Tariffs: A System of Perpetual Adjustment

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The initial tremor, a predictable consequence of the announced adjustments to trade protocols last April, registered on the indices with a force that was, if not unexpected, certainly noted. The S&P 500, a construct of aggregated valuations, experienced a decline. The Nasdaq Composite, a more volatile entity, fared, as these things go, less well. A temporary reversal of certain directives offered a brief reprieve, a bureaucratic gesture that postponed, rather than prevented, the inevitable reckoning. It was, one might say, a stay of execution, meticulously documented and subject to further review.

The implemented adjustments, after a period of modification and exemption – a process of infinite refinement – have not induced a catastrophic collapse, but a subtle erosion. A persistent drag on performance, barely perceptible to the casual observer, yet accumulating with the inexorable logic of compound interest. The data, as it begins to coalesce, suggests a pattern. A slow, methodical transfer of value. The precise mechanisms remain opaque, obscured by layers of accounting and regulatory filings, but the effect is becoming increasingly difficult to ignore.

The Imposition of Costs

The stated intention, of course, was to shift the burden of these adjustments to external entities. A curious proposition, as the very nature of tariffs dictates that the initial assessment falls upon those engaged in the act of importation. The logic, as presented, involved a complex negotiation of pricing, a hope that foreign suppliers would absorb the costs. It was, in essence, a request for voluntary compliance, predicated on a rather optimistic assessment of international relations.

The reality, predictably, deviated from the projection. A recent analysis by the Kiel Institute suggests that the vast majority of these costs – approximately 96% – are borne by entities within our own borders. Importers have reduced their volumes, a logical response to increased costs, which in turn suggests a contraction in final demand. It is a self-correcting system, perhaps, but one that operates at a distinctly unfavorable equilibrium. Harvard and the University of Chicago arrived at a similar, unsettling conclusion. Goldman Sachs, with its customary precision, estimates that U.S. consumers will absorb 55% of the costs, with businesses shouldering another 22%. The projections for 2026 are even more sobering: a potential 70% burden on the consumer, a 1.2% increase in pricing. It is a slow tightening of the screws, barely perceptible from one quarter to the next.

Rising prices, naturally, are not conducive to economic growth, nor to the valuation of assets. The Yale Budget Lab estimates a negative 0.4 percentage point impact on real GDP in 2026, accompanied by a 0.6 percentage point increase in unemployment. The December retail sales report, with its flat performance, offered a preliminary indication of this effect, falling short of expectations. It is a feedback loop, a subtle deceleration that is difficult to arrest. The market, of course, is forward-looking. It anticipates these pressures, and adjusts accordingly. Or, rather, it attempts to adjust. The precision is, inevitably, imperfect.

The Valuation and the Void

The primary challenge facing the market in 2026 will be to justify the current levels of valuation. The S&P 500 currently trades at a cyclically adjusted P/E (CAPE) ratio of 40. A metric, one should note, that attempts to normalize earnings over a ten-year period, accounting for inflation. It is a smoothing function, designed to filter out the noise and reveal the underlying trend. But trends, as anyone who has spent time in a bureaucracy knows, are often illusory. The CAPE ratio, at 40, is at a level seen only once before, during the period of speculative excess at the turn of the century. A historical parallel, one might say, though the past, as always, is a poor predictor of the future.

A higher CAPE ratio is historically correlated with lower future returns. A statistical observation, to be sure, but one that should be treated with caution. The sample size is limited, and the underlying dynamics are complex. But combined with the economic pressures described above, it does not inspire confidence. Companies will need to achieve an exceptional level of earnings growth to justify the current valuation, a feat that will be particularly difficult in a weakening economic environment. It is a precarious balancing act, a delicate equilibrium that could easily be disrupted.

The Search for Stability

Even in the current environment, with the market trading at elevated levels and the economy facing headwinds, opportunities remain. The initial adjustments to trade protocols resulted in a weakening of the U.S. dollar, a predictable consequence of the altered trade flows. This, in turn, benefited companies that derive a significant portion of their revenue from international sources. A temporary tailwind, perhaps, but one that should not be ignored. These companies, as the data from FactSet Insight suggests, experienced stronger earnings growth in the last quarter.

Alternatively, investors may find value in international markets. European and Japanese stocks, as a general rule, trade at lower valuations than their U.S. counterparts. A simple observation, but one that reflects the differing economic and regulatory environments. Investors with a long-term perspective, of course, can find opportunities in any market. Even in the current environment, with valuations near record highs, there are pockets of value for those willing to look. It is a matter of patience, and a willingness to accept a certain degree of uncertainty. The system, after all, is not designed to be understood. It is merely designed to function. And to perpetuate itself.

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2026-02-16 14:22