1Q 2025 Investor Letter - Shock and Awe

Market Commentary: Trump Tariffs and Market Volatility

Markets around the world are down today due to President Trump's unexpectedly punitive tariffs. These tariffs are feared to be inflationary and may cause a recession in the U.S. and abroad.

Understanding the Tariffs

President Trump believes in fair trade and has long expressed concerns about tariff imbalances between the United States and its trading partners. His goal was to cut the U.S. trade deficit in half, and reciprocal tariffs alone were not enough to achieve that objective.

According to reports, the administration evaluated trade relationships country by country, subtracting exports from imports and dividing that figure by two to determine each nation's tariff level. Countries with larger trade imbalances with the U.S. ended up facing higher tariff rates.

For example:

• Vietnam received a 46% tariff.
• Canada and Mexico, our two largest trading partners, were exempt for goods covered under the USMCA trade agreement.
• Canada and Mexico did not receive additional tariffs beyond the 10% tariffs already imposed earlier this year.

Ramifications of the Trump Tariffs

Slower Economic Growth

GDP growth will likely slow by at least 1% in 2025, increasing the risk of recession. Some economists are now projecting a 45% chance of a recession.

Rising Unemployment

As economic growth slows, unemployment is expected to increase. Oxford Economics estimates the unemployment rate could reach 5% in 2025.

Higher Inflation

Tariffs generally raise the cost of imported goods, which can lead to higher consumer prices. Oxford Economics projects inflation could rise to 4% in 2025.

It remains unclear whether this would be a one-time increase in prices or whether inflation expectations could become entrenched, creating longer-term inflationary pressures.

Stagflation Risk

A period of stagflation—characterized by slow growth, rising unemployment, and high inflation—is a possibility.

We do not expect conditions similar to those experienced in the 1970s unless an additional shock, such as an energy crisis, were to occur.

How We Expect the Federal Reserve to Respond

The Federal Reserve finds itself in a difficult position.

The Fed has two primary mandates:

1. Promote maximum employment
2. Maintain stable prices

In the coming months, these objectives may conflict with one another.

If the Fed lowers interest rates to support employment and growth, inflation could rise further. If the Fed keeps rates elevated to combat inflation, economic growth could weaken further and unemployment could increase.

We expect the Federal Reserve to move cautiously and wait for additional economic data before taking action. At present, we believe the Fed is more concerned about inflation than economic growth and may delay rate cuts despite the risk of slowing the economy.

The Bitter and the Sweet: Short-Term Pain for Long-Term Gain

Supporters of the administration's policies hope that the "bitter" effects of tariffs and government spending cuts will eventually be offset by the "sweet" effects of tax cuts and business incentives.

The sharp market reaction to the tariffs may increase pressure on Congress to complete a new tax bill.

Potential growth-oriented measures could include:

• Extension of the 2016 tax cuts
• Reductions in the corporate tax rate
• Expanded corporate tax deductions for equipment and facility investments (possibly up to 100% and retroactive to January 1, 2025)
• Tax breaks for tips, overtime income, and Social Security benefits
• Increasing the SALT deduction cap from $10,000 to $25,000

To help offset the revenue impact of tax cuts, Congress could potentially count tariff revenue as a budgetary offset—a concept promoted by President Trump.

This approach would be unconventional, however, and fiscal conservatives may object since tariffs can be modified or removed at any time.

The Upshot for the Economy and Markets

The Optimistic View

By making foreign goods more expensive, encouraging business investment through tax incentives, and generating tariff revenue, the United States could bring more manufacturing and production back home.

Under this scenario, the country would eventually benefit from:

• Higher GDP growth
• Increased domestic investment
• Better-paying jobs
• Expanded private-sector production

The Pessimistic View

The less favorable outcome is a period of:

• Slow economic growth
• Higher unemployment
• Higher inflation

In other words, stagflation.

The Challenge in Choosing Between These Outcomes

Several unknowns make forecasting difficult:

• The unpredictability of President Trump's future policy decisions
• Whether U.S. companies with historically high profit margins absorb some or all tariff-related cost increases
• How consumers react to higher prices
• The degree of retaliation from other countries
• Whether international consumers reduce purchases of U.S. products
• The impact of inflation on household purchasing power

Our Thoughts

It is important to remember that this is not a banking crisis, financial crisis, stock market bubble, or pandemic. Today's market reaction is largely an anticipatory response to the economic implications of President Trump's tariff policies.

We believe in positioning clients appropriately for their financial goals while ensuring portfolios can withstand both the ups and downs of the market.

To that end:

• We reduced equity exposure where appropriate in February.
• We rebalanced individual stock portfolios toward companies that we believe may perform better in a slower-growth environment.

The next market move remains uncertain and could be either positive or negative depending on future policy announcements from President Trump and the market's response.

Panic is not an investment strategy.

As always, please reach out if you have specific questions, changing needs, or simply want guidance during periods of market volatility.