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The worst thing that can happen to an investment bank is losing money, closely followed by failing to make money. But it’s often surprisingly disruptive to find your franchise is making money, but not in the places where you expected it to. It’s early in the year, obviously, but if 2025 continues in its current direction, we can expect to see some of the bloodiest and most acrimonious compensation committees in living memory.
You can get something of a clue as to what’s going on by looking at the breakdown of revenues in Jefferies’ Q1 results — bearing in mind, of course, that unlike the rest of the Street it has a November year-end. These numbers capture December, which was a surprisingly good month for capital markets and advisory, and don’t contain March which . . . wasn’t.
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Capital markets down a bit, FICC down a lot, advisory up and equities up. Swapping March for December seems likely to be bad news for both capital markets and advisory, but good for equities trading — BGC Expand is looking for 25 per cent growth in the industry revenue pool. It’s an ill wind that blows nobody any good, and the uncertainty and volatility of the last quarter has been great for trading volumes.
This means that one of the perennial Cinderellas of the investment banking industry is going to have a rare moment in the spotlight.
Equities trading (particularly cash equities) is usually quite a horrible business. Unlike bonds, equity shares are “fungible” — one share of Tesla is the same as any other, they don’t all have different coupons and maturities. This has always meant that trading is a commoditised business, in which commissions tend to be bid down to the marginal cost. And the marginal cost is very different from the average cost, because in a world of high-frequency trading and latency optimisation, equities trading needs a lot of very expensive IT infrastructure.
Why do banks keep doing it? Well, sometimes they don’t. Deutsche Bank, for example, cut the entire equities trading business line in its 2019 restructuring. But even then, they weren’t able to get rid of equity research, the most Cinderellaish function of all.
The trouble is that, although it’s not a good business to be in nine years out of ten, and barely covers the cost of capital in the tenth, equities have a lot of synergies with everything else. Corporate clients care a lot about their share prices, and the ability to have conservations with them about what investors are doing is often very valuable to the advisory and capital markets teams. Like the real Cinderella, equity sales and trading do a lot of dirty and thankless work in making forecasts, collecting feedback and being available for “colour of the market” updates.
It is going to be unnerving at best for bankers in other divisions to anticipate a bonus season later in the year in which they are reduced to asking Equities to share the wealth.
The maxim for bosses going into compensation committees has always been that if you’ve got revenue, bang on about revenue. If you’ve got a franchise, bang on about the franchise. If you’ve got neither, bang on the table. Given that many second-tier banks spent 2023 and 2024 building up their capital markets and advisory practices by hiring rainmaker Managing Directors who have so far failed to make it rain — and given that any promises or commitments made to the new hires will further drain the pool for the rest — there might be some percussive meetings later in the year.
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Monday was the end of the quarter, and you know what that means! That’s right: Trillions of dollars will be slightly rejigged because of an arbitrary date in an arbitrary calendar according to arbitrary rules of thumb.
Most big institutional investors and a lot of ordinary ones have some kind of asset allocation framework that divvies up their money into various markets. A common one is a 60/40 model, where 60 per cent goes into equities and 40 per cent into bonds, but they come in many different flavours.
Many investors regularly rebalance their portfolios to bring allocations back to the target. For example, if stocks have done phenomenally then you’ll end up overweight equities. So at the end of the month, quarter or year you might therefore sell some shares and buy bonds. Or vice versa if bonds have outperformed stocks. It’s a simple, rules-based buy-the-dip strategy.
However, there’s long been a suspicion that this is so predictable — and the resulting flows so gargantuan — that hedge funds and prop trading firms can profitably front-run these regular rebalancing flows.
A new NBER paper written by Campbell Harvey, Michele Mazzoleni and Allesandro Melone backs this up. They estimate that the “unintended consequences of rebalancing” costs US investors alone about $16bn a year.
A back-of-the-envelope calculation using our predictability results estimates that the rebalancing costs borne by institutional investors can exceed 8 bps per year. For a market potentially exceeding $20 trillion in size, rebalancing pressures could translate into an annual cost of $16 billion, or about $200 per U.S. household each year.
To put these numbers in perspective, these costs are higher than those institutional investors pay to invest passively across equity and bond markets. In other words, rebalancing a balanced equity/bond portfolio might cost more than the fees to access those markets in the first place. Further, since rebalancing costs recur annually, their true present value is substantially larger.
The economists modelled two of the most common rebalancing approaches, 1) a simpler, calendar-based approach of rebalancing on the final trading day of each month; and 2) a slightly more sophisticated one where investors allow some drift within a range, and only rebalance gradually once it crosses preset thresholds.
The paper found that the models were predictive of what actually happened around the end of quarters: When stocks had done well and bonds badly, rebalancing funds sold stocks and bought bonds, leading to a temporary decline in equity returns of 16 basis points and a 4 bps uplift in bond returns. When bonds had outperformed stocks the opposite effect happened.
