Balance, Not Complacency

The July 8th tariff deadlines came and went without consequence. As expected, pauses were extended by another month to August. So, at the end of July, we face the same circumstances we did on June 30th.

Of course, the White House did announce some “deals” following the July pause. Agreements were reached with Japan and then the E.U. to lower tariff rates down from their maximum proposed levels.

It may not be a coincidence both deals landed at 15% tariff rates. This is above the “baseline” 10% level, but well below the maximum levels. A compromise, but also maybe “the art of the deal,” and what the Trump administration wanted all along? Maybe.

Regardless, it seems like investors are now expecting much of the same. The current consensus sees additional pauses and extensions until more favorable deals are announced. In other words, investors don’t seem to take the upcoming August tariff deadline seriously.

We can see this below in the collapse of the VIX, aka the market’s “fear index.” The index spiked in April due to the Liberation Day tariff announcements. However, it experienced a substantial decline since, despite repeated threats of the tariffs coming back.

At this point, the VIX is bouncing around 15. That’s relatively low, and below its long-term average of about 20. Again, it shows investors do not take the tariff threats seriously, or at least believe conditions will be better than feared. It shows complacency.

That sentiment is understandable. After April’s worst case tariff scenario was taken off the table, economic and market conditions reverted to how they looked like in Q1 before the shock. That is, not great, but not terrible, and relatively benign overall.

That led us to increase our risk asset exposure in June, back to where it was in February (back up to a modest underweight). We did not further increase our risk exposure because conditions also do not look better than they did in Q1.

Actually, economic conditions look like they could weaken because the negotiated 15% tariffs are higher than the baseline 10% level. Investors seem to be shrugging it off because 15% is less shocking than April’s threats, but it’s important to recognize that 15% is still relatively worse than 10%.

On the surface, tariffs are negative. Tariffs are taxes, and taxes are a drag on economic efficiency and growth. Of course, the tariffs don’t exist in a vacuum, and there are reasonable arguments for why things may be different this time. But all that is yet to be seen and still speculative as of now.

What we know now is tariffs are higher, uncertainty is high, market valuations are high, and investors are complacent while relentlessly pushing prices to new all-time highs. Historically, those are not ideal conditions for substantial increases in risk exposure.

At the same time, we also recognize the folly of relying on market-timing. Even the most unlikely of rallies can go on for months or years longer than expected. Investors who sit out of the markets, waiting for their worst fears to materialize, often give up more gains than they avoid in losses.

We maintain our position, which is to remain invested with a modest underweight of risk assets, not because we are complacent. Rather, it is because we recognize both sides of the issues addressed above and the need to maintain a delicate balance in the current environment.

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Victor K. Lai, CFA