Stock Market Resilience: Encouraging Trump to Impose More Tariffs?

The stock market's impressive rally since early April has largely reflected investors' bets that former US President Donald Trump will not follow through on his tariff threats. However, Jamie McGeever, a prominent financial journalist and analyst at Reuters, warns that this resilience might actually embolden Trump to push forward with tariffs, which could be bad news for the stock market.

Investors seem to believe that Trump's tariff threats are largely a tactic to force countries back to the negotiating table, and that the tariffs ultimately implemented by Washington will be much lower than what he has announced. Tariffs might be higher than at the start of Trump's second term, but still better than the worst-case scenario that the market initially priced in.

Monday's stock market movements are an example of this. Despite Trump's threat on Saturday to impose 30% tariffs on imported goods from the US's two largest trading partners – the European Union and Mexico – global markets were largely unmoved. European and Mexican stocks fell only slightly, while US stocks rose, with the Nasdaq hitting a new high.

Days earlier, Trump also threatened to impose 50% tariffs on goods imported from Brazil and 35% tariffs on Canadian goods not covered by the USMCA agreement. Brazilian stocks fell 5%, but Canadian stocks hit a new high.

McGeever points out that the question now is whether the line between "complacency" and a "TACO trade" (i.e., betting that Trump will always back down) has become blurred.

US Stock Surge and High Valuations

The scale of the US stock rally since April 7th is indeed impressive. As Charlie Bilello, chief market strategist at Creative Planning, recently pointed out on platform X, it took the S&P 500 less than three months to go from its April bear market low to hitting a new record high. This is the second fastest bear market recovery in the past 75 years, second only to 1982 (when the recovery took less than two months).

Based on 12-month forward earnings, the S&P 500 is currently near its highest levels in many years, well above the long-term average. The technology sector, which has driven this rally, also has valuations that are unusually high over the past 25 years.

This doesn't mean that stocks won't go higher. Some might argue that current valuations are reasonable if artificial intelligence really does bring about the revolutionary productivity improvements that are promised.

But regardless, the rally since April has clearly stemmed from a belief that final tariff levels will be much lower than those announced.

If the tariff rates that the US faces for most countries are around 10%, like the UK, and overall rates stabilize at 15%, then stock pricing may be quite reasonable. But if not, growth expectations may have to be significantly lowered.

"We maintain an overweight to US equities but do not rule out more pronounced market volatility in the near term. The uncertainty over who bears the cost of tariffs means increased earnings dispersion and more opportunity to generate alpha (excess returns)," analysts at the BlackRock Investment Institute wrote on Monday.

A Potential Doom Loop

What worries McGeever is that the market's reaction to Trump's tariff policy could form a doom loop: that Wall Street's resilience and strength in the face of heightened trade uncertainty might embolden Trump to double down on tariffs.

However, most analysts still believe that rationality will prevail. Barclays says that Trump's tolerance for stock and bond market volatility (and therefore US economic pain) seems "limited."

But Barclays warns that if the market is too complacent and Trump really does raise tariffs on European goods to 30%, the EU's potential retaliation could trigger a sell-off similar to the post-"Liberation Day" sell-off, leading to a double-digit decline in European stocks.

Another possibility is that investors are so focused on China in the tariff issue that other factors find it difficult to shake the market – but this may be shortsighted.

The United States imported $605.7 billion worth of goods from the European Union last year, accounting for 18.6% of total imports, the highest among all single regions. Data from the US Census Bureau shows that the US-EU bilateral trade volume was $975 billion last year. The US trade deficit in goods with the EU was $235.9 billion, the second largest US trade deficit.

If Trump does not back down in his confrontation with Europe, it may be Wall Street that backs down.