Moreover, the impact faded in less than two weeks, “suggesting that rebalancing trades carry limited informational content about asset fundamentals”.
The economists constructed a sample portfolio that used these predictive signals, which generated average annualised returns of about 9.9 per cent across the 1997-2023 sample period. This equates to a pretty sharp Sharpe Ratio of more than 1, and the strategy performed “particularly well” when markets were especially turbulent, and rebalancing flows can be more meaningful.
However, the paper’s main point was that big, lumbering institutional investors are collectively letting traders scalp them for billions of dollars a year. Regular rebalancing remains important, but it just shouldn’t be so dang predictable, Harvey et al argued:
. . . Rebalancing remains a fundamental tool for ensuring portfolio diversification, managing liquidity, and generating utility gains for mean-variance investors compared to a non-rebalanced portfolio. Therefore, designing more effective rebalancing policies that preserve the benefits of rebalancing while minimizing its costs seems like a priority for future researchers and investors.
Alphaville’s understanding has long been that institutional investors ARE aware of the dangers, and there is as a result fairly little homogeneity when it comes to the hows and whens of rebalancing.
But these results suggest that collectively these efforts still amounts to a blob of capital moving in predictable fashion. And interestingly, Elm Research recently found that regular rebalancing doesn’t actually matter as much as you might think, at least for individual investors.
Jay Newman is a former senior portfolio manager at Elliott Management and an author. He has some, cough, ‘history’ with Argentina.
In a bizarre wrinkle of fate, three American judges hold the fate of a nation in their hands. The United States Court of Appeals for the Second Circuit will soon decide whether a $16bn judgment against the Republic of Argentina should stand.
For reference: Argentina is negotiating a $20bn lifeline from the IMF, $16bn is more than a quarter of the government’s 2024 budget — and reserves are negative $6bn. If upheld, the ruling would scuttle president Javier Milei’s efforts to remake his country’s political system.
Fortunately for the Argentine people, the Second Circuit has ample grounds to vacate the lower court decision in Petersen vs Argentina — a case that never belonged in a New York court in the first place.
The judgment arose from Argentina’s 2012 expropriation of shares in Yacimientos Petrolíferos Fiscales (YPF), an Argentina-based energy company. The Argentine government was a minority shareholder at the time, but then-president Cristina Fernández de Kirchner’s administration accused YPF’s majority shareholder—Repsol, a Spanish company — of prioritising distributions to shareholders instead of reinvesting capital to develop oil and gas production from the recently discovered Vaca Muerta shale formation. Exercising its public policy prerogative, president Kirchner’s government found that Repsol’s failures threatened Argentina’s energy security and its economic independence.
Takings of property — whether by the exercise of eminent domain or imposition of regulatory restrictions — are actually business as usual for governments. It’s the very definition of sovereignty: governments make the rules governing property rights, investment, and legal recourse for actions that take place within their territory. In the US, the Fifth Amendment of the Constitution governs takings: private property shall not “be taken for public use, without just compensation.” American victims of eminent domain can sue in Federal court for compensation.
Argentina has a comparable framework. Complaints pursuant to Argentina’s 1977 General Expropriation Law are the exclusive remedy, and Article 28 prohibits legal actions outside of that process. Once the Kirchner government exercised its prerogative, shareholders of YPF had the right to seek compensation — and some did, utilising the General Expropriation Law framework. They could also have pursued arbitration under the Spain-Argentina bilateral investment treaty. For their own reasons, the Petersen plaintiffs decided to forum shop — and gamble on the possibility of bamboozling an American judge.
They’ve gotten lucky — until now.
Legal proceedings should have remained in Argentina, because the dispute is purely local — comprising a microcosm of Argentine society and politics. It touches on practically every facet of Argentine civic life, from its historical development, governmental powers, legal regime, substantive law, energy policy, and legislatively declared public interest. To wit:
• The Argentine legislature created YPF in 1922. It’s an Argentine corporation that operates in Argentina. It’s governed by Argentine law, and develops Argentina’s natural resources and supplies domestic energy;
• The claims arise under YPF bylaws and were brought by former YPF shareholders against other shareholders — a type of claim without precedent in Argentine law;
• Petersen — the company that owned the claims before the current plaintiffs acquired them in a secondary market transaction — was originally created, owned, and controlled by Argentine nationals;
• Argentine legislation and executive decrees authorised the expropriation, including express legislative findings of the public interest in ensuring a domestic supply of energy at reasonable cost;
• Victims of the expropriation have clear, viable remedies under the Argentine constitution, Argentina law, and treaty.
You’d do well to wonder how a senior US judge got sucked into the vortex of a dispute with a foreign nation having nothing to do with the US — and everything to do with Argentina. No matter: it’s now up to the Second Circuit to clean up the mess.
