Key Points
- China responded to the U.S. tariff announcement; more retaliatory actions are expected this weekend.
- Despite the sell-off, stocks remain expensive — we prefer re-entry around 4,500–4,750 for the S&P500.
- The bond market’s assumption of rate cuts alongside rising inflation is contradictory, both can’t happen at the same time.
- The key macro risk: stagflation becomes entrenched if corporate investment slows.
The U.S. Places a Bet — China Raises
On April 2, 2025, the U.S. announced a sweeping schedule of import tariffs, with rates starting at 10% and going as high as 45%+, particularly targeting Asia-Pacific countries. China was hit hardest, with a 34% new tariff layered over a prior 20%, totaling 54% on $440 billion in goods.
China responded swiftly—with more than just tariffs. Because China only imports ~$140 billion from the U.S., it added non-tariff measures:
- Export restrictions on rare earths critical for tech manufacturing
- Blacklisting some U.S. firms as “unreliable”
- Import restrictions on poultry and farm products, using sanitary/quality loopholes
Expect similar retaliatory action from Japan, Korea, and the EU, likely targeting politically sensitive industries such as agriculture, motorcycles, and spirits.
Stocks Are Still Not Cheap
Despite a 12.3% YTD drop, the S&P 500 still trades above 20x forward earnings, which we consider expensive.
- 2024 EPS: $243 → 21.2x P/E
- 2025consensus EPS: $268 → 19.2x P/E (likely to increase as earnings arerevised down)
With rising input costs, dollar volatility, and trade-related earnings risks, we believe $4,500 on the S&P 500 is a more attractive re-entry point. This assumes stable real earnings and a normalized 18x P/E multiple.
Inflation vs. Rates: The Market’s Blind Spot
Once again, the bond market is pricing in a rate cut scenario, while inflation expectations move higher:
- Fed futures imply a 70% chance of a rate cut in June, and 4 cuts by year-end
- Inflation swaps forecast 3.5% average inflation in 2024
That’s a contradiction.
In stagflation, the Fed faces a dilemma: cut rates and risk runaway inflation, or hike rates and deepen recession. As Powell has alluded to—and as Paul Volcker did in the early 1980s—the Fed is likely to prioritize fighting inflation, even if that worsens the downturn.
Corporate Investment Is the Only Antidote
To avoid prolonged stagflation, corporate investment must accelerate.
- The U.S. needs to invest 17–20% of GDP just to maintain productive capacity.
- Tariffs and labor disruptions (e.g., deportations) raise this threshold, requiring more capital spending to increase productivity and offset labor losses.
If productive capacity shrinks with a protectionist trade policy:
- Prices rise due to supply constraints
- Consumption falls due to job loss and wage stagnation
- Investment slows in response, reinforcing the recession
This is how stagflation becomes entrenched — and why policy stability and investment confidence are so critical right now.
