April 2025
Ripping off the Band-Aid
Christopher P. Lorenz
Today is one of those days that test the mettle of investors and requires that we step back and focus on what we know, ignore things that are unknowable, and remember history. Investing is about math and how compounding returns grow asset values. I’ve had the good fortune to manage several client portfolios for more than 25 years. During that time, we navigated through September 11th, The Dot.com bubble, the 2007-2008 financial crisis and COVID. There have been numerous recessions, Presidents, Wars and none of those events were able to stop the power of compounding returns for our clients. Investors who lost money from those events did so because they forget that markets recovered from every sell-off they had and let emotion take control. During that time there have been periods of fantastic prosperity as well.
Investors often ask, “why not sell and wait for a better time to get back in”. Once again, math is what matters. Math is clear, if you are out of the market for the large recovery days, over time your returns are much lower, and you lose the mathematical power of compounding returns. Days like today are stressful for investors and inspire some to make emotional decisions, which in my experience have been bad investment decisions. I maintain a myopic focus on the math and the lessons history has provided, which allows me to temper my emotions and recognize that for most investors these are opportunities to acquire assets that are trading below their value. While my focus is on history and the future, I also need to understand what parts of the market are most impacted today. I want to identify business sectors being unnecessarily sold off because those sectors present the best opportunities while recognizing which sectors will have prolonged challenges.
The recent market downturn can be attributed to two key components. The first, and most important, is that the economy has slowed down after two years of rapid growth. The second is a loss of investor confidence because of the political landscape. Investor sentiment can move a stock price up or down, even if the business hasn’t changed. These two factors have the stock market trading down, but it might surprise some that we have only traded down to the levels markets were at early last fall. If an investor was pleased with their portfolio last fall, they can feel better about where it is today. Anytime we lose 10%, it is painful, even if we are just giving back recent gains.
The economic slowdown is important to monitor, but that isn’t something I get too worked up over because our economy is constantly accelerating then slowing. I also believe a recession from time to time is a healthy part of long-term economic growth. It tempers inflation, and rings out weak businesses, which allow new businesses to step in. The stock market does a good job of pricing the economy when it speeds up and slows down.
As a professional investor who believes math is the most important part of investing, it pains me to focus on politics. Historically, economic momentum is far more powerful than political momentum, but on a day like today we must respect the correlation between politics and macroeconomics. This morning the stock market is grappling to price for the uncertainty around tariffs and how that will impact corporate earnings over the next few years. Regardless of your political leanings, it is undeniable that globalization of the economy puts the U.S at a significant disadvantage, it isn’t hard to look at our trading partners and compare tariffs. U.S manufacturing has shifted to low-cost countries for decades, and if you drive across America, you can see the dilapidated factories. More importantly, we have some important products, like pharmaceuticals and steel, that we rely on adversaries to manufacture for us. It is common sense to see that this creates risks for us, and it makes sense to try and level the playing field. Most people on both sides of the aisle agree that international tariffs, currency manipulation and foreign subsidies should be addressed. So why hasn’t Washington tried to deal with this problem? Because it is very disruptive and political suicide.
The current administration believes it is time to “rip off the Band-aid”. The President doesn’t need to be reelected so his team can do things that that may not be popular in the short-term. Our economy has significant issues that have built up over many decades resulting in massive trade imbalances and enormous federal debt. The interest payments on our national debt now cost us more than our entire defense budget each year. If we don’t address the debt, we will have another debt crisis like 2007. Rasing taxes on high income earnings will not increase tax revenue enough to come close to narrowing the debt. When we pay tariffs to other countries we are subsidizing their economy at the expense of Americans. This administration believes that it isn’t fair. Matching the tariffs and subsidies of our trading partners will level the playing field but also bring in significant revenue to help lower our federal deficit. There are other things that can be done to reduce the deficit, like raising taxes, but the U.S is subsidizing other economies, like China, and tariffs can mitigate those subsidies that we pay.
While some of the tariffs start today, the majority don’t kick in until the 9th of April and there are numerous sectors, like automotive, that have exemptions, all of which mean the uncertainty remains very high. The White House knows this would cause a stock sell-off, but they see this as economic tough medicine. I am inspired by my mother, who went through chemotherapy recently, which was brutal, but is now strong and back on the ski slopes. Most medicine is very unpleasant, but we take it because it will make us better off in the future.
The tariff announcement last night has given us some clarity on the high-end of the tariff spectrum and the White house firmly believes that the end results will be less onerous. The uncertainty will remain for some time as the impacts work through the economy. I am very confident in our corporation’s capacity to adapt. The tariffs from 2018, which were smaller in scale, were far less impactful than originally feared, because the global economy is flexible. We will see more manufacturing in the U.S and some other countries that have lower tariffs will also see new business.
Let’s get back to the math. The market is down over 4% today and just over 10% from the recent peak, which is a significant drawn down, but not unusual for long-term investors. This is caused by the uncertainty and increased possibility that the tariffs will push the economy into a recession. A recession is not a foregone conclusion, but with these actions, the possibility has increased. The stocks getting hit the hardest are those most exposed to cheap Asian manufacturing, like Nike, Lululemon and cyclical businesses like banks, that will be hurt by a recession. Today we remember why we build diversified portfolios. We have full positions in companies like American Tower (cell towers), Pepsi and Amgen among others that are trading in the green today. We also have significant bond positions that are also doing well. There are many businesses getting sold, but have carve-outs from the tariffs, like semiconductors (Nvidia). So today I will analyze which babies are proverbially getting thrown out with the bath water and therefore represent the biggest opportunities.
Earnings estimates for this year are currently 10.6%, which in normal times would result in healthy stock market gains. The tariff impact on earnings this year will be hard to estimate for the coming months but will come down. First quarter earnings reports start next week, and we will hear a lot of cautious commentary from CEOs, so, I expect more downward pressure on certain sectors in coming weeks.
Many of you who’ve read my commentary for years know that I believe my value is greatest in these moments when I can separate emotion from investment decisions. The experiences I mentioned above, like the financial crisis of 2007-08 became fantastic investment opportunities. Our favorite companies, like Blackstone Group, that traded at $200 per share in November are now trading 35% lower, but their profitability outlook for the next few years hasn’t changed much. We are buying our favorite stocks because regardless of the sudden market drop, the math will prove it wise to buy quality companies during uncertain times. The best time to buy stocks is when it feels the worst.