Relief Valve

A pressure relief valve is a safety device that automatically releases excess pressure in a system when it exceeds a predetermined level, preventing potential damage or catastrophic failure. While a relief valve is a critical safety feature, it is not designed  to solve the underlying problem creating the excess pressure.

What we have seen this week is a pressure relief valve at work. The 90-day delay of reciprocal tariffs in favor of a 10% universal tariff levy, with the exception of China, released the rapidly building pressure in financial markets. Clearly, this is a positive development, but it is a far cry from solving the problem.

Now the tariff focus is squarely on China. This is a sizable escalation in the economic war with China that in our mind, began years ago.  This has been the elephant in the room, getting bigger over time. The US fiscal situation has brought it out into the open for all to see and discuss.

This is evolving into a high stakes game of chicken. The world leading Chinese manufacturing base can’t afford to lose the world’s biggest consumer of goods. Likewise, the world’s biggest consumer is highly dependent on China for many items it needs every day. While there is relative calm now, pressure can re-build very quickly.

Where Do We Stand?

The impact of policy on the economy is unpredictable. The policy of today seems unlikely to remain in place for very long.

• • Tariff rates have been lowered, but remain quite high relative to recent history. Whether this translates into inflation, and if so, how much inflation, remains a huge question mark. One argument is that tariffs area one time price adjustment, but we doubt the math is that simple. The cost of tariffs will be shared by suppliers, manufacturers, wholesalers, retailers and consumers. The only question is how much is absorbed by each. For example, a 10% tariff may initially translate into a 5% price increase to the consumer. However there will be underlying pressure to claw back the 5% absorbed by the supply chain, which can price pressure over time.
  • Recession probabilities remain elevated. Price shocks due to tariffs (particularly on autos) tend to kill economic growth. Likewise, supply shocks for “China-reliant” goods can be an economic drag as well as an inflation generator, generating stagflation pressure in the economy.
  • The Fed, which has dominated markets for many years, now appears impotent. Stagflation (high inflation and high unemployment) places the Fed in a box. There simply is no policy that can address unemployment and inflation simultaneously. The Fed will need to choose one, and that would appear to be inflation. As a result, the typical Fed response of rate cuts would be off the table and potentially invite a longer, steeper recession.
  • Something that is likely under the radar to most of our readers is the turmoil in the US Treasury market. Many large investment firms participate in something called the Treasury basis trade. This is an arbitrage strategy that profits from small deviations between treasuries and Treasury futures. To make the profits more meaningful, these firms use large amounts of leverage. That arbitrage has now reversed causing a massive de-levering (i.e. selling of Treasuries). That has placed an unwelcome, upward pressure on interest rates, thus complicating the current tariff tiff.

• • Where will earnings be this year? Corporate earnings have been quite predictable over the last several years, but not this year. Fist quarter earnings, and in particular, corporate guidance will be critical to short term market performance over the next several weeks.
  • A technical market perspective. The recent S&P 500 low of around 4800-4900 is an important level to hold, while the upside appears difficult beyond the 5,700 5,800 level. For now, that appears to be the trading range. A breakout above 5,700-5,800 would imply the bottom is in. A break below 4,800 implies another leg down before this is correction is over.

Stay the Course

The tariff issues are complex and will not disappear quickly. This almost ensures that volatility is here to stay for the time being. We caution investors not to get too excited or drawn into any rash decisions or conclusions by massive rallies, nor the same about big reversals. It may be a wild ride.

We’ve fielded many calls about stepping to the sidelines until the smoke clears, but we counsel against that. This is a time of high emotions and history shows that emotionally driven investment decisions typically leads to substantially reduced returns over time.

What is critical to remember is that you don’t own stocks in your portfolio, you own companies, vibrant companies with smart, adaptable management teams. When all is said and done, Home Depot will still be around, as will Microsoft, and Proctor and Gamble, and so many others. In the long-run, these companies providing needed products and services and will continue to succeed. We plan to stay diversified and stay the course through these rough seas.

Have a great week!

What We’re Reading

• JPMorgan Chase tops quarterly expectations as Dimon says U.S. economy faces ‘considerable turbulence’

• Trump’s pharmaceutical tariffs could raise costs for patients, worsen drug shortages

• Inside the bond market’s $800 billion ‘murder mystery.’ Here’s why the basis trade could be a time bomb—and what the Fed can do to stop it

Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Past performance is no guarantee of future returns.

General News

By: Adam