Trump’s Tariffs Aren’t the Sole Challenge for the Stock Market

The recent downturn in the stock market has highlighted a crisis of confidence on Wall Street regarding Washington’s policy direction, where optimism surrounding tax cuts — or even the cuts themselves — may fail to improve investor sentiment.

“The pace and sequencing of policy reforms seem to have fundamentally impaired confidence, hindering growth forecasts,” remarked Lisa Shalett, Chief Investment Officer at Morgan Stanley, in a communication to clients.

In the meantime, the anticipated policy shift towards deregulation and tax relief that Wall Street has relied on since the election remains out of reach. The issue is not merely political; the arithmetic simply does not work.

Even assuming the Republican base scenario, the cost of extending existing tax cuts is estimated at $4.5 trillion over the next decade. This figure exceeds the proposed spending cuts of $1.5 to $2.0 trillion, much of which would likely be derived from Medicaid and Medicare.

“Even in the most favorable scenario, the implication is limited genuine progress on the decade-long debt and deficit forecast,” Shalett stated.

Investors anticipating growth from new tax cuts, such as the elimination of the SALT cap or exemptions concerning tip income, might also find themselves disillusioned.

Shalett explained, “Many of the proposals fall into [high fiscal multiplier] categories… [and] this presents a rather regressive policy stance, where negative effects are unlikely to be balanced by positive outcomes from tax cuts targeting higher-income households and corporations.”

Tariffs won’t bridge the gap

The administration has proposed tariffs as a potential revenue generator, but the assumptions underpinning this are questionable.

Estimates from the Trump administration suggest that fully enacted tariffs — 25% on Mexico and Canada, and 10% on China — could yield $120 billion each year.

However, Shalett pointed out that this estimation relies on “a maximalist scenario enduring for a decade.”

In reality, approximately half of Canadian and Mexican imports will be exempt under the USMCA, and any revenue gains would likely be negated by retaliation, alternative sourcing, and reduced import volumes.

“Tariff-revenue offsets are elusive,” Shalett added, noting that the unpredictability of trade policy has exacerbated the situation.

Markets require more than tax reductions

Although the S&P 500 has retreated, it still cannot be classified as broadly inexpensive. Shalett remarked that “with forthcoming fiscal challenges likely to impact earnings estimates, the S&P 500 is not broadly cheap, even with enhanced risk premiums.”

Consensus earnings projections have already decreased by 3.5% for Q1. Shalett anticipates that “negative revisions will persist, diminishing the ‘value’ narrative that might be developing from the downturn.”

Her recommendation is to maintain a selective approach.

“Consider being opportunistic amid the recent turbulence,” she advised, highlighting stable growth sectors such as software, healthcare, and media, along with financials and regional diversification in emerging markets, Japan, and Europe.

As she stated, “It’s too early to declare the ‘all clear’; the market is likely to remain volatile and unpredictable.”