Litigation against governments sometimes involves tough judgment calls relating to jurisdiction and sovereign immunity. Not so here. It’s one thing for New York courts to judge a sovereign that agreed to be sued in New York: most dollar bond contracts for sovereign debt contain express waivers of immunity. Absent express agreement, the bar is high before American courts provide service to opportunistic litigants.
Whether American courts have legitimate basis for adjudicating disputes involving foreign sovereigns and foreign law is a matter of forum non conveniens and comity. Forum non conveniens invokes a court’s discretionary power to decline cases in which another jurisdiction or court has the right expertise. Baseline, cases involving novel questions of Argentina law relating to the government’s commercial obligations belong in Argentine courts.
More problematic, after finding Argentina to be an adequate “alternative forum for this litigation,” the judge ignored Argentina’s request that she reject the complaint as a matter of comity. According to the Second Circuit: “international comity takes into account the interests of the United States, the interests of the foreign state, and those mutual interests the family of nations have in just and efficiently functioning rules of international law.’’ A case in which the plaintiffs had multiple opportunities to seek redress — hinging entirely on the interpretation of Argentine law — only ever belonged where it began.
There’s more to this legal mischief.
Forum non conveniens and comity weren’t the only things the trial judge got wrong. New York law requires that when damages are measured in a foreign currency — like Argentine pesos — the judgment amount is converted into dollars by reference to the value of the local currency on the day judgment is entered (the judgment-day rule).
In a clear error, the judge calculated damages based on the value of the peso on the day of the breach (the breach-day rule). If the Second Circuit won’t tell a senior judge that she abused her discretion in getting forum non conveniens and comity wrong, it could obviate most of Argentina’s pain by correcting this purely legal error in calculating damages.
Because the peso has depreciated against the dollar over the 12 years since 2012, application of the judgement-day rule would produce an award vastly smaller than $16bn — closer, in fact, to $100mn. Calculating damages correctly is the low hanging fruit, since the Second Circuit will review the formula de novo. There’s no principled reason to coddle a judge who abused her discretion, but proper maths that produces a correct sum would be of considerable solace to Argentina and avoid fracturing Milei’s fragile peace.
It’s not only a matter of saddling Argentina with an unjust, crushing burden. As numerous — powerful — amicus briefs filed by the US government, four other sovereign nations, and legal scholars make clear, the credibility of US courts, and the US legal system is at issue.
Imagine the justifiable vitriol that would fill these pink pixels if Argentine courts — or those of other nations — opportunistically entertained lawsuits against the US based on events that took place here, governed by American law.
It can only end badly if the appellate court condones the profligate assertion of dominion over domestic disputes with foreign states — much less matters governed by a state’s own laws. The fate of one nation’s economic revitalisation project — and the probity of another’s judicial system — hang in the balance.
Last month the National Association of College and University Business Officers reported that the average American endowment returned 11.2 per cent last year. Huzzah! Trebles all round.
Unfortunately, this is slightly worse than what a passive global 70/30 equity/bond portfolio returned in 2024. OK, well maybe it was a weird year. Endowments and their racier asset mix must have done better in the long run, right? Nope.
Over the past decade, the $874bn worth of endowments that report to NACUBO have averaged annual gains of 6.8 per cent. A global 70/30 has gained 6.83 per cent. And this is a generous comparison for endowments, given their far heavier US asset mix in a phenomenal decade for almost anything American. Over the past decade the Norwegian sovereign wealth fund has returned 7.3 per cent, and now costs just 4 basis points a year in management.
Apropos of nothing, here is a paper by investment consulting pioneer Richard Ennis predicting “the demise of alternative investments”. Or to put it in a more nuanced way, the inevitable decline of the alternatives-heavy “Yale Model” of institutional investing pioneered by the late David Swensen.
The abstract pulls zero punches:
Alternative investments, or alts, cost too much to be a fixture of institutional investing. A diverse portfolio of alts costs at least 3% to 4% of asset value, annually. Institutional expense ratios are 1% to 3% of asset value, depending on the extent of their alts allocation.
Alts bring extraordinary costs but ordinary returns — namely, those of the underlying equity and fixed income assets. Alts have had a significantly adverse impact on the performance of institutional investors since the Global Financial Crisis of 2008 (GFC). Private market real estate and hedge funds have been standout under-performers.
Agency problems and weak governance have helped sustain alts investing. CIOs and consultant-advisors, who develop and implement investment strategy, have an incentive to favor complex investment programs. They also design the benchmarks used to evaluate performance. Compounding the incentive problem, trustees often pay bonuses based on performance relative to these benchmarks. This is an obvious governance failure.
The undoing of the alts-heavy style of investing will not happen overnight. Institutional investors will gravitate to low-cost portfolios of stocks and bonds over 10 to 20 years.
