdown from current levels to reach the 20 year average.  

Final Thoughts

If we are truly thinking about the long-term, history shows that drawdowns like we have already experienced are always great buying opportunities. There will be clear long-term winners and losers once the dust settles. Our job is to ensure we are allocating new capital to the right places given the structural shift that seems to be accelerating. In tandem, we also want to be careful to not catch the full brunt of a falling knife. 

As bad as sentiment is now, and although the possibility of further downside is elevated, there are potential positive market catalysts in the near term. 

1. The only country to immediately respond with retaliatory tariffs against the US was China. While its possible other countries are working on a more strategic response of their own, it may be more likely new deals are negotiated to lessen the overall tariff. A slew of new deal announcements could give the market some relief. 

2. The likelihood of a higher than expected tax cut package approved by Congress in the coming months has risen, from our perspective. A low corporate tax rate dovetails well with enticing businesses the build in the US. It would also lessen the blow on corporate earnings for US based companies. 

3. US midterm elections are less than 2 years away. In a perfect world for Trump, we suspect markets and economic activity recovers well before election season. The alternative is the US has a deep blue Congress overseeing the President in the last half of his term. 

4. As we entered the year, we highlighted concerns regarding high valuations and high corporate earnings expectations. Both have come down substantially which leaves room for positive surprises to have an outsized impact. 

For decades we have been taught about the benefits of free trade and have become accustomed to the normality of purchasing goods and services from all ends of the world. Unwinding decades old trade agreements represents more than a shift in policy, it represents a structural change in the only world we’ve known. Despite our best efforts to analyze the situation and form our own independent perspective, the harsh reality is nobody can know for sure what will happen next. Be mindful of those individuals or firms who emphatically state otherwise. An age-old quote attributed to Mark Twain remains true in this situation:

“ It ain’t what you don’t know that gets you in trouble. Its what you know for sure that just ain’t so.”