Navigating the Markets: Tariffs and Trade

[Webcast title page is displayed: Navigating the Markets: Tariffs and Trade]

MARK RIEPE:  Welcome to the webcast. We appreciate you taking the time to join us today. We're recording this on the morning of April 9th, 2025. My name is Mark Riepe, and I head up the Schwab Center for Financial Research, and I'll be your moderator today.

[Mark Riepe profile page is displayed]

We've got three of our thought leaders here today with me. Liz Ann Sonders is our Chief Investment Strategist. Kathy Jones is our Chief fixed Income Strategist. Finally, we'll be wrapping up the call with Jeffrey Kleintop. He's our Chief Global Investment Strategist.

This is a stressful time for investors. We've got policy uncertainty, economic uncertainty, market uncertainty. We can't fix the uncertainty, not surprisingly, but by providing you with information to help you better understand what's going on, hopefully it will be easier for you to work with your Schwab representative to form a plan to make sure that you're still on track to reach your financial goals.

[Liz Ann Sonders profile page is displayed]

Liz Ann, let's start with you. We've seen the stock market reaction recently to sort of all the different tariff announcements. The economy was slowing before this started. So where do you think we're at now?

[Red, yellow and green dominoes for "Recession's dominoes" are displayed]

LIZ ANN SONDERS:  Yeah, the economy was flowing before this. Kevin Gordon and I wrote a piece, I think it was published on March 17th, that talked about recession risk rising. And in it we discussed the history of recessions, and the combination of recessions and bear markets, and one of the visuals that we put in that report was this dominos visual. At that time, we just laid out what it looked like back in the global financial crisis, the last true economic recession that we had, and this is now updated to reflect the current backdrop. So red obviously means these are dominoes that are very fallen, yellow is mixed, and green is […audio dropout…]. One of the points that I think is important is recessions unfold each cycle in different ways with different drivers. Obviously, if we're heading into a recession now, it's a very unique driver, given that it's been a, you know, specific policy decision on the part of the administration. COVID was another unique example. But I do think that with all this recession discussion, one thing that's interesting is that if we are heading into recession, we're probably already in it because what the NBER does when they declare a recession, they simultaneously date it. And they go back to the peak and the collection of data points that they use to gauge whether you're in a recession or not. That's clearly reflected in what the market is doing. It's reflected in what has been already, I think it's 17 consecutive weeks now of downward adjustments to earnings estimates. And I think more is yet to come, and we've got earnings season coming up. So what I don't think, unfortunately, will happen is I don't think we're going to get a lot of specific color on the outlook from companies. I would be surprised if first quarter reporting season ended up being pretty good, but that's very much in the rear-view mirror. I think the consumption data and the labor market data is particularly important to watch. Consumption of course, because it drives 68% of GDP, and the labor market because that is what has kept consumption, which drives the big portion of GDP afloat even though traditional metrics like the savings rate has come down. So we're watching all of these. It's a very unique set of circumstances, but I would put the odds of recession at this point unless policy changes well better than even odds.

MARK:  Liz Ann, given that, how are you sort of thinking about the equity market right now, and any guidance on how people should be thinking about positioning their equity portfolios?

[Market sentiment chart indicating that "sentiment not fully washed out yet" is displayed]

LIZ ANN:  Well, it's incredibly volatile. That goes without saying. And some of the intraday volatile has been off the charts. You really only tend to see this type of volatility on a day-to-day basis and the swings intraday in past somewhat serious crises or serious bear markets. So we saw something similar during the brief COVID bear market, also saw it several times during the global financial crisis, and even to some degree during the 2000 to 2002 tech bust bear market.

One of the things that's interesting, though, is that we really haven't seen full scale capitulation yet. Sentiment has shifted quite noticeably. This is one measure of sentiment. It's American Association of Individual Investors. They do a weekly survey asking their tens of thousands of members, Are you bullish? Are you bearish? Are you neutral?' This in the top part of it chart here is the spread between the bulls and the bears, meaning when you're down at a very low level, you have a significantly higher percentage of bears than bulls. And that's the case now where we've seen a renewed spike up in bearishness and a renewed plunge down in that bullishness.