Ennis’s main concern has long been that about 35 per cent of US pension plans are currently invested in what he sees as illiquid, laughably expensive and, in reality, often mediocre alternative investments. The paper therefore primarily relies on the data he has for 50 large US public pension funds for the 16 years up to the end of June, 2024 as well as the less granular NACUBO reports.
But as he points out in the paper, a whopping 65 per cent of the average large US endowment fund is now invested in alternatives of some kind, as virtually all of them have sought to mimic Swensen’s model at Yale.
Unfortunately, most investors have not been able to replicate Swensen’s results, even when they copy his recipe of loadsa alts — primarily private equity and venture capital, with a few big dashes of hedge funds and real estate to top it off.
Ennis estimates that the average endowment has underperformed even the average pension fund by 143 basis points a year over the period studied, once you’ve accounted for the differences in market exposures and risks. Pension plans have in turn markedly underperform a comparable public market benchmark, by 96 basis points a year over the 16 years.
Over the years those basis points add up:
This is a new-ish phenomenon, according to Ennis. Between 1994 and 2008 large endowments produced excess returns of 410 basis points a year thanks largely to their alternative investments, he calculates.
Ennis argues the stark shift from good to woeful results happened simply because results led to popularity, and popularity led to crowding. The outcome has been poorer returns but the same eye-watering fees.
The very investor enthusiasm that helped propel alts’ returns pre-GFC began transforming the markets generating those returns. Many trillions of dollars poured into alts, which were relatively small, isolated areas of investment in the early days. Aggregate assets under management increased more than tenfold between 2000 and 2020. More than 10,000 managers now vie for a piece of the action and compete with one another for the best deals and trades. Market microstructure advanced accordingly. Private market investing is more competitive and efficient than it was way back when. Costs, though, remain high — far too high to support much value-added investing.
The most controversial suggestion is that this will inevitably end in the demise of the Yale model of alts-heavy endowment management, citing the famous law articulated by the economist Herbert Stein: “If something cannot go on forever, it will stop.” Here are 13 reasons proffered by Ennis for why the privates merry-go-round has to stop spinning.
1. Failing to meet stated investment goals. Since the GFC, public pensions have failed to meet their actuarial return requirement, which many say is their paramount goal. Endowments have not kept pace with typical stated inflation-based return objectives.
2. Realizing that their portfolio is worth half of what it would have been worth had they followed a simple indexing strategy. With underperformance of 2.4 percentage points per year since the GFC, large endowments are worth 70% of what they would have been worth had they followed an indexing strategy. If they continue to underperform at the same pace for the next 12 to 15 years, I estimate their value will be half that associated with a comparable index strategy. At some point the performance problem becomes too big to ignore.
3. Illiquidity: Universities, with tens of billions in endowment (e.g., Harvard), borrowing at unprecedented levels to support operations. Public pension plans (e.g., CalSTRS) borrowing against their portfolio to raise funds for the “flexibility” to rebalance their asset allocation. (It’s not leverage; it’s flexibility.) The heavy reliance on private assets is compromising institutions’ normal operation, while increasing risk.
4. Trustees recognizing the agency issues at work and acting to redress them. Some diligent trustees will stop paying CIOs bonuses for beating benchmarks created by the CIOs and/or consultant-advisors. They will find other ways to compensate truly excellent performance. Switching to index-based benchmarks would have a benign effect on practice.
5. Media reports of undergrad investment clubs with track records better than those of elite university investment offices.
6. The advent of an accounting requirement that public pension plans report their investment expenses fully and in detail, including carry. With that information, it would be easy to figure out what educational endowments are paying. This would come as news to most trustees, public and private, and make them uneasy.
7. CIOs acknowledging that leveraged private real estate equity and hedge funds have been really poor performers for a long time and dropping one or both.
8. With the advent of normal interest rates after years of the Fed’s zero-interest-rate policy, substantial leverage of buyout investments coming into play in a way we have not seen since the GFC. News of a thousand bankruptcies among zombie corporations, many of them in buyout funds, would not be lost on trustees.
9. Enlightened trustees leaving their successors notes that say, Put an end to this. I wish I had.
10. College and university boards discovering that, like Harvard, they are spending more on money managers — for no benefit — than they collect in tuition.
11. Trustees discovering that secondary market pricing of private assets can be much lower than reported NAVs. Real estate and venture capital interests, for example, have been transacting at discounts of 25% or more of NAV in recent years.
12. Being sued for breach of fiduciary duty. Trustees serve on behalf of others. Their duty is to be prudent and loyal to the beneficiary; there is no requirement to be clever or to attempt to maximize gain. Wasting assets is verboten. We live in a litigious world.
13. Taxpayer revolts. Taxpayers have about had it with public worker pensions as it is. Heightened awareness of investment waste might accelerate the transition to defined contribution plans for new employees.
