Why Did Markets React So Negatively To Tariff Announcements
I have been asked why the market reacted so negatively when investors knew about the President’s plans to put in place large tariffs. I have been asked this question a few times now so thought would write about it.
The most important point to understand is that the market is efficient in incorporating all information. Thus, it is only new information (surprises by definition) that move prices. With that said, the market is The Wisdom of Crowds, taking the AVERAGE estimate of what is expected will happen.
As I have been writing in my posts there was great uncertainty as to what would be the actual outcome. What we got was the left tail of the potential distribution, not the MEDIAN, so markets reacted violently to the negative as a “grey swan” appeared.
The second key point is that as I have also written the markets have become less liquid for various reasons with result being that you now get more volatility with new information. Note the role alternatives played yesterday, playing the role they are designed to play being uncorrelated (like reinsurance) or have low correlation (like senior, secured , floating rate private credit and L/S factor strategies).
Investors should expect more volatility due to the high degree of uncertainty, which investors hate, which creates more risk of downside as investors could demand larger risk premiums to compensate for the increased uncertainty.
Finally, all financial plans should have already incorporated the risks of such events and thus, for those investors who have done so, stay the course and rebalance.