I put a reference point here to 2022, the last bear market that we had, and you saw something similar because what we're comparing it to is AAII's own survey of allocations on the part of their members. So the top part is sort of an attitudinal measure of sentiment. The bottom part is a behavioral measure of sentiment. You'll see we had the first big low in the 2002 bear market right around the midpoint of the year, at which point that total washout in sentiment was not corroborated by any meaningful move down in exposure. Fast forward to October of that year, well, we did actually have the market bottom. You did see that what I sometimes lovingly call the puke phase, where you saw it in the attitudinal measures, you saw it in the behavioral measures. As you can see here, we've seen a bit of a retreat, but probably need to see a little bit more capitulation.

It's also, last reminder, is that even if we are in a bear market… and we're already there for the NASDAQ and the Russell 2000, pretty close for the S&P 500… that doesn't mean you don't get some, as technicians like to call it, 'rip your face off' kind of rally. So I wouldn't be surprised alongside this volatility to see some… whether it's in for day or throughout the course of a day or a week, some significant rallies, even if this weakness is not fully over.

MARK:  So Liz Ann, one of your frequently used phrases is 'panic is not a strategy.' And we hear a lot from clients, other people we run into that this environment is different. And a lot of truth to that, but do you think it's so different that you throw out some of your kind of classic investing advice?

LIZ ANN:  Well, no, panic is never an investment strategy, and every cycle is different. That's why I often chuckle at the line, you know, that that's, you know, something not to think about, it's different this time. It's always different this time, and panic is not a strategy. This is maybe a healthy reminder of what, Mark, you know. We pound the table all the time on the traditional disciplines around diversification across and within asset classes, the beautiful discipline that is rebalancing, because it forces investors to do a version of buy low/sell high, which is add low/trim high. And in the last year-and-a-half, we've really been forceful about talking to clients about be aware of concentration risk. Within the US equity market, that was embedded in groups like the Magnificent 7 or AI-related, tech, tech-adjacent, whatever categorization you want to use. But it also referenced across asset classes. Don't just have all your eggs in the US equity basket. And I know Jeff will talk about the other side of that. We've also been really, really factor-focused. And in fact, this week, we've neutralized all of our sector ratings. So there's no ratings right now. Everything is essentially neutral. Because correlations have gone up, I think it's really hard to navigate through this at some monolithic sector way. But we've really been focused on factors, high-quality factors, which is just another word for characteristics, so strong balance sheets, stability in profit margins, strong free cash flow, high interest coverage. And one of the factors that we kind of added to the factor focus list as we came into this year was low volatility. And for what it's worth, the low volatility factor in the factors that we track in conjunction with our colleagues at Schwab Equity Ratings, is one of, if not the best-performing factor on a year-to-date basis, but in particular during this period of volatility. So that's one way to think about how you navigate. It's the traditional disciplines of diversification, don't get concentrated, use rebalancing to your benefit, but that factor-based approach with a high-quality wrapper has also been a bit of an anchor to windward.

MARK:  Okay, thanks, Liz Ann. Kathy, why don't we bring you into the conversation to talk a little bit about one of the classic diversifying asset classes for stocks, and that's bonds. So far, the Fed hasn't really acted on interest rates. Do you see that continuing? And what will they be kind of thinking about, what will they be looking at when deciding how to act?

[Kathy Jones profile page is displayed]

KATHY JONES:  You know, Mark, I think a lot of people have been sort of sitting and hoping that the Fed would react to the slowdown in the economy that we're seeing, and all this volatility with rate cuts. But the Fed has made it clear, at least for the time being, everyone from the Fed has been on message that they're waiting to see how this all plays out before making a move because inflation is still too far above their 2% target. So it's sitting roughly around 2.8% or so right now, as measured by the Personal Consumption Deflator Index that they use in their benchmarking, and it's more likely to go up than down over the next six months to 12 months because of tariffs. So they have to be concerned about the prices rising because of tariffs. And now we've had tariffs ratcheting up even more, so that's likely to mean more and more price increases, and of course the offsetting factor of the potential to slow down growth. So I think for the time being they will wait.