Perhaps. Alphaville is a bit too cynical to think anything is going to change much, even in the decade that Ennis envisages. In finance, inertia can be a phenomenally powerful force.
For example, these days people get very excited about index funds eating up markets, but forget that we’re still talking about a penetration of 10-30 per cent, (depending on the market) over a half a century after the invention of the index fund and crushingly compelling data on active management underperformance. Anyway, alternatives have found a brand new mark market to woo.
Further reading: — American endowments’ complicated love affair with private equity (FTAV)
Sam Lowe is a partner at Flint Global, where he advises clients on UK and EU trade policy. He is also a senior visiting fellow at King’s College London and runs Most Favoured Nation, a newsletter about trade.
The Tariff Man has tariffed, again.
This time, under the guise of reciprocity, he has moved beyond his passion for the number 25 and applied individualised “reciprocal” tariffs to countries, dependent on the extent to which they fall foul of a pretty arbitrary equation treat the US unfairly:
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These individualised rates mean that where a product is from is increasingly important. Actually, I should rephrase that: where the US decides a product is from is increasingly important.
For example, under the terms of the new tariff action, if you export a product from Ireland to the US, it will be hit with an additional 20 per cent tariff. But if it is from the UK, the tariff will be 10 per cent.
When you take into account the cumulative impact of all the different tariff measures, the importance of origin becomes even more acute.
Let’s say you were making a hydraulic turbine (I’ve just picked a random bit of machinery from a list, don’t read too much into it) in the EU for export to the US, but it is primarily made of Chinese parts.
If the US decides the hydraulic turbine is of EU origin, the tariff would be 20 per cent plus the 3.8 per cent Most Favoured Nation tariff, making 23.8 per cent. Not ideal.
But if the US decides to treat the hydraulic turbine as Chinese, the tariff could be up to 82.8 per cent: 3.8 per cent MFN tariff + 20 per cent China-specific tariff + 34 per cent China reciprocal tariff + 25 per cent tariff because China buys oil from Venezuela. (Note: I’ve probably missed a product-specific tariff there, too and there might be extra duties relating to the steel content.) Existentially bad.
Indeed, this is what happened to Volvo back in 2019, when US customs decided their Swedish-made vehicles should be treated as Chinese and thus subject to a Trump 1.0-era 25 per cent tariff. (A useful, critical, summary of the decision by US customs lawyer Lawrence M. Friedman, here.)
But how exactly does the US determine the origin of an imported good?
Well, for exports not covered by a free trade agreement origin determinations are kinda … vibesy.
It’s not that there are no rules — the general focus is on whether a product is wholly obtained (eg a cow) in one jurisdiction or, if not wholly obtained, “the last country in which it has been substantially transformed into a new and different article of commerce with a name, character, and use distinct from that of the article or articles from which it was so transformed”.
It’s just that, in practice, it can be difficult to predict which way US customs will go on a specific issue.
For free trade agreements, there are usually product-specific rules that determine whether an exported good is local enough to benefit from the agreement’s preferential tariff treatment.
So far, under Trump 2.0, these preferential rules are most significant for trade between the US, Canada and Mexico.
For example, the recent action on car tariffs stipulates that if a car exported to the US from Canada or Mexico qualifies for the US, Canada, Mexico free trade agreement (USMCA), then the new 25 per cent tariff will only apply to the non-USA value of the vehicle. Dataviz:
(More on that, with further hand-drawn pictures, here.)
In practice, this could mean an effective additional tariff of well below the headline 25 per cent, depending on how much US “value” is embedded in the vehicle.
To qualify for USMCA the rules of origin are… complicated. USTR has a helpful summary:
The USMCA ROOs for motor vehicles require a specific amount of North American content in the final vehicle in order to qualify for duty-free treatment under the USMCA. The USMCA raised regional value content (RVC) requirements to 75 percent for passenger vehicles and light trucks, compared to 62.5 percent under the NAFTA. In addition, certain “core parts” must also meet the higher RVC thresholds for the entire vehicle to qualify. The USMCA also requires that at least 70 percent of a vehicle producer’s steel and aluminum purchases originate in North America. Finally, the USMCA introduced a new LVC rule that requires that a certain percentage of each producer’s qualifying vehicles be produced by employees making an average of $16 per hour. Collectively, these new requirements are intended to incentivize increased investment in autos and automotive parts production within the United States and North America.
So, on the one hand, significant country-by-country tariff differentials create new incentives for supply chain … *ahem* … optimisation. But on the other, US determinations of origin are not always the easiest to predict and will (in my opinion) probably become increasingly weighted towards ensuring products are classified as being from whichever country delivers the highest tariff.
