A Note on Market Volatility
On March 13, 2020, at the onset of the coronavirus pandemic and after the Dow Jones Industrial Average had dropped almost 8% on March 9 and almost 10% on March 12, Prudent Management Associates sent a special note to its clients that, among other statements, repeated the quip that the “job of a pilot and an investor are defined by years of boredom punctuated by moments of terror.’”
We are now in another such punctuated moment, although it remains true, as we noted in March 2020, that the investor has something critical that the pilot lacks – a moment of time to catch his or her breath and to remember his or her long-term goals. In other words, quoting financial writer Michael Batnick, “talking about being a long-term investor during bull markets is practice. Behaving like a long-term investor during a bear market is the game.”
With those critical points in mind, what perspective can Prudent Management Associates provide in addition to those it stated in the special note it sent out on March 17, 2025?
First, ironically, there is a similarity between the market events in March 2020 and in March 2025. More specifically, both severe downturns were caused not by any conditions within the financial markets or the economy at large, but instead by what is known as an “exogenous” event, i.e., a factor outside of the capital and business markets – a new plague and shutdowns in March 2020, and in March 2025 a seeming overhaul of an international trading system in place since 1945. By contrast, the Global Financial Crisis of 2008-2009 involved the unravelling of new and exotic financial products engineered by Wall Street (mortgage-backed securities and the like) and a downturn in the real economy, an “endogenous” event.
Second, it is unclear at least to us at the moment whether President Trump’s intention is to, in fact, permanently overturn international supply chains built up over the last 80 years as restrictions on international trade eased, or to commence what he would see as a type of grand negotiation with the rest of the world over claimed unfair restrictions put on American exports while importers “take advantage” of American open markets.
In this respect, at least some Republican politicians have indicated that they expect President Trump to follow this latter course of action and to quickly commence and conclude negotiations with major trading partners. Texas Senator Ted Cruz, for example, was quoted in the Wall Street Journal that he “hopes President Trump’s tariffs work as leverage to get other countries to quickly lower trade barriers, which could spark an economic boom.” But if “90 days from now, with massive American tariffs and massive tariffs on American goods and every other country on earth, that is a terrible outcome.”
On the other hand, many of Trump’s economic advisers have indicated that they see international trade as an evil unto itself, a process by which America exports its wealth to foreign countries leaving its own citizens poorer. This view, taken to its logical extreme, would want the United States to become an autarky.
In our opinion (which is also the opinion of most economists and also of politicians such as Senator Cruz) striving for this autarky goal would be a profound policy mistake. As stated with his usual pithiness, Nobel Prize-winning economist Milton Friedman remarked in 1978 that a tariff “does protect; it protects the consumer very well against one thing. It protects the consumer against low prices.”
To see why this is so, consider one product used by virtually every American – the sneaker. Four Asian countries, China, Vietnam, India and Indonesia manufacture the vast majority of the sneakers bought by millions of Americans every year. While the tariffs imposed on each of these four countries is not identical (Vietnam for example is subjected to a 46% tariff while Indonesia’s is 32%), if we assume an average tariff of 35% and a $100 cost of the average sneaker, the question then becomes how much of this additional $35 cost will be passed to the consumer, and how much absorbed by the manufacturer.
This would have to be worked out over time, but in a low-margin business such as sneaker manufacturing, a meaningful percentage of this tax would have to be incorporated into higher prices. A conservative estimate is that at least half of this new cost would be passed on, meaning each sneaker would cost 17.5% more than before the tariffs, and with an average of 112 million sneakers sold each year, Americans as a whole would be spending almost 2 billion more dollars on sneakers as a result. Now do a similar analysis with every imported product and it becomes easier to see why some reasonable economists expect that these tariffs would constitute a tax increase equivalent to 2% of GDP or approximately 500 billion dollars.
In short, the market is now reacting to a political process that is creating numerous uncertainties, and until these issues are resolved, and depending on how they are resolved, further volatility is very likely to occur. At the moment the markets seem to be favoring the hypothesis that tariffs are here to stay (at least in the short-term). For example, key macroeconomic indicators that PMA follows to monitor the US economy in real-time are beginning to flash red: in addition to the equity market plunge, the US dollar has weakened over the last few weeks, spreads on junk-rated corporate bonds are spiking, and economists and some betting markets are ramping up calls for a recession.
It is this final point that truly matters most for how the next few chapters in this saga unfold. Should the US economy weather this storm to some extent, be it because tariffs are soon enough removed by President Trump after negotiations or because investors are overestimating their negative implications for US businesses, the markets will begin to recover more quickly. If, however, Americans feel the economic pain foreshadowed by Senator Cruz and consumers begin to pull back spending amidst price hikes and economic uncertainty, a mild-to-moderate US recession is a plausible outcome. Under this realization of events, a market drawdown may be steeper, and any subsequent recovery slower.
PMA’s Investment Committee will be holding a special meeting on Tuesday, April 8 to discuss the state of the markets and any potential actions we may take in our clients’ portfolios. As you know, PMA generally avoids making major portfolio shifts during times of crisis because we believe such market timing decisions lead to lower returns. We do, however, make modest adjustments as our view of risk evolves, and it is very possible that our Committee will take some action this week. PMA’s advisors also may use these extremely volatile periods in markets to tax-loss harvest (in taxable accounts) and rebalance portfolios for risk-control purposes.
Ultimately, because we believe that PMA’s clients generally entered April 2025 with a good investment plan in place, staying the course is our best advice. These “moments of terror” are the very reason that PMA focuses on building well-diversified portfolios, which typically hold fixed income investments (which have held up well during this turmoil so far), and international stocks, which have declined by less than their US equity peers this year.
We know how unsettling these last few weeks have been, we certainly feel it too. But we repeatedly quote the saying above that in times like these we must draw on our practice as long-term investors, because, as Warren Buffett has stated, an “unsettled mind will not make good decisions.”
Buffett made that comment in the context of describing how he has seen his own Berkshire Hathaway stock decline nearly 50% three times in his career, leading him to conclude that “no-one can tell you when these [large declines] will happen” and the light can at “any time go from green to red without pausing at yellow.” A necessary corollary to this statement is that no-one can tell you when markets will recover, which makes an attempt to jump in and out of the markets not the recommended strategy. Ultimately, although the timing cannot be known in advance, markets have recovered from these types of large drawdowns historically.
Buffett quotes the poet Rudyard Kipling exactly for times like these: “‘If you can keep your head when all about you are losing theirs, if you can wait and not be tired by waiting, if you can think – and not make thoughts your aim, if you can trust yourself when all men doubt you, Yours is the Earth and everything that’s in it.”