What will they look for? They will look for a real deterioration in economic growth that we haven't seen yet, and probably won't see because you're seeing people rush to buy stuff ahead of tariffs going into place. So we'll probably see a bump in terms of consumption short-term. But they're going to wait and see how that plays out, how the economy works out going through all this tariff business. And then they'll look at the unemployment rate, because, you know, the Fed has this dual mandate, price stability and full employment. Right now, the unemployment rate has been starting to move up. We're seeing signs of some slowdown in hiring, some layoffs starting to pick up, but it's still in the low 4% region, which is near full employment, what we used to think was full employment. So I think they have to sit and wait and see, which is what they're telling us.

If the unemployment rate were to start to really rise, I think the Fed would react to that because arguably their rates are pretty high now relative to where inflation is and to where short-term rates are. So they could make the argument that there's room to ease a little bit if the labor market starts to really cool off.

The other factor there, obviously, we have to keep an eye on is financial conditions. So as stocks sell off, credit spreads in the bond market widen, they want to make sure that the financial system is stable, and that businesses and consumers have access to financing that they need to continue on with their activities.

So those are two big factors. Labor market and financial conditions. Right now, they don't warrant a rate cut, and because we have the inflation pressure and inflation stuck too high, I think the Fed wants to sit and wait to see how this all plays out.

And the third factor is just, you know, this could all disappear tomorrow if we decided we didn't want to have the trade war anymore, right? So the Fed doesn't want to be caught reacting to something that may change in two or three days or two or three weeks, and then have a policy… look like it's a policy mistake. So I think there's a lot of waiting and seeing at the Fed. I think they will react if things get a lot worse, but it has to get worse before they react.

MARK:  Kathy, typically when the Fed reacts, the interest rate they're focused on is the Fed Funds Rate, the short end of the yield curve. But as you've said, many times there's no one interest rate, and normally when the economy slows, we see longer term rates start to drop. Is that what we're seeing right now?

[Chart showing fixed income yield by asset class is displayed]

KATHY:  No, it is not. And that's one of the anomalies about this particular situation. So we've seen a lot of volatility in long-term rates, and they were dropping, they're rising, they're dropping, they're rising again. And I think that that reflects a couple of different things going on in the market. So short-term rates will move with the Fed. The further out you go, the less impact that has. And since the Fed isn't riding to the rescue with signaling rate cuts, that affects yields across the curve to some extent. At the longer end of the curve, we also have, you know, inflation still stuck, and the more tariffs we get, the more price pressure we'll get, and the more risk of higher inflation down the road.

And then there's the question of, I think what we've seen recently, is some unwinding of leverage trades. And a lot of leverage involves, you know, borrowing treasuries and using treasuries for that kind of leverage. And I think what we're seeing in some pockets of the market is traders, like hedge funds, other leveraged investors, unwinding some of those positions and going to cash, or trying to raise cash. And, you know, when you get in a position like this where you need to scramble for liquidity, you sell what you can sell, and treasuries are still liquid. And so I think that to some extent what we're seeing is this push up in rates as people selling treasuries in order to raise cash.

One speculation has been that China might be selling bonds. I really don't think so. Although we're engaged in, obviously, a pretty fierce trade war with China, we haven't seen it in the numbers yet. Now, they do get delayed. China doesn't hold as much as they used to in terms of US Treasury, so it's not as big a factor as it had been in the past. And plus, we're not seeing it yet in the currency market, they haven't pledged a devaluation of the currency yet. In fact, they denied that this morning.

So, you know, my guess is that this is not a lot of foreign selling. This is a lot of people unwinding trades, going to the safety of very short-term treasuries.

But you can see where we are now in the markets. We've got yields have bounced up quite a bit. And the other thing that we're seeing is some of the unwinding of that leverage. We're seeing things like lower credit quality, like high-yield, emerging markets, long duration, like preferreds, and those yields have risen quite dramatically relative to what we've seen in the core bonds, the more stable part of the market, but they're all elevated right now.

MARK:  One more question for you, Kathy, and then we'll bring Jeff into the conversation. What is the most attractive part of the fixed income universe right now?

