Tariffs 2.0

Despite an early-month stumble and no Santa Claus rally, January turned out to be a good month, which bodes well for 2025. In the last 110 years, a positive January for the Dow meant a positive year 77% of the time. It also meant an average 8.5% return versus just 5% in years when the Dow declined in January. February, seasonally the second-worst month of the year for the S&P 500 (after September) is now underway, and it’s been good so far. Breadth remains the bull market’s Achilles heel—more than half the market cap of the Russell 1000 Growth is in the Magnificent Seven, and they even make up one-third of the less-growthy S&P 500. Do ordinary index-fund investors understand the concentration they’ve assumed? Nonetheless, January’s gains came from elsewhere in the index; thanks to underperformance from Apple and Nvidia, the top 10 names were little changed. So far, DeepSeek doesn’t appear to be slamming the brakes on the AI infrastructure buildout: Microsoft, Amazon, Alphabet and Meta announced plans for capital expenditures of about $300 billion this year. The ISM report showed manufacturing expanding in January following 26 months of contraction. Still, the rebound was not broadly based, and trade and monetary policy could imperil it. China looks to be the wild card on trade. Canada and Mexico quickly came to terms with Trump. This episode suggests that Trump means what he says on tariffs but is willing to negotiate. On balance, the market may be in a holding pattern as it adapts to a new administration and new sector leaders emerge. On the earnings front, it looks like we’ll see large-cap earnings growth stay the course while smaller company earnings inflect higher, thanks, in part, to deregulation.

Trump has been nothing if not aggressive in his second term—whether in his Cabinet nominations, pardons, geography, DOGE or trade policy. Some of these matters, such as DOGE and tariffs, could have significant macro effects depending on how far they are pursued. Some people are already wondering whether controversy surrounding DOGE could derail relations with Congress, which could eventually lead to trouble getting a government funding bill signed. As for tariffs, there is some risk that trading partners will seek alternatives. The market is priced for a good outcome, so a sense that policy was hurting the economy would tend to hurt stocks and other risk assets. This is especially the case if trade conflicts spiraled to the point that supply chains were disrupted. Until Friday’s University of Michigan consumer sentiment survey revealed a January spike in one-year expectations, inflation expectations had remained tethered. The 2018 tariffs were mostly not passed along to consumers, though the PPI saw a bump upwards. Trump’s immigration policy is likely to slow if not reverse the flow of workers into the country. This, coupled with more restrictive trade, will underline the need for productivity gains (AI) if inflation is to be kept at bay. So far, 108 of 247 companies have mentioned tariffs on earnings calls, on pace for a 15% higher rate than at the height of Trump’s first-term tariffs. It’s likely that American companies have less exposure to tariffs than previously, though. For one thing, only 40% of S&P 500 revenue comes from abroad. What did well in June-September 2018 during tariffs 1.0? Defensive sectors outperformed, though the market as a whole rose. How might the tariffs on China net out? Before tariffs 1.0, the US received $13 billion per year from Chinese imports. That went up to roughly $44 billion due to tariffs 1.0. The new tariffs should double that, which Trump will apply to the extension of the tax cuts.

Trump’s 10% tariffs on China go across-the-board, affecting the entire $400 billion we import from China each year; his first-term’s tariffs were less sweeping. The market mostly shrugged it off, perhaps partly because China was ready with a swift—and modest—retaliation of 15% on US coal and liquified natural gas and 10% on farm equipment, oil and select autos. China did not devalue the renminbi, nor were its measures as sweeping as during tariffs 1.0 in 2018-19. The Chinese leadership may hope that by exercising self-restraint they will be rewarded with a deal. Anything’s possible, but it’s hard to see this as more than the opening act of a deeper trade dispute between the US (and its western allies) and China. Instead of focusing on its own consumers, China has simply deployed its resources to become better at advanced manufacturing. Currently, China supplies 32% of global manufacturing but consumes only 12% of production. The result is a $1 trillion trade surplus for China. Given Trump’s reshoring agenda, it’s hard to see this continuing unchanged. Some change, then—but how much? Both sides have cause to seek a deal. The tariffs imposed so far may not prove costly at least for the US. Trump likes the leverage, and China is perhaps not quite certain what Trump wants. The 10% hike on China is much cheaper both politically and economically than the 25% on Canada and Mexico would have been. If the trade conflict were extended, China would have a bigger potential than Canada or Mexico to hit profits at Magnificent Seven companies. Any tariff-induced weakness in China is unlikely to hurt the US economy much, though, because China only accounts for 6% of total US exports. In liquified natural gas, China, despite being the world's biggest importer of the product, buys just 4% of US exports; the Russia-Ukraine war disrupted prior trading arrangements. Furthermore, the Chinese economy has been struggling while the US enjoys expansion. The dollar is one area where this affair could come back to bite the US. Indeed, it already has, with the 6% increase in valuation since Trump’s election said to be worth a 20-basis point drop in US GDP. “We’re only a little over a month into the year,” Wolfe Research wondered, “but is anyone else already exhausted?”

