> Thoughts from the Road

I attended an investment conference last week alongside investment management peers. There was a lot of discussion around the tariff announcement and its potential implications. I also spent a morning with GQG Partners, one of our international investment managers, to discuss their perspectives. I’d like to share some of the key insights from these discussions, as they were both thought-provoking and highly relevant given the current market volatility.

Tariff Rates Were Much Higher than Anticipated
The scale of the announced tariffs on April 2nd was a surprise to all conference attendees. Investors had expected reciprocal tariffs to be manageable. In 2023, foreign countries imposed an average tariff of 4.6% on U.S. goods, compared to 2.2% by the U.S. on foreign counties. This implies that tariffs should have increased about 2.4% to be “reciprocal.” Instead, the Trump Administration raised the average weighed tariff to 22%. This included a baseline 10% duty on all imports, as well as country-specific tariffs based on trade surpluses.

Markets Slide as Investor Concerns About the Economy Mount
The S&P 500 dropped 11% in the two days following the tariff announcement – the fourth-largest two-day decline in 40 years. The escalating trade war represents a major self-inflicted policy shock. Tariffs of this scale, along with heightened policy uncertainty, may undermine business and consumer confidence, increasing the risk of tipping the economy into recession. Strategas Partners, a macroeconomic research firm we work with, now estimates recession odds at 45%. Because the cost of tariffs ultimately gets passed along, investors are also concerned that they could fuel higher inflation.

Trade War Uncertainty May Be Peaking
Over seventy countries have approached the Trump administration seeking lower tariffs on goods. Access to U.S. markets is critical, especially with rising recession risks. In a potential shift toward pragmatism - or concern over financial instability - President Trump granted a 90-day pause on the “reciprocal” tariffs for non-retaliating countries on Wednesday. At the same time, he raised duties on Chinese goods to 145% escalating tensions with Beijing. In response, China raised tariffs on U.S. imports to 125% but signaled further increases would be economically futile. While trade policy remains fluid, this may signal that the U.S. will take a more tailored negotiable approach with most countries. The Trump Administration has a growing incentive to ease tensions. A recession or market crash would lead to major Republican losses in next year’s midterms. Announcements of trade deals could help lift market sentiment.

The Trump Administration Must Pivot to Pro-Growth Policies
Tariffs function like a consumption tax. At current levels, the universal tariff could generate $4-$6 trillion in government revenue over 10 years – but at the cost of slower economic growth. To offset this drag, Congress needs to extend the 2017 tax cuts and further reduce taxes on savings and investment. This might include lowering marginal income, corporate, and capital gains tax rates or a variety of other taxes. Deregulation and falling oil prices may help mitigate the slowdown in the months ahead. We will monitor these factors closely.

Expect More Volatility
The outlook is particularly unclear, and we expect continued market volatility in the coming months. However, the shift in investor sentiment from overly optimistic to highly pessimistic is a positive sign. It’s counterintuitive but changes like this often precede stronger market performance. As Denise Chisholm, Director of Quantitative Market Strategy at Fidelity, notes, the speed of decline often correlates with the speed and likelihood of a rebound. A year after the last three instances of 10%+ two-day market drops, markets were up considerably – although the path to recovery was volatile. When sentiment is this negative, markets don’t need great news—just news that’s “less bad.”

We Seek to Build Resilient Portfolios
Portfolio drawdowns are an inevitable part of market cycles. We strive to build resilient portfolios to weather periods of turbulence like this. We do so because we recognize that losing less means a higher starting point when markets eventually recover. Recognizing that we are in the late stage of the economic cycle, we tilted our portfolios toward defensive sectors and high-quality assets. As discussed in the last Investment Thoughts, the portfolios we manage for our clients are diversified. These factors have helped this year.

We apply the same resilience principle when selecting investment managers. Our "telescope to microscope" selection process begins with technology-driven screening of the broad fund universe. We then do a detailed review of the top candidates. We prioritize experienced managers who have effectively managed risk through past investment cycles. Once selected, we conduct regular due diligence meetings. We incorporate their insight into our broader decision-making process.

GQG Partners: A Proven Track Record Navigating Market Turbulence
Last week, I visited GQG Partners and met with the co-manager of the international funds we hold and one of their analysts. I've been investing with founder Rajiv Jain for years, dating back to his time at Vontobel Asset Management before he founded GQG in 2016. GQG has a strong, consistent record. Importantly, their portfolios have been resilient during market downturns – exactly what we look for when selecting investments for our clients.

GQG’s risk-management success is driven by several key factors. They focus on "forward-looking quality," targeting large companies with sustainable competitive advantages and reliable earnings. Their team also evaluates risks from multiple perspectives. For example, they use non-traditional research methods, including investigative journalists and forensic accountants, to uncover hidden risks. GQG has navigated the current downturn effectively. Their international fund is up this year despite market declines and is outperforming 90% of its peers.

The markets have been turbulent, and we understand this uncertainty can be stressful. Please don’t hesitate to contact your wealth management team if you would like to discuss these topics in more detail or review your portfolios or financial plan. We are here to help.

Douglas B. Phillips, CFA
Chief Investment Officer
douglas.phillips@ledyard.bank