[Chart showing total returns in 2025 by fixed income asset class is displayed]

KATHY:  Well, we have been… much like, you know, Liz Ann, we've been on the cautious side in terms of positioning, suggesting investors stick with intermediate-term high-quality bonds By intermediate-term, we typically look at the Bloomberg Aggregate Bond Index. It has a duration of about six years. And current yield, I think is back above 5% today. It's been in the 4-1/2 to 5-1/2% for quite some time now. And we think that that's an attractive place to sit, and let this ride out. You not taking… you're not sitting in cash and incurring reinvestment risk, which is a big possibility. If things really go bad and the Fed starts to cut, if you're just in short-term T-bills or something, you're going to roll that over into lower and lower yields. So we think you want a little duration, or some moderate amount of duration to capture these yields. And for me, you know, getting close to 5%, if you lock that into five to seven years, that's a pretty good base for most investors.

But we also want to stay up in credit quality. And so like the Ag is an investment-grade index, and it reflects the values of investment-grade bonds, treasuries, and investment-grade corporate bonds, we still look at the higher credit quality as a place to be. We've started to see a sell-off in high-yield, those spreads widening versus treasuries, and then things with very long duration, as you see here, munis and preferreds, both very typically long duration. Munis are less liquid. That's more of a buy and hold strategy. We like munis, and we think the gap up in yields and gap down in price that we've seen recently could present an opportunity for somebody in a higher tax bracket, in a high-tax state or city, to look at these yields. But there's going to be a lot of volatility, and munis are typically pretty long-term and less liquid than, say, the treasury market. So you have to be careful there. But for a buy and hold investor, these after-tax or tax-equivalent yields are pretty attractive.

So investment-grade, intermediate-duration, and look for opportunities when yields really rise from here. But there's too much volatility, I think, to jump in looking for some sort of short-term gain.

MARK:  Alright, thanks, Kathy. Appreciate it.

[Jeffrey Kleintop profile page is displayed]

MARK: Jeff, we've got you at the end. You've been tracking the details of the tariff policies and negotiations the closest. Who knows? Maybe they've changed somewhat in the 20 minutes or so that we've been recording this. But here we are, as I mentioned, April 9th. What's the latest in terms of the situation, as far as you know?

[Chart displaying countries by dependence upon exports to the U.S. is displayed]

JEFF KLEINTOP:  Well, Mark, they haven't changed the last 20 minutes, but they have changed this morning. So we've got the 104% tariffs on China hitting last night, and China responded with 84% tariffs on US goods to go into effect tomorrow. Also, I expect sector tariffs on pharmaceuticals and semiconductors, which were spared from those April 2nd announced tariffs to come very soon, in the next day or two or three very likely. And the big ones, of course, are that big, giant table that President Trump held up on April 2nd hit tonight. We know that more than 50 countries have already reached out to negotiate, and Trump said he's opened to deals. And some members of the administration are in favor of doing them quickly, while some are seemingly not in favor of doing them at all. So it's hard to get a read there.

Asia was the hardest hit. You had very high tariffs on goods from Cambodia, 49% tariffs; Vietnam, 46; Thailand, 36; Taiwan, 32. You can see it in the column chart that shows the share of GDP of these countries that's made up of exports to the US. So we've got high tariffs and high GDP exposure. That's motivated these countries to reach out first.

Trump said yesterday that he has the framework and the probability of a great deal with South Korea, and he said he's, likewise, dealing with many other countries as well. On Monday, our treasury secretary said Japan is at the top of the list of countries to work out a deal. Historically, Japan has sourced a lot of manufacturing in the US, and they've sort of moved them to the top of the list. So that may be moving along. The leader of Vietnam had a call with Trump on Monday, and offered to drop all import tariffs on US goods. Trump characterized it as a good call, and Vietnam's government said they would be following up and formalizing a deal soon. Malaysia said they're coordinating a response among 10 Southeastern Asian nations, and many others. But we don't know for sure what the end game is, but perhaps some deals will begin to come together soon, Mark.

MARK:  Thanks, Jeff. The performance of international stocks, sort of depending on the country and the region, has been all over the place recently. Maybe you could elaborate a little bit on what kind of countries or regions are most exposed, and which are least exposed to some of these tariff policies.

[Chart indicating that European stocks with less U.S. tariff exposure have tended to outperform since September 30, 2024]

JEFF:  Yeah, so we just talked about sort of that list of countries there, and Asian countries getting hit the hardest. They were hit the hardest in the markets too outside the US because they were hit with the biggest tariffs. But stepping back a minute, often investors retreat to what they know when they're confronted with uncertainty, and that often means selling international stocks because they seem less familiar, more risky. But the America-first policies have left America last when it comes to year-to-date stock market performance and performance since April 2nd. International stocks are outperforming across the board this year, to varying degrees, and that's added to their outperformance since the current bull market began back in October of 2022.

