This is what real market uncertainty looks like
If tariffs stick, the economic and investing landscape could be altered in unknown ways for years to come.
A week ago, you could read market pundits opining that “Liberation Day” would end the uncertainty that had pressured the stock market since President Donald Trump’s inauguration. Some predicted a “sell the rumor, buy the fact” trade once his plans were clear.
Wrong. There is more uncertainty than ever. The result is damage to portfolios on a historic scale.
Unless Trump’s trade wars are quickly called off, investors don’t have to look far back to see how large and long-lasting this disruption of the global economy could be. Just consider how the impact of the 2008 global financial crisis could be felt in the form of low interest rates for well over a decade, until the inflation surge that followed the covid-19 pandemic. In many ways, the ripples from the pandemic in the economy and politics are very much still with us.
Why markets ‘hate uncertainty’
The phrase “markets hate uncertainty” gets overused. However, it’s grounded in what long-term investing is about, especially when it comes to stocks. Picking a stock entails forecasting what its value will be in the future compared with where it is today. Central to this is profitability, which requires a sense of the costs of what a company does, what it can charge, and how well it can sustain and grow its business. Morningstar’s economic moat ratings fit this mold, wherein our analysts determine whether a company has a competitive advantage that will last the next 10-20 years.
The future, of course, is always uncertain. But the less clarity investors have, the harder it becomes to assign values to investments. With prudence being the better part of valor, the greater the uncertainty, the more investors will discount the future value of investments. In other words, they demand lower prices.
A new world disorder for trade
With a single hard-to-read poster, Trump’s press conference on tariffs in the Rose Garden took uncertainty to a whole new level by throwing global trade networks built over a period of decades into disarray.
This starts with the simple question of how long the tariffs will be around. As has been the norm since Trump returned to office, the administration has sent conflicting signals, sometimes saying it is open to negotiations and other times suggesting the tariffs are here to stay. On Sunday, Trump said tariffs will stay until the US trade deficit disappears. (Morningstar senior US economist Preston Caldwell has explained why he thought even before Trump’s announcement that tariffs won’t accomplish this.)
The uncertainty around how long tariffs will be in place, at what level, and how other countries will respond means the countless businesses affected by tariffs can’t predict what their costs will be or what consumers will have to pay for their products.
‘Unknown unknowns’ a worry for markets
But the uncertainty goes deeper than how much a car will cost this summer, or the price of Parmesan.
For examples of how shocks can play out well after an event is over, Caldwell points to the pandemic and its impact on the economy. “This kind of regime shift is so unprecedented that the historical data and models derived therefrom are only a best guess,” he says. ”Looking back to the pandemic, we had little idea of the repercussions of abruptly shutting down and turning back on the global economy. Likewise for trying to reconfigure from global to domestic supply chains. Also, the full effects will take some time to manifest, just like how it took about a year of straining supply chains during the pandemic before things really started crumbling in mid-2021.”
Recalling the 2008 financial crisis, long after the collapse of Lehman Brothers and the real estate market, interest rates remained extremely low. During the crisis, the immediate panic was over whether the financial system as we know it would even survive. But even once conditions stabilized, the crisis played out for years in a myriad ways, diminishing the ability of bonds to provide income and fueling high valuations in growth stocks all the way up until the pandemic.
And then there are “unknown unknowns,” as Caldwell puts it, such as “a lasting impairment of global confidence in the US economy.”
The dollar’s decline as a canary in the coalmine
This impairment could potentially be playing out through the decline in the value of the US dollar. That’s an anomaly in times of crisis, when global investors usually seek out the safety of US dollars and assets.
In addition, Caldwell points to an economic relationship between the level of the dollar and tariffs. “A roughly 20% rise in the average tariff rate should lead to something like a 5%-10% appreciation in the dollar, depending on the extent of foreign tariff retaliation,” he says.
This time around, investors appear to think that buying the dollar might be akin to running into a burning house instead of away. This decline “suggests the countervailing force in terms of diminished appetite to put capital into the US is quite large,” Caldwell says.
Should the dollar’s decline foreshadow a sustained shift in global capital flows, the ramifications could be significant. That could include making it harder for the US to finance its massive pile of government debt, which in turn would require higher interest rates on bonds, which would filter through to the economy through higher mortgage rates and make it more costly for businesses to finance their growth.
At the same time, a weaker dollar is inflationary, which could make it harder for the Federal Reserve to lower rates. That’s especially the case when, as Fed Chair Jerome Powell made clear Friday, tariffs add to the upward pressure on inflation.
There is one key difference between the current crisis and both the 2008 crisis and the pandemic. “In 2008, you couldn’t ‘unpop’ a bubble that was being popped,” Caldwell says. “Likewise, in the pandemic, the government could only mitigate the economic fallout, not cure the pandemic entirely.” But with tariffs, it’s a different story. Caldwell says, “more than 90% of the damage can be undone if the tariffs are rescinded quickly and there’s a credible promise to not bring them back.”
Until then, uncertainty reigns.
