In aviation, instrument meteorological conditions (IMC) are weather conditions where visibility deteriorates to the point that usual visual references outside the airplane can no longer be seen or safely relied upon. Instead of being able to see the ground below and use landmarks to fly to their destination, pilots are forced to rely upon their instruments to safely navigate the plane.
Fortunately, pilots go through instrument training, which teaches them to safely fly solely by reference to instruments. They spend tens and hundreds of hours flying with special blinders on so they cannot look outside the airplane, are taught to ignore the sensations their brains and bodies are telling them and can only use the tools inside the plane to navigate and fly straight and level, on heading, and on course. The most important mantra they are taught is, Trust Your Instruments.
This analogy is apropos to the current state of markets – there is little to no forward visibility as to what’s directly in front of us or what unseen obstacles may loom in our way.
We normally publish the Capital Insights mid-quarter, after earnings have rolled in because we think waiting for the quarter-end noise to settle down gives us a little better perspective on the true state of the economy and markets. However, given the extreme events of last week’s “Liberation Day” and the ensuing chaos that unfolded in the markets, we felt it was warranted to publish early and provide our clients with what we know at this point. Given the extreme volatility and unpredictability, this edition of Capital Insights is somewhat abbreviated – no charts, no graphs, just straight talk.
We would also like to stress that we are apolitical in our commentary and are simply here to point out objective and the likely economic/market-based implications of these recent policy actions.
What happened:
The tariff package announced by the White House was far more severe than what the markets were expecting. Despite the rhetoric from the White House, tariffs reduce economic growth and raise prices in the short term, thus causing inflationary pressures. Mechanically, tariffs are paid by the DOMESTIC companies (not the exporters) who import foreign goods and depending on whether they have pricing power or not, either absorb those costs internally, i.e. reducing their profits, or pass them onto consumers by raising prices. So net net, either domestic business or domestic consumers pay the higher price. Long term, tariffs make imports less competitive and destroy demand, thus balancing the market, but that’s long term. Short term, tariffs can create stagflation or worse, a recession. This doesn’t just happen domestically, it happens globally. Instead of growing the total economic pie, it’s now shrinking. We are fairly sure the laws of economics haven’t changed in 2025, but maybe we’re wrong.
Market reaction:
We’ve experienced the largest 2-day equity market drop since the COVID era. 100 years of trade policy and its associated economic playbook have been torn up and thrown out. Markets are trying to figure out which way is up and price assets accordingly. Further, they are trying to price in the risk of what happens next, i.e. retaliation. Nobody knows how much worse the situation can get, so risk-appetite gets lower, and asset prices drop. On Friday, China announced retaliatory tariffs, and equity markets downshifted again. Further, what had been stable credit spreads have started to widen materially, which shows the bond market is now worried. Credit spreads are the bond market’s risk measure and an excellent indicator of near-term economic health. When they are tight, everything’s rosy, when they widen, conditions are less so and the outlook is poor. Interestingly, US spreads have worsened more than Euro and Emerging Markets spreads, indicating confidence in the US markets is diminishing relative to other major trading blocs.
Markets are ALL about confidence. Confidence in rule of law, confidence in predictability and stability of policy, confidence in inflation and employment outlooks, confidence in corporate profits and real consumer incomes. When participants have confidence in the future, they are more inclined to invest and spend, i.e. capex for businesses, or consumer spending for individuals. Currently, confidence has fallen off a cliff and corporations and consumers are pulling back hard. The jobs outlook is fading, and inflation expectations are rising. The top 10% of consumers account for 50% of consumer spending in the US and this same group owns the vast majority of equities. When that economic cohort is feeling flush, they spend, creating the “wealth effect,” which is a real phenomenon. Given the material drawdown we’ve seen in the last few days, it’s safe to say there is now a negative wealth effect in place. Further, given the deterioration in international relations, we now have countries boycotting US travel and goods, further adding to the rapidly deteriorating conditions.
What to do about it right now:
We have collectively entered IMC, and this is the time to Trust Your Instruments, namely your financial plan, your asset allocation and the diversification we have built into your portfolio. As mentioned before during past market/economic events, the time to revise your investment objective is NOT during a market meltdown. Fortunately, we have prepared by positioning portfolios as best we can to weather these storms. The asset allocations we have designed should help to reduce volatility and will continue to drive strong cashflow. We have biased the portfolios to be up-Quality since 2022 and now is especially the time to be invested in the debt and equity of very strong companies that can withstand the environment around us. In every asset class, public and private, we have focused on exposures to resilient businesses with low leverage, strong profitability and staying power. Our cash and gold allocations are helping mitigate volatility as well. For now, there’s not much to do portfolio-wise. Don’t sell good assets at low prices, don’t try and be a hero to invest cash and catch a falling knife. Rarely is it a good idea to be the first one to stick your head out of the foxhole and take a peek just because the shooting stopped. Eventually, we will look for tax-loss harvesting opportunities and opportunistically pick up some good names at these lower prices and perhaps shift some more of our US equity exposure to International.
Outlook:
It’s hard to see a catalyst for a turnaround here. Hard to see the Administration reversing course on tariffs, even if simply used as a negotiating tactic. Hard to see confidence coming back in corporate or consumer sectors in the short term. The damage to confidence and relationships has been done and it will be difficult and take time to recover to previous levels, if possible. We do not expect the Fed to come to the rescue and cut rates unless the labor market materially breaks down. Our call for Q1 stagflation was already happening prior to “Liberation Day,” but due to this drastic policy action a recession is now a real risk. How long and severe a recession could be depends on how long and severe this new era of tariffs will exist. We will have to wait to see how this shakes out, but in the meantime, hang on and hang in there, we have flown into IMC and there is more turbulence ahead. Most importantly, ignore the signals your brain and body are telling you and simply Trust Your Instruments – they will guide you safely to your destination.
We appreciate your continued support of our firm and your trust in our team. We stand ready to review your personal financial plan and discuss how these policy uncertainties could affect your current situation. If you know of someone who might benefit from our services, we would welcome your referral. Until next quarter, we wish you a happy Spring season with friends and family.