For example, see this caveat to the USMCA wheeze described above:
(3) If U.S. Customs and Border Protection (CBP) determines that the declared value of non-U.S. content of an automobile, as described in clause (2) of this proclamation, is inaccurate due to an overstatement of U.S. content, the 25 percent tariff shall apply to the full value of the automobile, regardless of the actual U.S. content of the automobile. In addition, the 25 percent tariff shall be applied retroactively (from April 3, 2025, to the date of the inaccurate overstatement) and prospectively (from the date of the inaccurate overstatement to the date the importer corrects the overstatement, as verified by CBP) to the full value of all automobiles of the same model imported by the same importer. This clause does not apply to or otherwise affect any other applicable fees or penalties.
But I do wonder if all of this means that, in the aggregate, the true impact becomes a question of capacity and enforcement. Or rather, how difficult does the US really want to make life for importers?
Because, as per the general argument about the global economy made in FTAV contributor Dan Davies’s book, Lying for Money, the secret ingredient of an efficient global trading system is [a tolerance of some] crime. By this, I mean that checking every single product that enters a country would be incredibly resource-intensive and bring trade to a grinding halt.
In this context, if US border enforcement continues as it always has, you would expect most companies to accurately declare origin to the greatest extent possible and while some will accidentally get it wrong, and some will commit crimes, only a few will get pulled up on it every now and then.
However, in his press conference Trump threatened to jail people for 10 years if they try to claim the wrong tariff rate. And if the US decides to crack down — which it will need to if it wants to enforce the tariff differentials and achieve the ultimate objective of forcing companies to make stuff in the US — then, well, let vibes and chaos reign.
Further reading: — Reciprocal tariffs: you won’t believe how they came up with the numbers — The stupidest chart you’ll see today — Wall Street analysts anguish over ‘Liberation Day’
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Here’s a word you don’t hear much these days: Magnificent.
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Based on intraday pricing, America’s tech megacaps are in a bear market, having lost more than 20 per cent from Christmas Eve record-high close.
The above chart uses UBS’s Mag7 index, which is fixed to 100 on incorporation in October 2023 and rebalances twice yearly. Arguments about technical bear-market definitions are for the comment box.
Below is the view from an individual stock level. Click the stock names to turn the lines on and off.
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Maybe we can worry a bit less now about stock-market concentration?
Further reading: — Global stock markets tumble as Donald Trump’s tariffs loom (FT)
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
“Liberation Day” has quickly turned into Libation Day for many Wall Street analysts, who are being forced to take Donald Trump both seriously and literally.
The tariffs announced went far further than anyone had expected. As JPMorgan’s Michael Feroli points out, a static calculation implies that these tariffs would raise almost $400bn in taxes, relative to GDP terms the biggest tax increase since the 1969 Revenue Act.
It will increase inflation by 1-1.5 percentage points and take the average effective tariff rate back to 23 per cent — the highest in a century.
This alone could be enough to push the US economy into a recession, Feroli warns:
The resulting hit to purchasing power could take real disposable personal income growth in 2Q-3Q into negative territory, and with it the risk that real consumer spending could also contract in those quarters. This impact alone could take the economy perilously close to slipping into recession.
And this is before accounting for the additional hits to gross exports and to investment spending. Headlines about retaliatory measures by US trading partners are already coming out, and we expect to learn more in coming days. The somewhat confusing nature of today’s news, coupled with uncertainty over how long these tariffs will remain in place, should make for an even less friendly environment for investment spending (though that is one way to narrow the saving — investment imbalance and hence narrow the current account deficit).
We plan to revisit our forecast later this week.
We’ve already written about the clownish methodology underpinning the calculations of the “reciprocal” tariffs, and it seems that the sell-side is also pretty stunned by the bizarre approach.
Here are the three main conclusions by Deutsche Bank’s George Saravelos:
First, the US administration is squarely focused on penalizing countries with larger trade deficits in goods (services are ignored). This determination is highly mechanical, rather than a sophisticated assessment of tariff and non-tariff barriers. It is also in line with the declaration of a national emergency on the trade deficit used as a legal justification for the tariffs.
Second, there is a very large disconnect between communication in recent weeks of an in-depth policy assessment of bilateral trade relationships with different countries versus the reality of the policy outcome. We worry this risks lowering the policy credibility of the administration on a forward-looking basis. The market may question the extent to which a sufficiently structured planning process for major economic decisions is taking place. After all, this is the biggest trade policy shift from the US in a century. Crucially, major additional fiscal decisions are lining up over the next two months.
Third, the tariff calculation approach arguably makes for a more free-wheeling and open-ended nature to potential trade negotiations in coming months. It seems there are no specific and identifiable policy asks per se but ultimately a desire to reduce bilateral trade imbalances.
Saravelos points out that the Trump administration’s crude approach to calculating the tariffs “raises serious concerns about policy credibility” and thus undermines the dollar. As he emphasises, that the dollar is dropping in tandem with US equities is “extremely damaging” for a global investment community that is still extremely long US assets.
