Keep Calm ..... MMM v6-14

After years of minor battles, last week the Trump Trade War exploded across the globe with his "Liberation Day" announcement on Wednesday afternoon. On day 1 in office he signed an order to study all trade agreements with a due date at the beginning of April. We knew the day was coming, but I think everyone hoped given the market sell-off since mid-February, the announcement would be on the lighter side. The 10% "baseline" tariff was mild by comparison to the jaw-dropping increases in "reciprocal" tariffs announced last week.

One issue the market has taken with the calculations is the formula for "reciprocal" tariffs essentially comes down to "what is the % trade deficit for goods from that country? Take that and divide by 2". Services are not included nor are actual tariffs charged on specific American goods. In the eyes of the President, the trade deficit represents "currency manipulation, trade barriers, and other areas" which were identified as being part of the formula. No consideration was given to the SIZE of the country (meaning they simply cannot purchase enough goods from the US to decrease the deficit) or the DEMAND of that country's products by US businesses and consumers.

Right or wrong, that is what the decision was. Rather than rehash any more of this, check out my Liberation Day analysis in the "Bonus Content" of our Spring Newsletter.

My opinion on "Liberation Day"

I'm going to do my best to leave my opinions out of this.......after this section. If you only want the news, analysis, and data, keep scrolling. This is what I will say as a fiscal conservative and registered independent:

The lack of supporting evidence behind the reciprocal tariffs is frustrating. Just because there is a trade deficit does not mean the country is doing something to restrict trade. And where are these numbers coming from? How does Trinidad and Tobago or the Turks and Caicos Islands make the tariff list, but Russia does not? We're running a $84 Billion trade deficit with Russia after we imported $3 Billion of Russian goods. Using the formula for reciprocal tariffs, that would put them around a 48% tariff rate. Hopefully the White House just forgot to include them.

The biggest issue I have is that the US has taken advantage of poor countries for decades to make our stuff cheaply to turn around and sell back to Americans. Yes, some countries have taken advantage of the United States and do not play fair. China is at the top of the list and every administration since Regan allowed it to happen. Others, however have been solid trading partners who have helped transform American businesses (Mexico & Canada) while also being a source to remove our independence on China (Vietnam). For more than 40 years American countries in order to compete globally have been the ones choosing to move manufacturing out of the US because it was ENCOURAGED by our government. They cannot simply start making their products in the US for many reasons, starting with the lack of workers willing to do that type of work for minimum wage (or investing in robots to do the work).

Lets take Nike as an example. Nike's costs just increased by 40% since most of their products are made in Vietnam. They have a 10% operating margin. They either raise prices (which slows sales), eat the cost increase, or find a way to make their products in the US (which will both erase their margins and cause their prices to go up.) There is no easy, quick answer. My hope is this is a negotiation tactic and the President will bring the top CEOs to the White House to discuss ways to gain waivers on the tariffs while they work towards the end goal of making more stuff in the US.

If this doesn't happen, growth will slow, which means earnings will drop. At the same time the "risk premium" will go up. All of this leads to a sharp drop in prices. If uncertainty and rhetoric continue to rule, stocks will keep going down. At some point the expected growth rate (or lack of growth) will be overly pessimistic and the risk premium will be too low and stocks will start a new uptrend. This is not a slam on the President. He is who he is. NOBODY knows what will happen next. It is truly anybody's guess and not something SEM does.

It's about expectations

The reason the market dropped over 10% in 2 days was everyone (myself included) thought like his first term, President Trump would back down from policies the stock market took as a negative in order to keep the stock market from dropping too much. The so-called "Trump Put" does not seem to exist like it did throughout 2018-2020. I've gone on record saying long-term this is not a bad thing because it will take long-term thinking and a willingness to endure hardship to fix all of the things broken in our economy.

The market needs to adjust to this. Remember, going into the year, the expectation was for another "above average" (10%+) increase in the stock market on the backs of an "above average" (10%+) growth in earnings. At the same time inflation was supposed to come back down to "average (2%), allowing the Fed to cut interest rates 4 times for a total of 2% in cuts.

None of that is going to happen based on the current stance of the White House. This means expectations need to change and with that stock prices need to adjust.

Speaking of expectations, our Spring Newsletter posted last week and the theme was setting correct expectations for the market, how your investments impact your financial plan, and what we should expect from our economy. I'd encourage you if you missed it to check it out here.

Did your financial plan change last week?

One thing we mentioned in the newsletter, which is more important today is our behavioral pyramid.

The basis of every decision needs to start with a financial plan. I would argue that unless you are a government worker who was laid off or you own or work for a small business that relies on imports, nothing changed last week, meaning you should not change your investment plan because the market dropped 10%.

