“I don’t do it for the money… I do it to do it. Deals are my art form.
I like making deals, preferably big deals. That’s how I get my kicks.”
Donald J. Trump in The Art of the Deal
The stock market clearly agrees that President Trump is using tariffs to negotiate new trade deals, sometimes only marginally better deals, but better, nonetheless.
However, risk assets could be poised for disappointment on a short-term basis. In his famous book, published in 1987, President Trump explains how he gets to make a deal.
Taking a page from his own book, his negotiation tactic follows a sequence of steps. Basically, it starts with a ridiculous offer, then confuses your negotiation partners with lots of irrelevant noise, then takes a step back to look more reasonable. This is often followed by a demand to pull the deal when your counterparty thinks they have a deal, before eventually settling on a deal and declaring victory, no matter whether it is a good deal or not.
The Trump administration has so far been closely following this playbook. That means we could be in the latter stages of the negotiations, but that also means we can expect a few more twists and turns that can unsettle the market. So, global equity markets will remain volatile in the coming months, though the trend may well remain up as corporate earnings and a still solid global economy support asset prices.
The announced U.S.-China deal has taken everyone by surprise. President Trump has signalled a pause in the fight against China, followed by a similar pause in the tariffs on European products. Yes, the situation can reverse, but when the Secretary of the Treasury says things like “neither side wants to decouple,” the world should listen.
President Trump has pivoted towards negotiations as expected. However, we did not expect the pivot on China to come this quickly. Markets have cheered the event, not merely because U.S. trade with China is substantive but because investors are assessing that if Trump is willing to make a deal with China, he can make it with everyone. Nonetheless, investors should expect more volatility in the near future as the deals are yet to be finalized.
- Where is the Recession?
- One Big Beautiful Bill or One Big Ugly Mess?
- Q1 Earnings Season: Companies Keep Performing
- Buy Europe on the Dips
- U.S. Dollar: Plaza Accord 2.0
- Portfolio Positioning
Where is the Recession?
The big question on investors’ minds is whether the U.S. could fall into recession in the near term, after the negative GDP number in the first quarter. And does a recession matter? We are not sure that a recession or hard data will matter. Markets will trade on the policy outlook in a policy-induced recession. This was clear when the Trump administration’s decision to pare back tariffs on China came faster than expected, justifying a lower probability of a U.S. recession.
Conventional wisdom was that the tariffs imposed by the Trump Administration would cause higher inflation, slower growth, and potentially stagflation. But recent economic data defied this prediction. The trade deficit plummeted in April, signalling economic growth could surge in the second quarter. The Atlanta Fed GDPNow model has the Q2 growth forecast at +3.8% for now. Inflation also slowed sharply with the Federal Reserve’s preferred measure of inflation now up only 2.1% on a year-ago comparison basis, just above the official target of 2.0%.
Investors can be forgiven for finding this confusing. After real GDP declined at a 0.2% annual rate in the first quarter, many thought this dip was a harbinger of recession, with more declining real GDP ahead. However, the decline in Q1 real GDP was largely due to an unprecedented import surge due to front-running tariffs, which would reverse in Q2 and beyond. At this point, it looks like this is happening now.
If we focus on Core GDP, which is real GDP excluding government purchases, inventories, and international trade, each of which is volatile from quarter to quarter, we get a slightly different story. Core GDP grew at a 2.5% annual rate in Q1, faster than the average annual rate of 2.2% in the past twenty years.
The economy was not in massive trouble in Q1, and it is not booming in Q2. Now that some of the threatened tariffs have finally taken effect, firms selling goods in the U.S. are ordering more from their domestic suppliers.
In the meantime, the fact that inflation continues to decline really shouldn’t surprise anyone. The M2 money supply has been basically flat since 2022. Yes, tariffs can mean the items being tariffed cost more. But inflation is ultimately a monetary phenomenon, and tariffs don’t change monetary policy. So, if the tariffed goods cost more, that means less money is left to buy other goods and services, putting downward pressure on those other items. Inflation data show a quiet past three months, with PCE prices up a mere 0.1% in April. They are now up only 2.1% from a year ago, a much slower increase than last year.
On the other hand, personal income rose by an unexpectedly large 0.8% in April (which makes up $25 trillion of the $30 trillion U.S. economy) and is running at a 6%+ annual rate in the second quarter. That is more than enough to generate above trend GDP growth. The main culprit appears to be government spending, especially in entitlement programs, even before the new budget adds higher deficits in 2026 and beyond.
Inflation is typically caused by too much money chasing too few goods and there is plenty of money, while tariff uncertainty is limiting new investment. That is potentially a recipe for higher consumer prices in the coming months, but asset prices tend to go up in that environment as well, as long as inflation does not get out of control.
Nevertheless, we continue to see a recession as a possibility. Although tariffs have come down, the effective U.S. tariff rate is still the highest since the 1930s. This means we are not out of the woods on recession risk and higher inflation brings a different kind of risk to equity markets. But this probably means that Fed policy will remain on hold for the foreseeable future and bond yields will not come down.