Barclays analysts are also reeling from tariffs that were both higher than expected, and more weirdly calculated than anyone would have thought possible, even by this administration.
However, their main point is that while tariffs are mostly priced into markets, the danger that this tips US and Europe into recession is still underestimated by markets.
Recession risk on the rise. These new tariffs and the lingering trade policy uncertainty dampen the global economic outlook, both globally and in Europe. However, the statements from authorities and the way the final tariffs were arrived suggests that there may be room for negotiations. So it is possible the announced tariffs may be seen as a ceiling and may go lower from here, although potential retaliation by US trading partners would add to downside growth risks. Policy support from central banks and government is also to be expected, which could mitigate some of the drag from the trade war. But overall, our economists see downside risks to their growth forecasts . . .
. . . Tariffs risk largely priced in, recession risk less so. As discussed in our latest Who Owns What, equities were already pricing-in some tariffs risk, with main indices off the highs and significant rotation under the hood at the sector level. SPX down 8% implies ~25% of recession priced-in already, but arguably, SX5E still up 8% ytd may have more catch-up to the downside if a recession becomes reality. This is particularly the case as tactical HF/CTA positioning on Europe is higher than for the US, although LO/Retail positioning is far more crowded for the US. In both regions, equities typically fell ~35% peak to trough during recessions, but we are not quite there yet, and further market pain may force some policy u-turn from Trump at some point.
Steven Blitz at TS Lombard also reckons this is a is a “recession-producing” set of measures for the US economy, but fears even this may miss the broader implications.
The Fed is not inflating to offset tariffs — the whole point is to create pain to force reshoring. They ease when payrolls decline, meaning after recession begins. Trump appears willing to accept this risk for the eventual reward from reshored activity.
For capital market participants, tariff tinkering from here is besides the point. They are repricing against Trump breaking the trade/dollar contract that has ruled for 40 years. A higher price to hold US dollar assets is likely demanded and that, in turn, creates higher hurdles to reach Trump’s promised land. Among the things Trump gets wrong with tariff nostalgia, is that then the US was a net exporter of capital, it is a net debtor nation now.
. . . Trump is right in saying the game is rigged against the US, but the first rule of an operation is that the patient comes out healthier. The damage from his tack to reset trade may very well create a worse, less healthy outcome. There is more to write, and we will in the days to come.
We’ll update this post with more sell-side reaction as it filters in.
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Though Alex set last week’s chart quiz, it falls to muggins here to sift through the entries and award the T-shirt.
The enthusiasm muggins here will bring to the task is equalled only by their ignorance about the answers. Let’s get it done.
Chart One shows US corporate profits, though by what measure isn’t obvious. Francisco, a regular correspondent, says:
Among the different combinations: before/after tax, with/without IVA or CCAdj, the closest I found was “After Tax with Inventory Valuation Adjustment (IVA) and Capital Consumption Adjustment (CCAdj)”, which is nearly a perfect match, except for a few points: 2019Q3, 2020Q2, 2021Q3, 2022Q1 — I don’t know why, though.
Me neither!
Chart Two is University of Michigan five-year inflation expectations. Francisco adds:
I believe the units should be %, rather than percentage points. Though, I guess one could cheekily say it’s the difference with respect to 0% inflation.
Maybe? Not my problem.
Chart Three is the 10-year Treasury term premium. Commenter Anthony Cheng adds that it’s the Adrian, Crump and Moench (ACM) premia model, which sounds likely but gets no extra credit.
Cheng also highlights that the wording of last week’s quiz post suggests all the correct answers get a T-shirt. They won’t. We can’t afford two T-shirts:
Congratulations to Francisco, who’ll be receiving the exclusive “I Heart Charts” merch shortly. Another chance to win will come around this Friday,
The US’s “liberation day” approaches, and Goldman Sachs sees a greater chance the country is . . . freed . . . from economic expansion this year.
Jan Hatzius and the bank’s economists are raising their predicted likelihood of a recession this year, along with their forecasts for the ultimate amount of tariffs levied by the US, according to a note that made the rounds on Sunday.
Now, in more normal times, it’d be tempting to compare the US’s tariff headlines to the “guidance game” that public companies like to play ahead of earnings.
Ahead of companies’ quarterly results, Wall Street analysts slowly cut their forecasts, usually without any public statement from the company. And then — what do you know? — the company’s report beats “Wall Street expectations”. It’s not especially unusual for 70 per cent of companies in the S&P 500 to beat estimates.
But these aren’t normal times.
And while the US’s tariffs news could qualify as expectation management, it has not been subtle. Over the past week, we’ve heard:
1) The US will impose “reciprocal” tariffs but even worse, because they’ll count things like value-added taxes, which are not tariffs.
2) Just kidding, the US will “probably be more lenient” on tariffs, focusing them on its biggest 15 trading partners (most of its trade, but whatever).