If you loved stocks then, you should love them even more now

Following back to back 20%+ years for the S&P 500, we heard from many clients and advisors who felt this new "AI" driven investment market was going to lead to yet another strong year for stocks. Add to that a "business friendly" president and you get a recipe for strong returns. I would argue if you loved the market at the end of 2024, you should love it even more now. It is on sale, 13% off of where it was at the start of the year.

The P/E ratio at the start of the year was 29 and it is now down to 25. If stocks were correctly valued at 29 at the beginning of the year, then a P/E of 25 should be something to get excited about.

Warren Buffet has often lamented how stocks are the only thing Americans don't buy when prices drop. If you were shopping for a car and it dropped by 13% in a week, you'd run to buy it at a discount. Why is it Americans seem to want to buy stocks the more expensive they become? (Hint: It's human nature).

Going back to what we said about the financial plan — if your financial plan allowed you to increase your stock allocation at the beginning of the year and that plan hasn't changed, you should stay the course (or even consider adding MORE to the riskier investments if your plan allows.)

Again, if you loved stocks 4 months ago, you should love them even more now (not investment advice – please consult your financial advisor — and your financial plan, to see if an increase in riskier assets is warranted.)

Was this a fundamental change?

Taking the counter argument to the one made above, which was most people cited either (or both) these things as justification to increase their stock allocation at the start of the year:

1.) The AI driven investment market is a game-changer and will continue for years to come

2.) We have a business friendly president who will unleash strong growth

The "Liberation Day" announcement could strike the AI driven investment market at its core. We simply are not and cannot making enough chips in the US to not have the extreme tariff levels hurt the return on those investments. For now, chips made in Taiwan are exempt, but that is a small percentage of the overall chip market. We've seen some chip manufacturing start back up in the US, but not the high powered chips necessary to support the resource hungry AI applications.

In the newsletter I asked, "Did the Deep Seek Announcement Burst the AI Bubble?" Here's an updated chart. Nvidia has now lost 1/3 of its value since the Deep Seek Announcement.

Turning to the other argument – a business friendly president and administration. Is that still the case? I guess time will tell, but it's probably still true. Sure the tariffs can be seen as anti-business, especially for the multi-national corporations, but we can hope that the president will soon turn his attention to other things businesses will appreciate. The first is tax cuts, something that has taken a back seat, but appears to be working its way through Congress once again. The next is cuts to regulations. We've seen some cuts in regulations that could unleash growth, but with oil prices slipping we are unlikely to see more oil production come online any time soon.

Looking at last week's policy stance it is entirely possible the fundamental reason people loved stocks to start the year has been erased. I'm not one to make that call. We don't focus on fundamentals, but instead focus on the data.

What does the economic data say?

Based on the rhetoric (and market losses) you'd think we were already in a recession. Certainly the "soft" data (based on surveys) has been quite dire, lead by Consumer Sentiment, which we again highlighted in our 1st Quarter Newsletter.

Other survey data, such as the ISM Manufacturers' Survey also are showing problems in our economy.

However, something that was lost on Friday was the March Payrolls report, which again showed a rather robust labor market.

More importantly, the Aggregate Weekly Hours, one of the most predictive indicators in our economic model IMPROVED last month.

Initial Unemployment Claims also remain a positive, with claims again falling last week. The primary negative in the labor market seems to be if you do lose your job, it seems to be difficult to get another one, as shown in the Continuing Claims data, which remains near a 3 year high.

Another bright spot for the economy is Capacity Utilization, which has been climbing since last October.

Besides Consumer Sentiment and Manufacturers' New Orders, Building Permits are showing continued signs of stress, with permits plummeting nearly 7% over the past 12 months.

In other words, it's a mixed bag. Here is our latest economic dashboard.

Most of the indicators are 'flat', leading to our model once again sitting in the "neutral" position for the next month.

Now a lot can change in a month. Looking inside the model, our updated heat map shows a much more negative trend. If the tariff scare starts hitting the 'hard' economic data, we could see our model shift to 'bearish' next month.

Is this 'unprecedented'?

We heard from more than a few people last week "concerned" that our models were not developed in a market where we are entering an all-out trade war with some worrying about another "Great Depression". First of all, yes the last time we had tariff rates increase as much as was announced last week we were in the Great Depression. What people forget is we were ALREADY in the Great Depression when the US Government attempted to boost the economy by implementing tariffs.

Second of all, it is far too early to say the new trade policy will be a disaster. A lot can (and will) change in the days, weeks, and months ahead. We should all know by now, the President (and Congress and the Fed) can act quickly and swiftly as they attempt to save the economy if that is necessary. They may not be able to save it immediately, as history has shown, but we shouldn't think these trade policies will throw our economy straight into a recession (or depression).

