Moving Markets and Asset Allocation
On the evening of Wednesday, April 2nd President Trump announced reciprocal tariffs for about 90 countries, with many of the tariffs far higher than previously expected. Mr. Trump’s so called “Liberation Day” led to a historic two-day selloff with the S&P 500 dropping 10.5%. The decline represents the fourth worst two-day drop since the index was created in 1957, trailing the outbreak of the pandemic in 2020, the aftermath of the collapse of Lehman Brothers in 2008, and the 1987 market crash. Going back to the 1920’s using the S&P 90, the precursor to the S&P 500, Mr. Trump’s two-day loss has been eclipsed only six times, surpassing disasters including the 1929 crash, the Nazi Blitzkrieg in 1940 and a couple of declines near the bottom of the Great Depression in 1932 and 1933. That’s keeping quite some company. On the bright side, subsequent returns have been more positive.
After more than a decade and a half of bull market returns interrupted only briefly by the pandemic and the onset of the Ukraine war in 2022, investors have been conditioned to look at declines as buying opportunities. However, in early 2025 the market looked vulnerable to the downside, regardless of tariffs. Around mid-February the S&P 500 was up about 4%, almost half the return of a typical year, and that nice performance came after two 25%+ yearly advances. At the time, the 2025 forward P/E ratio of the S&P 500 had risen to 22.2, 12% above the five-year average of 19.8 and 21% above the 10-year average of 18.3. The multiple wasn’t that far below the spectacular 26 achieved in 2000 before the dot-com crash.
This high relative valuation was fine if backed by earnings growth. Pre-tariffs, analysts expected earnings growth for 2025 and 2026 of 12.7% and 13.9%, respectively. These robust earnings growth expectations supported a higher market multiple plus the opportunity for further advances. However, even with Liberation Day tariffs suspended for 90 days, Mr. Trump has instituted selective tariffs up to 25% on certain countries and products, along with a 10% across the board tariff, and has raised tariffs so high on China as to practically freeze trade with our third largest trading partner.
Economists can, and are, arguing about the degree of impact on the economy. Basic economics and common sense dictate that tariffs operate as a tax. For consumers, if the tariff is passed on to them in the form of higher prices they can’t use that money for other things, in turn slowing growth. Alternatively, if producers pay the tariff their profits are lower. Both these negatively impact stock prices through slower growth and lower profits, hence the market’s retreat. We can all hope the ultimate impact on the economy and financial markets is modest, but we simply don’t know.
Given this heightened level of uncertainty what are we to do? A snap reaction would be to sell stocks and wait for the uncertainty to resolve. We have found market timing to be one of the best ways to destroy wealth, as you must be right twice: when to sell and when to re-buy. Various academic studies and my own experience as a young investor back this up.
This doesn’t mean that Provident sits on its hands during periods of market stress. We follow many more stocks than you see in your portfolios, constantly challenging existing holdings to earn their keep lest they be replaced by something better. You will see from your statement confirmations that we have already made some moves and are likely to do more as this tariff saga unfolds.
Just as important as portfolio management is understanding your own evolving financial circumstances. The long bull market supported a significant increase in wealth for many long-term clients, while time inevitably promotes us into a new life stage. If you are younger and still working the recent market decline likely isn’t changing your appetite for stocks much, but those nearing, or in, retirement might now find being in the market unnerving and possibly haven’t carved out enough safe assets. I’d say from the clients I’ve talked to recently asset allocation is suddenly much more top-of-mind than just a couple months ago.
In recent years Provident has expanded its investment offerings to better address clients’ goals, risk tolerance and time horizon. Our growth portfolio has an enviable long-term track record of market-beating performance that we recommend as the backbone of an equity allocation. On the equity side we also offer a dividend portfolio, targeting a dividend yield of at least twice the rate of the S&P 500 (about 3%) with a long-term expected return less than growth stocks but with diversification benefits and overall lower volatility. Finally, we build low risk individual municipal bond portfolios for investors seeking better after-tax bond returns than U.S. government securities. Because these investments are individual securities they don’t carry an expense fee, saving a client from paying both a management fee and investment fees to the product sponsor, as is the case with most other advisors. Individual bonds also provide a predetermined return; their prices can fluctuate, but they will pay the promised interest and full par value upon maturity.
Given your goals, risk tolerance and time horizon, Provident can help you take these investment offerings and vary their mix to suit your needs. For example, an investor in their 30s with a job that covers their spending and a sufficient emergency fund of six months of expenses would be best served by our growth portfolio as it maximizes wealth creation even while enduring the occasional market decline. For a retired investor a diversity of growth/dividends/bonds might be particularly helpful if there is a need for liquidity in market downturns, which runs in parallel with a desire to preserve capital rather than grow capital aggressively. Everyone’s financial circumstance is different, and one-size does not fit all.
If you have felt any uncertainty about your asset allocation during this recent market meltdown, we encourage you to contact us for a review of your current financial situation and to discuss alternatives. Asset allocation is a personal decision and, importantly, changes over time. We are always here to help you make good decisions with your investment dollars.
Dan Boyle, CFA®