3) Never mind, the US wants to impose 20-per-cent tariffs every country in the world.
4) And it’ll collect . . . $6tn doing it? What?
Anyway, whatever happens, President Donald Trump is calling the April 2 announcement “Liberation Day”, a catchily bizarre phrase.
Like a company heading into a bumpy earnings season, Wall Street seems to have gotten a steer too. It translates to “more tariffs than we thought there’d be a few months ago”.
On Sunday, Jan Hatzius and his GS economics team ratcheted up the bank’s tariff forecast. They now expect a 15-percentage-point increase in 2025:
For the second time in less than a month, we are raising our tariff assumptions. We now expect the average US tariff rate to rise 15pp in 2025 — our previous “risk case” and 5pp more than our previous baseline. Almost the entire revision reflects a more aggressive assumption for “reciprocal” tariffs. We expect President Trump to announce reciprocal tariffs that average 15% across all US trading partners on April 2, although we expect product and country exclusions to ultimately whittle the addition to the average US tariff rate down to 9pp.
The bank’s equity strategists now predict another 5 per cent decline in the S&P 500 over the next three months, followed by a mild rebound to leave it 6 per cent higher a year from now. They give the following reasoning:
Slowing growth and rising uncertainty warrant a higher equity risk premium and lower valuation multiples for equities. The S&P 500 entered 2025 trading at a 21.5x P/E multiple on consensus forward EPS, and currently trades at a multiple of 20x. With little change to consensus EPS estimates, all of the 9% sell-off from the market peak in February has stemmed from valuation contraction. We expect a further valuation decline in the near-term, with the P/E registering 19x in 3 months and rising modestly to 19.5x in 12 months.
And finally, Hatzius & Co raise their predicted recession likelihood to . . . 35 per cent. More on that in a second, once we see their reasoning behind this change:
[a] lower growth baseline, the sharp recent deterioration in household and business confidence, and statements from White House officials indicating greater willingness to tolerate near-term economic weakness in pursuit of their policies. While sentiment has been a poor predictor of activity over the last few years, we are less dismissive of the recent decline because economic fundamentals are not as strong as in prior years. Most importantly, real income growth has already slowed sharply and we expect it to average only 1.4% this year.
Now, 35 per cent doesn’t sound especially bold. It doesn’t even meet the Perkins Rule, named for TS Lombard’s Dario Perkins: You can predict basically anything, as long as you assign it a 40 per cent likelihood.
But it is rather interesting to see Government Goldman Sachs stick their neck out while writing from an American jurisdiction. It’s also unclear whether they’re following our Recession Watch.
Anyway! The bank’s economists now expect three Fed rate cuts as “insurance” this year, in the style of Powell’s 2019 shift:
We have pulled the lone 2026 cut in our Fed forecast forward into 2025 and now expect three consecutive cuts this year in July, September, and November, which would leave our terminal rate forecast unchanged at 3.5-3.75%. The downside risks to the economy from tariffs have increased the likelihood of a package of 2019-style “insurance” cuts, which we now see as the modal outcome under our revised economic forecast. While the Fed leadership has downplayed the rise in inflation expectations so far, we think it does raise the bar for rate cuts and in particular puts greater emphasis on a potential increase in the unemployment rate as a justification for cuts.
But in 2019, there wasn’t comparable inflation in basics like eggs, or a series of inflation-fuelling tariffs expected to go into place. (The bank does expect tariffs to boost inflation by half a percentage point, to 3.5 per cent PCE YoY.) So we’ll see.
Over at Barclays, the strategists are taking a broader world-historical view:
We think the direction of travel is clear: average tariff rates are increasing, likely to levels not seen since before World War II. At the end of 2024, the US weighted average tariff rate was 2.5%. After the tariffs that Trump has implemented so far, the average tariff rate has increased more than 3 times to over 8%. We assume once Trump is finished, it could be as high as 15%.
It’s worth noting that the 15 percentage point figure was cited by GS as well, though GS expects tariffs to increase by 15 percentage points, while Barclays expects them to end at 15 per cent.
Others at the British bank are finding their solace in literature. Barclays’ FICC team comes out with a more tormented take:
‘Love is a reciprocal torture’ lamented Marcel Proust, reflecting on the inherent suffering in romantic relationships. Donald Trump has the US’s suffering in foreign trade relationships in mind when introducing reciprocal tariffs next week, in addition to a 25% tariff on cars already announced this week. In his view, the US has ‘been ripped off for decades by nearly every country in the world’, which reciprocal tariffs will now rectify.
But just as with Proust’s love, Trump’s tariffs may also end in reciprocal torture because they risk hurting not only foreign exporters, but also domestic producers and consumers. The drop in confidence reflected in surveys and the sell-off in equities and risky assets more generally suggest that this is what consumers and investors fear.