Third, while we haven't specifically been in this type of situation we've had plenty of cases where most people FELT like we were heading towards recession/depression because of something which occurred that sparked a big market sell-off. Last week we updated this graphic, which we created during COVID to remind our clients and advisors how many "unprecedented" events SEM has been part of. I would argue a virus completely shutting down the world economy is far more dangerous than a Trade War.

Finally, and most importantly, we do not rely on our opinions, which can become just as emotional as everyone else, but rather on the data inside our well-tested models. I spent the weekend reviewing all of our models to evaluate their reactions on last week's sell-off. As we will discuss in the Market Charts and SEM Model Positioning below, some changes were made in our allocations last week.

Would I have liked to side-step all of last week's selling? Obviously, yes!

Am I happy? No. I hate to see any of our clients lose money.

Was there anything we could have done differently? Not that I can see as selling sooner would have meant not having the strong performance we enjoyed in 2023 & 2024 (and other years.)

Was there a sense of calm on our investment team and inside our offices? Absolutely! When the markets are in a free-fall, this is when our quantitative, data-driven approach brings the most value. We may not be able to side-step all losses, but we can provide a way to navigate what can be scary moves in the stock market.

Market Charts

Oh where to begin. I guess we will start with the chart we've been using at the top of this section all year. I started tracking it after the President took credit for the move in stocks following the election. I also thought it was important as during the first term, every 5%ish drop in stocks led to a "business friendly" announcement that would spark a spike in the market. That is clearly not the case this time around.

The S&P 500 is now down 12% since the election and 17.5% since the peak in mid-February.

This is the more important chart. The uptrend has obviously been broken and the hopes of the "consolidation" pattern resolving to the upside has been dashed. The S&P had been holding the 5520-5550 level quite well. When that level was broken at the open on Thursday it seemed to unleash selling that would not let-up.

The 5-day chart shows the optimism that was being built going into the Wednesday post-market close Liberation Day announcement.

About the only good news for investors this year is bonds thus far have been doing what we were all accustomed to – holding up when stocks were down.

Small cap stocks were once again hit the hardest.

Corporate bond spreads did increase fairly significantly at the end of the week, but still remain well off where we would be more concerned about rising defaults.

SEM Model Positioning

The sell-off was swift. The market had sold off the last week of March down to solid "support" levels. Both our stock and bond models had systems ready to sell, but then the market had a steady rally Monday-Wednesday ahead of the "Liberation Day" announcement.

Thursday's sell-off was enough to trigger a high yield bond sell. The "trend" indicators inside AmeriGuard and Cornerstone are still mixed. One issued a sell on Friday, but the other has not sold yet, mostly because the "breadth" (number of sectors up versus down) is not as dire as the S&P 500 drop would indicate. This has allowed the more diversified Cornerstone portfolios, which cannot by design own the mega-caps to perform better the last week.

-*New* Tactical High Yield sold high yield bonds on 4/3/25 after 9 weeks in these funds. All proceeds were moved to money market or short-term bonds, with a yield around 4.1% in money markets.

-Dynamic Models are 'neutral' as of 6/7/24, reversing the half 'bearish' signal from 5/3/2024. 7/8/24 - interest rate model flipped from partially bearish to partially bullish (lower long-term rates).

-*New* Strategic Trend Models received 1/2 of the trend sell signal on 4/5/25

SEM deploys 3 distinct approaches – Tactical, Dynamic, and Strategic. These systems have been described as 'daily, monthly, quarterly' given how often they may make adjustments. Here is where they each stand.

Tactical (daily): On 4/3/2025 our tactical high yield model sold out of high yield bond into money market.

Dynamic (monthly): The economic model was 'neutral' since February. In early May 2023 the model moved slightly negative, but reversed back to 'neutral' in June. This means 'benchmark' positions – 20% dividend stocks in Dynamic Income and 20% small cap stocks in Dynamic Aggressive Growth. The interest rate model is slightly 'bullish'.

Strategic (quarterly)*: One Trend System sold on 4/4/2025

The core rotation is adjusted quarterly. On August 17 it rotated out of mid-cap growth and into small cap value. It also sold some large cap value to buy some large cap blend and growth. The large cap purchases were in actively managed funds with more diversification than the S&P 500 (banking on the market broadening out beyond the top 5-10 stocks.) On January 8 it rotated completely out of small cap value and mid-cap growth to purchase another broad (more diversified) large cap blend fund along with a Dividend Growth fund.

The * in quarterly is for the trend models. These models are watched daily but they trade infrequently based on readings of where each believe we are in the cycle. The trend systems can be susceptible to "whipsaws" as we saw with the recent sell and buy signals at the end of October and November. The goal of the systems is to miss major downturns in the market. Risks are high when the market has been stampeding higher as it has for most of 2023. This means sometimes selling too soon. As we saw with the recent trade, the systems can quickly reverse if they are wrong.

Overall, this is how our various models stack up based on the last allocation change:

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