Geopolitical storms, trade disputes, and consumer anxieties are converging to create powerful headwinds for growth. In our latest analysis, we decode the most pressing policy-driven forces—from tariffs and student-loan restarts to government layoffs—and lay out four economic scenarios investors can’t afford to ignore. Dive in to see how to navigate these turbulent waters and position your portfolio for every outcome.
We’ll start with a deeper look at Torsten’s “headwinds” graphic. I find the sailboat image quite evocative. Sailing against the wind means slower progress and an uncomfortable ride but it may be the only way to reach your port. Similarly, the economy has to face headwinds in order to move forward. Our only choice is to deal with them.
Sailing against the wind may slow progress, but facing these headwinds—trade policy, credit shocks, and geopolitical tensions—is the only way forward for the economy.
Source: Apollo
Here are some of Torsten’s comments on those points. On tariffs:
“Both small and large businesses have reported significant impacts to their bottom lines as a result of all the confusion. We can see that most clearly by the fact that the number of companies that have been reporting forward guidance has been crashing—that is a warning sign about what’s coming, as companies are no longer able to say what they are seeing going forward…
“We do not believe that the current policy turbulence is going to go away. This is not a political view; it’s just a view expressing that policy uncertainty is elevated and is likely to remain so. Such view is built on our constant consultations with market participants and corporate CEOs…
“Assuming that the June 16 tariff rates stay in effect in perpetuity—it’s hard enough to model this stuff as it is, so you have to make assumptions like this—the Lab sees GDP growth 0.6 percentage points lower through 2025 and the unemployment rate 0.3 percentage points higher by year-end.”
On trade war retaliation:
“While the reduction in standoffishness in the US-China trade talks is cause for optimism, there remains the risk of trade war retaliation in the months ahead. What shape or form that may take remains to be seen, but consider, for example, trade in prescription drugs.”
Critical drug ingredients remain highly concentrated in China, exposing U.S. supply chains to policy and security risks.
Source: Apollo
On consumer confidence:
“While the Conference Board did report an increase in consumer confidence in May after five consecutive months of decline, it continues to be challenged in the US, according to University of Michigan polling… The number of consumers worried about losing their jobs is at levels normally seen during a recession.”
A sudden jump in job-loss worries has historically heralded recessions—today’s spike is a clear alarm bell for investors.
Source: Apollo
I circled the most recent spike in that last chart because it should be an alarm bell. Since 1980, jumps like that have always been associated with recessions (the shaded areas).
Maybe people are just more prone to worry now – but workers usually know when their jobs are in jeopardy. They sense it even if not directly told. At the very least, this says recession remains a real possibility.
On student loan repayments:
“While tariffs are obviously top-of-mind, we feel obligated to remind readers about an issue that has nothing to do with any of the above, but, purely by coincidence, is happening in the background. Nine million student loan borrowers enjoyed a moratorium after President Biden gave them the opportunity to not pay back their student loans and have it not impact their credit scores.
“As of early May, that reprieve was no longer, and a lack of student loan repayments will now impact credit scores. FICO scores could go down roughly 65 points on average, with up to 10% of US households facing a steep decline in their credit score. This could impact their ability to get new loans to finance the purchase of a car, a house, or new furniture.”
This is a good example of the way policy changes always have side effects. If you think, as I do, that ending the student loan reprieve is the right move, it can still have negative short-term consequences. Suddenly reduced credit scores for a large group of consumers could also mean a sudden drop in the number of qualified home buyers, for instance.
Finally, Torsten had some observations about DOGE:
“As of this writing, DOGE has clocked just $150 billion in reductions, although estimates of his team’s precise impact have fluctuated. Additionally, the department had laid off roughly 260,000 federal government employees as of the end of May.
“Regardless of its precise impact, we see DOGE’s cost-cutting as having a negative impact on the economic outlook due to continued uncertainty with government workforce reductions.”
The DOGE layoffs have both direct and indirect impact. Economically speaking, those 260,000 now-jobless people are only part of the story. A much larger number of federal workers are now wondering if they will be next. This affects their spending and investment behavior. As with the student loan issue, even the most necessary changes will have side effects.
Stagflation Risk
I said last week I thought “stagflation” is not the likely course unless unemployment rises considerably more than we’ve seen. Nonetheless, Torsten sees stagflation as the likely result of the president’s trade policies.