That's especially true for Europe, Mark. Europe works either way the tariffs go, in my opinion. Only 3-1/2% of European Union GDP is exports to the US, and when we calculate that, a 20% tariff is a drag of about 0.6% on GDP if you assume a higher […unintelligible…]. But Germany, which is Europe's biggest economy, has already approved stimulus this year equal to about 2-1/2% of GDP. So way more than offsetting the potential tariff impact. You've got lower valuations, and maybe more stable earnings revisions might help to support stocks in Europe. Domestically-focused companies are performing better in Europe. That makes sense, right? This chart shows that companies with a high share of domestic sales in Europe relative to those with a lot of international sales are faring better. Not surprisingly, if you have a lot of domestic sales exposure and you're stimulating your own economy, whereas international sales are subject to these tariffs, you can see how that's really showing up. And it's actually worked consistently better on both up and down days in the market. So that might be a place where investors can find somewhat of a relative safe haven.

Also, the stocks in the hotel, restaurants, and leisure industry in Europe may benefit as travelers divert away from US destinations to Europe. We've already seen that, with flight bookings from Canada to the US plunging 70% compared to last year. Where are they going? The other top destinations are in Europe.

And I've been a fan all year of Europe's seven defense stocks, which I've been calling the New Mag 7, just to be fun.

Quickly, China is pushing back with tariffs, but they can, since less than 3% of China's GDP is made of direct exports to the US. That may surprise a lot of people. China has three budgets, but if you aggregate them together, the combined impact is an 11%... a deficit equivalent to 11% of GDP this year. That is a record amount of domestic stimulus, if they follow through. Consumer spending is about 40- to 50% of China's economy, so they feel they can more than make up for a loss of US exports, Mark. So that's one of the reasons why China is pushing back the hardest.

MARK:  So Jeff, last question for you. You know, impossible to kind of sketch out what the end game is going to be, but what do you think that might look like? What will kind of a more steady state situation emerge from a lot of these negotiations that are just beginning?

JEFF:  Well, it may be some combination of higher tariffs in key industries with some trading partners. But long-term there are just too many unknowns to really guess right now, which is why the markets are jumping around so much. And that's in part because many of the US goals conflict. For example, raising revenue from tariffs could work if imports continue unabated, but then US manufacturing doesn't rebound if that's the case. And we know it can be politically costly to raise tariffs by this much. Smoot and Hawley were both tossed out of Congress in the election that followed their infamous Tariff Act of 1930. So there's definitely not only economic costs, but political cost as well to this type of risk of recession and bear market. So it's hard to say what the long-term goal is. We've long said, we're likely to see slightly higher tariffs. You know, going from 2.6% at the start of this year, I thought maybe 7- or 8%. Obviously, we've cleared that hurdle by a wide margin, looking at 25%, roughly, tariffs on US imports. Hopefully, would come down, but in what form and how quickly we don't know.

What I can say is already for this year, we can see supply chain problems emerging already, with the container ship booking schedule falling sharply just two weeks from now. And other leading indicators of supply chain efficiency are flashing some warning signs, as well, as the reciprocal tariffs on US exports might be implemented at least temporarily.

And that's why I think that while there are no absolute winners in a trade war, diversification in international, in the areas I mentioned, could fare better on a relative basis, or at least offer a less wild ride, Mark, no matter how it ends up.

MARK:  Thank you, Jeff. Appreciate it. We are out of time, so thank you. Liz Ann Sonders, Kathy Jones, and Jeffrey Kleintop.

[Webcast title page is displayed - Navigating the Markets: Tariffs and Trade]

We've got many resources at schwab.com/learn that we're updating regularly. In addition to the work of Liz Ann, Kathy, Jeff, and their teams, we've got trader-oriented material, as well as wealth management material, which is especially important if you're concerned about whether you're taking the right level of risk given your goals. And of course, times like these are a great time to talk to your financial consultant.

Thanks for your time today, and have a nice day.

[Disclosures displayed]