One Big Beautiful Bill or One Big Ugly Mess?
Investors have breathed a sigh of relief at the prospect of reduced trade tensions. The hope is that with the trade war on the back burner, President Trump will pivot to more market-friendly policies such as cutting taxes.
President Trump’s signature bill is surprising to the upside with budget deficits. Some form of the bill is guaranteed to pass, no matter how many tries it takes.
The bill will entrench the president’s first round of tax cuts, expand border control and defense funding, and add some new tax cuts to fulfill the president’s campaign promises. The bill will cut taxes by more than it cuts spending. Thus, it will maintain large budget deficits, cushion the economy against a trade war, and stoke inflation expectations.
Rising bond yields may actually be more damaging than the trade war. Unsustainable public debt dynamics in the U.S. could lead to higher bond yields, which could also push the economy into recession.
The Republicans’ growth-boosting tax cuts may end up achieving just the opposite. According to the Congressional Budget Office, net government debt in the US will rise from 98% of GDP in 2024 to 149% of GDP in 2040 if the 2017 tax cuts are made permanent. This does not even include other measures in the House budget bill that entail lower fiscal revenues.
And the tariffs will not generate enough revenue to cover the tax cuts, despite an increase in the effective tariff rate to 16.4% from 1.5% before his election. Moreover, these revenue benefits are uncertain and revocable.
The base case is that the deficit will go from 6.4% of GDP in 2024 to an estimated 6.1% in 2025, then 7.7% in 2026, 8.4% in 2027, and 8.6% in 2028. The bond market selloff is underway, and any further rise in yields could force Republicans to revise the bill. Given narrow majorities and total Democratic opposition, Republicans will struggle to achieve significant compromises. At best, bond market turmoil may force the GOP to water down its new tax cuts.
We do not have a strong view on bond duration at the moment. While a slowdown would normally cause bond yields to fall, the prospect of even more unfunded tax cuts could push Treasury yields higher in the short term.
Q1 Earnings Season: Companies Keep Performing
Despite the uncertainty created by the trade war, first-quarter U.S. earnings have outperformed expectations. A deteriorating economy will eventually weigh on profits, but for now, that is not visible in the results.
A solid U.S. economy is supporting corporate earnings. However, executives are worried about a recession, and sectors exposed to tariffs have revised guidance lower. Consumer spending remains afloat, but soft data are weakening.
Nevertheless, cyclical headwinds to profits may be less strong than feared on “Liberation Day.” The U.S.-China/U.S.-Europe trade truce will likely result in lower tariffs than originally announced, leading to a shallower recession. Moreover, U.S. companies will mitigate the financial impact of tariffs through diversifying supply chains, cutting costs, and passing price increases to customers.
Buy Europe on the Dips
Ongoing military tensions between Ukraine and Russia and renewed U.S.-EU trade friction reinforce tactical opportunities to add European exposure on dips. Ukraine’s drone strike on Russian air assets and the limited outcome of the latest Istanbul talks point to continued conflict rather than de-escalation. However, heightened aggression often precedes serious negotiations, making it unclear whether we face a sustained deterioration or positioning ahead of talks.
Despite persistent geopolitical risk, five factors continue to support European asset performance: Attractive valuations, supportive fiscal policy, structural reforms, single market integration, and an abundant supply of Liquefied Natural Gas (LNG). Pullbacks tied to Ukraine developments should represent tactical buying opportunities in European assets.
Tense U.S.-EU trade negotiations will be challenging, but dips should also be used to build exposure to Europe.
U.S. Dollar – Plaza Accord 2.0
Since the start of the year, the U.S. dollar has already weakened substantially, but we think longer-term downside risks to the U.S. dollar might be underestimated. In September 1985, at the Plaza Hotel in New York, a group of five major economies agreed to depreciate the US dollar against the Japanese yen and Deutsche mark. This led to a complete reversal of the previous U.S. dollar bull market and even new lows. Could the same happen again and push the dollar below the lows of 2007?
The collapsing dollar led to a massive underperformance of U.S. assets. The Dollar Index plummeted 48% from its 1985 peak to the end of 1987. Although U.S. equities soared 45% during this period, the gain was largely offset due to the dollar’s 48% collapse. Meanwhile, international markets thrived, with Japan notably entering bubble territory. If history repeats itself, could Europe or China be poised to enter bubble territory in the coming years?
Our Portfolio Positioning
Markets have recovered most of their losses, with U.S. large caps performing well in May. Our core portfolio has performed well since the start of the year. Fixed income is hurting due to higher Treasury yields, but we are comfortable holding a balanced position, including a small position in long-dated U.S. Treasuries as a hedge against further weakening economic data.
We remain slightly defensively positioned for the coming months as we expect markets to remain volatile and prone to swings based on new announcements by the Trump administration. However, despite the risk of a shallow recession, we are not bearish. Maintaining a globally diversified portfolio and staying invested is the right strategy in this type of market.
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
