March Insights: Overcoming Barriers

Overcoming Barriers

“Life is pain, and anyone who says differently is selling something.”
~ Dread Pirate Roberts, “The Princess Bride”

Will tariffs be the end of us? Lately I am reminded of my college microeconomics professor who liked to say that the economy was stronger than any government. I did not have a clue what he was talking about back then, but as most of my hair went goodbye and what was left of it has turned grey, I now believe that may have been the most valuable lesson I was taught in my four years of undergraduate studies. I would add that both the economy and the market are stronger.

Tariffs and the mere threat of tariffs have caused a lot of uncertainty, and contrary to the motto, they have actually put America last. Through March 21, international stocks as represented by the MSCI EAFE index are up 10.26 percent year-to-date, while the S&P 500 is down 3.34 percent. On the surface it would seem that my good professor and I are wrong.

However, one needs to look deeper. When we entered this year, U.S. large-cap stocks were extremely expensive. Based on our work, large cap stocks were between 2 and 3 standard deviations above their average valuation; in other words, they were more expensive than they are 95 percent of the time and approaching 99.7 percent of the time. There was not really any room for them to go up.

International stocks, on the other hand, were within their average band. They were not cheap in that sense, but compared to the U.S., they were an absolute bargain. It makes perfectly good sense that international stocks would outperform. Add currency on top of the relatively low valuation and the recent results make even more sense. The dollar strengthened considerably in the 4th quarter of 2024, which means that euros were losing relative value, so investments denominated in euros therefore lost value for American investors. That has reversed itself in 1st quarter and subsequently provided a tail wind to European stocks. The Japanese yen has done likewise. These represent the two largest international markets.

So, is this what we are doomed to see in 2025? Will U.S. stocks continue to drop? Not so fast. Stock valuations are based on the companies’ earnings. For stocks to get less expensive, the price could drop and/or the earnings could increase. With the mild correction we have had in prices and an earnings season that saw over 17 percent growth in reported earnings, suddenly the large-cap stocks have gone from almost 3 standard deviations back to just over one standard deviation. In addition, expectations have come way down because of all the tariff talk. There are few things as freeing as low expectations.

This is what always happens: Wall Street exaggerates. They exaggerate how good things are and they exaggerate how bad things are. This likely bodes well going forward for stocks. This does not mean that tariffs will not cause pain. They will, and it is frustrating because it is a self-inflicted voluntary pain, but it isn’t all doom and gloom. There is always some form of pain somewhere. People will still consume goods and services. There will be jobs to be had. Life will go on, pain and all.

We will continue to talk about tariffs. We will also discuss tax and regulatory reform, which are also on the administration’s agenda. We discuss these things because our clients are interested in them, we are interested in them, and they do provide a backdrop that could impact certain companies. Investment decisions, however, are made from the bottom-up. Apple will sell phones regardless of tariffs. AI will continue to grow demand for Nvidia chips regardless of Canadian lumber cost. We could go on.

The future is always uncertain, and uncertainty is painful. It is when they tell you that the future is certain and there will be no pain – that is when they are selling something. Pain is a barrier that can be overcome.