The economy’s direction will be determined largely by the way businesses respond to the new tariffs and other policies. A May survey by the Dallas Fed gives us some preliminary answers. Both manufacturing and service firms were asked what actions they are taking in response to higher tariffs. They could choose multiple answers.
While most manufacturers pass tariff costs to consumers, half absorb them internally—signaling both inflationary and recessionary pressures ahead.
Source: Apollo
A big majority (76%) of manufacturers say they are passing on at least some cost increases to customers. That’s inflationary. Some 50% say they are “absorbing cost increases internally.” That probably means some combination of layoffs and lower profit margins, which are more recessionary. Put them together and yes, stagflation is a risk. But we’re not there yet.
By the way, notice something else in this survey data. The stated goal of all these changes is to bring manufacturing and jobs that went overseas back to the US. There’s little sign this will happen. Only 37% of manufacturers say they are looking for new domestic suppliers. Only 11% say they are relocating production to the US. That’s less than the 17% who say they want to find new foreign suppliers.
I share the goal of wanting to make the US less dependent on China. Everything I see says the tariffs aren’t going to accomplish that goal. I realize many people think otherwise. They are operating on hope, not evidence. The evidence we have says the tariffs are harming the economy while, at least so far, delivering few benefits. Tariffs are a tax on consumers. They do raise some much-needed revenue, but not enough to cut deficits all that much.
Four Scenarios
All that said, we should also recognize that tariff impact doesn’t fall across the economy equally. Some sectors feel greater pain than others. Torsten had another good graphic on that point.
Sectors like cable, healthcare, and utilities face minimal tariff risk, whereas consumer/retail, energy, and industrials sit squarely in the line of fire.
Source: Apollo
He added these comments:
“What can this all mean to investment opportunities? We continue to believe that seniority in the capital structure and a sharp focus on businesses able to generate strong cash flows remain paramount.
“We also believe that sectors with less impact from tariffs and the uncertainty around the macro environment—i.e., cable/telecom, healthcare, utilities/power, and technology—are preferable to those with higher potential negative impact, such as industrials, energy, and consumer/retail.
“If, for example, one were running a long-short trading strategy around tariffs, you could argue that they would be short consumer goods makers, retailers, even energy. Energy is generally at risk because we trade a lot of energy with different countries and tariffs will be disruptive to that trade. Industrials are also at risk. Why? Because 37% of imports from China go to industrial customers—auto parts components, airplane components, washing machine components. Why is media on the right? Because digital advertising is the first thing to decline in a recession.
“Long positions in this strategy would be on the left. Tariffs don’t really play into your need for healthcare. We will still get sick. (On the other hand, medical devices will be impacted.) Regarding cable and telecom, our mobile and internet subscriptions won’t really be affected by tariffs. (Mobile phones themselves, on the other hand, will be.)”
Torsten also included this graphic summarizing the four basic scenarios.
These four scenarios—Goldilocks, Overheating, Recession, Stagflation—capture how stocks and rates behave under different growth and inflation combinations.
Source: Apollo
- In the lower right “Goldilocks” scenario of low inflation and high GDP growth, stocks rise while interest rates (and inflation, too) aren’t a problem. Investing is easy in such times: Just buy the riskiest assets you can afford.
- “Overheating” is straightforward, too. It’s an inflationary boom in which higher interest rates start hitting marginal borrowers. The answer is to invest in higher quality credit and equities.
- In a “Recession” environment, stocks are falling so you avoid them. Meanwhile interest rates are falling, which helps long-term bonds you want to extend your maturities.
- “Stagflation” is quite different from any of those. You face both rising inflation and interest rates and weaker growth and stock prices. The best bet is to hoard cash and look for buying opportunities in distressed assets.
Now is a particularly confusing time because you can make a plausible case for all four scenarios. You can also argue plausibly against all four scenarios. Record highs in the S&P 500 are inconsistent with stagflation or recession. But falling GDP (note that Q1 was just revised lower to -0.5%) doesn’t seem compatible with overheating or Goldilocks.
For the moment, we seem to be in a heretofore unknown quadrant in which stocks rise while economic growth falls. The only explanation I have is “markets are irrational.” But they won’t stay that way forever.
Great Quotes
“In the end, only three things matter: how much you loved, how gently you lived, and how gracefully you let go of the things not meant for you.”
— Gautama Buddha
Picture of the Week
Balat, Istanbul
Balat’s colorful streetscape reminds us that, like diverse assets in a portfolio, layering different elements can create resilience and beauty amid change.
All content is the opinion of Brian Decker
