Approaching peak uncertainty in the Strait of the Sirens

With markets selling off big time following yesterday’s tariff announcements, we have finally hit the entry level we set back in early January when we thought uncertainty around a “Baker’s Dozen” of risks might finally give us the 10-15% market correction stocks needed. As of this morning, futures have the S&P 500 at about 5,500, 12% off its highs. Importantly, the growth indices, where much of the excess was, are down much more. The Russell 1000 Growth stock index, composed of some of the greatest companies in the world, is down almost -16%, and the vaunted Mag 7 are down an even more impressive -20%. Wow!

As regular readers of this space are aware, some time ago I “strapped myself to the mast” and decided to plow the Straits of the Sirens, trusting to the skill of my sailors to get me to the more placid waters on the other side: lower taxes, lower regulatory costs, more free trade, more efficient government and an economy with accelerating economic and earnings growth. We knew that getting there would be difficult, given the uncertainty that would necessarily accompany a mid-course correction of the scale that President Trump envisions. Whether we are “there” yet or not remains to be seen; that answer is probably “no.” But in our judgement we are now close enough to begin legging into stocks, and today our PRISM^® committee drew down its cash overweight and put another point into US stocks, specifically US growth stocks where we have been lightest.

Everyone is well aware of all the downside risks at this point; all the media outlets and Wall Street strategists are shouting them from the rooftops. So let me instead point to a number of upside risks we are assuming our sailors (the economic team in the administration, the Federal Reserve and the corporate managers running their companies) can see, and will steer us toward.

1. Tariffs move down from here, not up. If yesterday was the start of a shooting war, the President’s news conference might have been described as “Shock and Awe.” Applying a methodology that attempted to quantify not just actual tariff levels, but the tariff equivalent level implied by a variety of non-tariff barriers many countries employ, Trump announced some spectacularly high tariffs against virtually all of our trading partners. If they all stick, we are probably heading for a global recession. For that reason alone, policymakers on both sides of the trade war are now highly incented to negotiate improvements. This won’t be easy or quick, but from here on out, we anticipate a steady flow of “less worse” trade agreements. As bedeviling as a process like this can be, markets tend to reverse course and move higher not necessarily on “good news,” but rather on “bad news getting less bad.” That’s the path we envision ahead.
2. The Fed takes interest rates lower. With tariff uncertainty and the DOGE cuts, and their multiplier effect through private sector government contractors, already having an impact on labor markets (see today’s Challenger Job Cuts number of 204.8% year-over-year growth), the key structural cause of ongoing inflation is abating. Other causes, implied rents and commodity prices, have already begun declining. With the fed funds rate nearly 200 basis points above the inflation rate we seem headed for, the Fed has plenty of room to cut. And now, with the economy softening and growth threatened, they have reason to. To us, the two together mean they will cut, despite whatever their backward-looking models have them “guiding” us toward. We anticipate the first of three cuts this year coming at the June meeting, which will be welcome news for the economy and particularly the interest-rate sensitive elements of the economy: banking, small caps, and housing. Note: the Russell 2000 small-cap index of stocks is down -20% off its highs.
3. The government releases more labor to the constrained private sector. One constraint on growth over the last few years has been the explosion in government sector jobs, with some 1.8 million added during the Biden years, not counting the number of jobs in the private sector directly supporting the government workforce. That has squeezed the private sector, constraining growth. In my trip to D.C. last week, I was struck by the number of young, mid-level managers I met with who have already landed jobs in the private service sector or are actively looking. Given the higher productivity of private sector jobs, this should net, net help growth as we clear out of 2025 and shift into 2026.
4. (Legal) immigration is accelerated. At his press conference yesterday, it was interesting to note that Trump, right on cue, began talking up “legal immigration” and the need for immigrants to fuel our economy. We have always seen this as the likely next step in the immigration battle, once sealing and controlling the borders has happened: accelerating the flow of legal, tax-paying immigrants that we need to grow the US economy. With the pain of deportations now taken, we expect to see action on this front which, again, should help growth into 2026 and beyond.
5. Tax cuts are agreed to at larger-than-expected levels. There is nothing like a good stock market correction, with accompanying incoming calls from worried constituents, to stir lawmakers past the sausage-making negotiating stage and into the action stage. So the pullback we are seeing now in stocks should be a good thing. Our meetings in D.C. last week, again, highlighted for us the desire of the administration to move on from the instability of the tariff wars and towards the stimulative agenda of tax cuts. The good news ahead on this front is likely to accelerate given the selloff in stocks.
6. Deregulation efforts are accelerating, supporting growth. Similarly, plans to deregulate key elements of the economy, especially banking, M&A, and telecom, are now likely to accelerate given the pressure on markets. Regulations are costly, and by some estimates, just the new regulations created during the Biden administration added nearly $1.4 trillion in extra operating costs to US companies. With Trump’s cabinet now in place and the markets in a tizzy over tariff costs, we expect Trump administration officials to accelerate their cost-cutting regulatory plans.

Why we are still only one half of our potential overweight to stocks

With today’s add to stocks, Federated Hermes’ PRISM^® allocation committee is now at 50% of our max overweight to stocks. Given the reality that, over the long term, “stocks move up and to the right,” 50% of max overweight is, frankly, about our “normal” overweight positioning. Said differently, we still have plenty of room to add further, though in the past when we’ve gone to larger than 50% of max overweight stocks, we’ve done so in more substantial pullbacks where the upside is that much greater. So, while we are adding materially to stocks today, with what we see as about 20% upside to our recently lowered year end target of 6,500, we have more room to add and will likely do so if the present correction continues.

We see two major uncertainties which could cause stocks to go lower from here, that would present an additional buying opportunity:

1. The Q1 earnings season comes in light. Although pre-announcements have been less than normal so far, the coming earnings season starting next week is unlikely to provide much near-term relief for stocks. The quarter itself seems to have been a bit weaker than initially anticipated, for sure. More importantly, with so much uncertainty ahead of how the tariff rules play out as negotiations begin following yesterday’s “Shock and Awe” announcement, guidance is likely to be soft among nearly all but the most defensive of businesses. A lot of this is already anticipated in stock prices, but we are not sure all of it has been. We’ll see.
2. Tariff negotiations might initially look bad. Another big near-term issue for stocks is that as much as everyone was hoping that April 2 would finally give us certainty on the tariff environment going forward, it is now clear that April 2 was, to borrow from Churchill, “the end of the beginning rather than the beginning of the end.” Negotiations among sovereign nations are never easy to watch, with plenty of brinksmanship likely on both sides designed to stake out favorable ground. While we anticipate things getting less-worse from here, for sure, the coming weeks could bring announcements that imply the contrary. Again, we’ll see. But if stocks plumb lower levels on such news, we’d see it as an attractive point to get even more overweight equities.

Sailing the Straits of the Sirens was never going to be easy. Rocks are everywhere, and the waters are rough. But our position, strapped to the mast, gives us a view towards the calmer, good sailing waters on the other side, and we are fixing our gaze there. And we are trusting our sailors to use the tools at their disposal to keep us from crashing into the reefs. Remain confident. No promises, but if history is any guide, equities are likely to be considerably higher by this time next year.