Last week’s new tariffs jolted markets. The amount of news coverage and estimates forecasting a twisted economic path made our heads spin at Cornerstone, and probably yours too.
Pullbacks are nauseating to sit through. However, the extreme nature of the proposed measures points to a high likelihood that they’ll ultimately prove to be short-lived as a deeper analysis would indicate their foundation is shaky.
Initially, the baseline 10% tariff on all imports was perceived as a relief. But additional, country-specific surcharges (based on a dubious reciprocal tariff formula) radically changed the narrative:
We say this because the reciprocal rates are based on an odd calculation – the U.S. trade deficit divided by import value – and it’s yielding strange results. For instance, the calculation attributes a 67% rate to China, 39% to the European Union, 46% to Japan, and 50% to South Korea:
These figures appear to reflect an effort to impose leverage, rather than reflecting economic realism.
In a sense, we would argue that the resulting market fury is not due solely to a reaction of a potential trade war, but rather, the fact that the White House broke a core covenant of capitalism, a stable and predictable regulatory environment. Over the years we have consistently stated that markets and corporations hate uncertainty more than anything else. Breaking this covenant of predictability has companies now facing massive amounts of potentially stranded capital or capital that would earn a lower return.
The tariffs’ staggered implementation dates give trading partners a small window to respond and leave room to scale back penalties if “significant steps” are taken by the counterparties. Optimistically, President Trump's specific invitation for foreign leaders to terminate their own tariffs and pursue fairer trade further indicates a desire for dealmaking.
In our view, what will be most indicative of the overall risk, will be the expediency and results of the negotiations and countermeasures:
This optimistic viewpoint is rooted in developments suggesting most affected nations prefer diplomacy over retaliation. Most importantly, further support for this interpretation is shown in the fact that these tariffs are highly concentrated on six countries:
Thus, only a few deals would diffuse a lot of pressure.
Interestingly, a recent trade war simulation detailed in the New York Times seemingly backs the argument for a shorter lifespan of these tariff risks. In the simulation, a global trade confrontation was played out by trade experts. The result was negotiations that led to a significant, quick escalation. Most countries ultimately dropped tariffs against the U.S., implying that aggressive posturing followed by new bilateral agreements is a viable outcome.
The key insight was that the U.S. maintains the upper hand in negotiations as the world's largest consumer. The conclusion was that reciprocal tariffs are more persuasive than punitive when used as leverage.
That said, we can't ignore the fact that the market’s initial reaction to the tariff announcement was sharply negative. Equity futures plunged after hours last Wednesday and continued through market open today.
Similarly, the term structure of the CBOE Volatility Index* (VIX), known as the market’s “fear gauge,” immediately surged higher:
On the positive side, even as the VIX rose, inflation expectations remained anchored. This seemingly undermines the argument the tariffs are structurally inflationary and supports short-term pain over an elongated and drawn-out trade war.
If stocks have mispriced the political strategy behind these tariffs, it would be because of two reasons:
- The president has clear incentives to boost markets and attract investment ahead of midterm elections.
- The reciprocal tariffs are actually used to force concessions and generate domestic economic activity.
When Data Is Crucial
Understanding the macroeconomic landscape more, it’s vital we not ignore the overall equity market reaction. This is when data is crucial.
During extreme uncertainty, MAPsignals’ trusty Big Money Index has been our best and most important barometer. It is a 25-day moving average of “big money” investor activity and provides unemotional insight into the market.
Currently, the BMI is at 36.6% though we wouldn’t rule out it being oversold very soon:
It takes lots of damage for the BMI to hit oversold territory. But once there, history shows it precedes the beginning of market stability and opportunity.
Market stability could arise if countries come to the table and negotiate or if the Federal Reserve is now forced to cut interest rates. It's interesting to point out that as of this morning, expectations for rate cuts increased as the 10-year Treasury yield almost fell below 4% (and actually breached the 4% mark for awhile on Friday):
This will be important to keep an eye on as the Fed can't fight market rates forever. Still, forecasting the path of interest rates has been a losing battle over the past year. So, let’s hope for the best but prepare for the worst.
In the short term, troubling market episodes lead to an oversold BMI ensnare stocks of all sizes# ^ +, leaving nowhere to hide:
Over the next week or so, we will be watching the data as it attempts to firm up after historical levels of fear based selling:
However, the latest tariff news could continue the trend sending the BMI to oversold territory.
Despite the discomfort, as always, it's important to keep a steady head and follow the data. Remember that when the BMI hits oversold, it’s followed by a quick and aggressive reversal rally.
Lastly, there is additional data supporting forward looking market strength in an oversold market:
1) Extremely compressed valuations where they now sit at only 15x on 2026 earnings and only 17x assuming a 15% decline in earnings.
2) Historically, back to back -4.5% drops like last week have only occurred four times since 1950 and each one of those instances saw strong 12-month forward returns.
3) Historically, when the VIX term structure is inverted (as it now is), it has been followed by one-month win ratios of 100%.
The near-term data will likely be extreme. Let’s not get lost in the daily emotional headlines.
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* The CBOE Volatility Index is a measure of the short-term volatility of the S&P 500 indexes, indicating how quickly market sentiment changes and the level of investor confidence or fear in the market.
# The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
^ The S&P MidCap 400 tracks 400 companies that broadly represent companies with midrange market capitalization.
+ The S&P SmallCap 600 is an index of small-cap stocks tracking a broad range of small-sized companies that meet specific liquidity and stability requirements.
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