Invert, always invert – the tariff edition
I have written before about how education trains us to think in a specific way. Back then, I mentioned that I like to follow the maxim of Carl Jacobi to “invert, always invert”. By teasing out from market prices the assumptions needed to justify these prices, you can learn a lot about these prices.
It so happens that markets have been in a somewhat volatile phase lately and a reader asked me to repeat an analysis I did at the height of the pandemic panic and check what is priced into global stock markets today.
I have taken a simple dividend discount model and applied it to the S&P 500, the FTSE indices and the Stoxx Europe. Assuming a weighted average cost of capital of 8% for all markets, I can tease out the implied dividend growth rate for each market. Then, I can do a nice little experiment and test, for how long dividends would have to stay at current levels to justify the drop in stock markets since 2 April 2025 (the last day before markets really went crazy). In essence, I can calculate, for how long corporate earnings should show no growth to justify the share price drop (I assume a stable dividend payout ratio so earnings growth equals dividend growth).
A second exercise I can do is to assume companies will have zero earnings over the next few years, stop paying any dividends and then resume paying dividends after the crisis is over. In essence, this is a simulation of the end of the world and how long it would have to last to justify the share price drop.
Below are the results:
Markets are currently pricing in between 2 and 4 years of zero earnings growth or the complete collapse of earnings and dividends for the next 3 years. On the one hand, this is less extreme than what we have seen during the pandemic, but it bears reminding that we have never in modern history have seen 3 or more years of no earnings on a market level. In individual sectors and companies, yes. But not for the market overall.
Given that services are exempt from tariffs which means that the price pressures for services companies should overall be much lower than for manufacturing companies, I doubt that we will get anywhere near the extreme earnings drop currently priced into markets. In short, if you have an investment horizon of more than a couple of months, it’s a good time to buy stocks.
The ‘reader that asked’ wishes to thank the author! Although the ‘drop in stock markets since 19 February 2020’ surely must be a typo. I suppose it’s 2 April as in the table.
Now that Trump has rolled out Big Bertha – when he blinks (and blink he will, my bet is before Easter) who will take him seriously on _anything_? Pootin and Xi probably never did, and the EU, Carney and Sheinbaum will certainly follow. I fully expect this to be recalled as an ‘inverse Roosevelt’ (as in, ‘speak softly and …’).
Musk already expressed his preference for no tariffs between EU and US. Today, Bill Ackman tiptoed away. Interesting times indeed. Let’s all sit on our hands.
I like the concept of invert thinking very much but one question: the drawdown implies 2-3 years of no growth. Does that mean stable earnings/dividends? For me the scenario of no earnings (growth of minus 100) looks way harder than no growth/stable earnings so I wonder how 7 years of no earnings equal 2-3 year of no growth.