Positives

• Spring is home shopping season The latest Senior Loan Officer Opinion Survey shows lending standards for Q1 2025 tightened modestly across a variety of loan types. The net percentage of banks tightening commercial and industrial loans to large and medium firms rose to 6.2% from zero in Q4 2024, but those tightening to small firms slid to 11.1% from 13.3%. Good news, the net percent of banks willing to make consumer installment loans rose to 5.1% in Q1 2025, the highest since Q3 2022. In turn, construction spending increased 0.5% m/m in December, above expectations (0.2%), with strength in residential spending. This spring/summer should be the first season in which we exceed pre-pandemic inventory levels. But Strategas notes the median home price is up 31% from January 31, 2020, while monthly mortgage payments are up more than 112%.
• Continued productivity improvement Nonfarm business productivity rose as expected, at a 1.2% annualized pace through Q4. Still, the overall average pace through 2024 was 1.6%, matching the average between 2015-2019. Unit labor costs rose at a 3.0% pace, a bit below consensus expectations (3.4%). This leaves the pace of unit labor cost growth at 2.7% over the year in Q4, a little ahead of a 2.2% year-over-year pace in Q3, and remaining well above its pre-Covid trend.
• Manufacturing picking up January's ISM Manufacturing PMI finally rose above 50.0 after 26 months in contraction, its longest spell below 50.0 on record, with strong new orders, expanding employment, and higher production. It’s uncertain if this improvement is real or just pulling forward activity in anticipation of tariffs. Meanwhile, the S&P Global US Manufacturing PMI was revised up 1.1 points to 51.2 in January, the highest since June 2024. New orders surged to 55.1, the highest since May 2022 and the fifth consecutive monthly gain. Employment climbed to 50.3, the best since May 2024. Respondent commentary was mostly upbeat across the survey. 

Negatives

• Mixed news on the jobs front Payroll employment climbed a slightly less-than-expected at +147K in January and the prior two months were revised up. The leading components of the release suggest acceptable job growth for the next few months. Average hourly earnings rose 0.48% m/m in January, which puts the y/y gain at a healthy 4.1%. Also healthy, the unemployment rate slipped to 4.0% in January with the participation rate edging up to 62.6%. Last month, total job openings (JOLTS) slid for the first time in three months, leaving the ratio of job vacancies to unemployment at 1.1, about where it has been since July 2024. The combined 36.8% decline in job openings in construction and manufacturing suggests cooling labor demand in cyclical sectors. The private sector quits rate stands at a low 2.2%, unchanged since August, and the layoff rate remains low. Elsewhere, Challenger job cuts declined, but so did hiring plans.
• A weaker consumer, or just frontrunning tariffs? Unit auto sales appear to be adjusting following the pull forward of demand into 2024 to beat the lapsing of EV credits and tariffs. In January, total vehicle sales slid to an annual rate of 15.6 million units, the lowest level since August. Total car retail sales fell to 3.03 million units, according to data from Autodata while total light truck sales fell to 12.8 million units. The slowdown in January auto sales implies weaker consumer spending.
• Services slowing down The ISM non-manufacturing composite declined by 1.2 points to 52.8, against consensus expectations of holding steady at 54.0.  The 4.0 drop in its prices paid measure is consistent with further slowing in PCE supercore services, an important measure for the Fed. As well, the S&P Global US services PMI declined 4 points to 52.8, and all the regional Fed services surveys softened in the month too. Importantly, new orders sank to 51.3, the lowest level since June 2024. The composite PMI, which blends manufacturing and services, stood at 52.6, historically consistent with 1.5 to 2.0% real GDP growth—a sign growth might be slowing.

What Else

Dizzying progress Tesla may start delivering Optimus robots to customers in the second half of 2026, with the cost of production expected to fall to $20,000 per robot once production rises to one million robots a year. In China, Shanghai Qingbao makes robots used in tourism and conventions, and UBTech’s robots are on NIO’s EV factory floors, a February 4 South China Morning Post article reports. Unitree Robotics’ robots recently went viral dancing during China’s Spring Festival Gala.

Interesting times, Trump 2.0 In compliance with Trump’s Executive Order, the Gulf of Mexico will be renamed to the Gulf of America in Google Maps. JP Morgan notes that even though the effective tariff rate on the US imports remains historically low at around 2.4%, tariffs 1.0 have helped diversify the global supply chain to its highest level in over 35 years. And as central banks have scooped up gold out of fear that the US would eventually boot them from the global financial system, the same reasoning has likely boosted the price of bitcoin. Compared to the price of gold, the cryptocurrency is even more richly valued than it was during the 2021 meme-stock mania.

What are you doing this weekend? Betting on the big game? Americans are expected to wager a record $1.39 billion through legal platforms on the big game, according to an American Gaming Association survey. Prediction markets now enable any adult to bet on the Super Bowl even if your state hasn’t legalized gambling. For Super Bowl LIX, Americans will eat 1.47 billion chicken wings. As for me, I’m off to Orlando, to tool around the most magical place on earth with my bff Disnoid sister. Did you know that the actors who voiced Mickie and Minnie Mouse got married in real life?