The Global Financial System is Breaking…

Key Concepts

• S&P 500 vs. Gold Valuation: The divergence between the S&P 500's performance in US dollar terms versus gold terms.
• Tariff Hike Threat: Donald Trump's proposed 100% tariff increase on China and its potential economic implications.
• Flight to Safety: The historical tendency for capital to move to safer assets like gold during times of market concern.
• US Government Deficit: The impact of a large government deficit on economic resilience.
• Federal Reserve Interest Rate Cuts: The effect of lower borrowing costs on businesses and financial conditions.
• Corporate Profit Margins: The role of high profit margins in driving business earnings and asset accumulation.
• Risk Management: Strategies for protecting profits and positioning for future market movements.

Divergence in Market Valuation: S&P 500 vs. Gold

For the past four months, the US stock market, as measured by the S&P 500, has been consistently reaching new all-time highs in US dollar terms. However, this trend was significantly disrupted by a tweet from Donald Trump threatening a 100% tariff hike on China, which caused a $1.7 trillion wipeout in the S&P 500's market capitalization. While the market rebounded the following day as if the event hadn't occurred, this correction highlights a critical underlying divergence.

When the S&P 500 is measured in terms of gold, it is actually making new lows, hovering around its lowest levels in over a decade. This divergence between the S&P 500 in dollar terms and gold terms began in early 2024, accelerated with the initial tariff announcements in early 2025, and is now intensifying.

Historical Precedents of Market Decline in Gold Terms

Historically, periods where the stock market declines in gold terms have coincided with stagnation in dollar terms. This pattern was observed during the dot-com bust in the early 2000s and the 2008 financial crisis. Further back, the 1970s also saw the stock market declining in gold terms alongside stagnation in US dollar terms.

Typically, a significant inflow of capital into gold suggests a "flight to safety," indicating widespread market concerns and capital outflow from the stock market. However, the current situation is different. While gold is rising, so are stocks. The stock market has largely shrugged off the risks associated with tariffs and the historically low consumer sentiment observed since the beginning of the year, which is usually associated with economic recessions.

The Impact of a 100% Tariff Hike Threat

Despite the market's current resilience, the threat of a 100% tariff hike on China, even if Trump has since backed off, is significant. Such a hike would raise the effective tariff rate on Chinese goods entering the US to approximately 140%. This level would effectively shut down trade, making it unprofitable for businesses to import goods from China. This scenario could potentially trigger an economic depression.

Investors understand that Trump is unlikely to fully implement such a drastic measure, viewing it as part of a broader negotiation strategy. This is why stocks are not currently plummeting. However, this threat further fragilizes the US-China relationship and lays the groundwork for such a policy to be enacted in the future.

China's Shifting Trade Position

China is in a stronger position to withstand trade pressure today. Its exports to the US have dropped by 27% since the start of the trade war. However, China has significantly increased its non-US exports, offsetting the decline in US-bound shipments. Overall, Chinese exports have grown by 8% in the past year, despite US tariffs.

This indicates a gradual misalignment and growing independence between US and Chinese trade interests. If these interests diverge sufficiently, a future US president might be compelled to sever ties with China. The mere possibility of such a policy signifies a clear deterioration in global trade relations, which will likely impact economic growth at some point.

Factors Propping Up Corporate Profits and Asset Prices

The reason the stock market is not currently reacting to these trade tensions is primarily due to record-high corporate profits. These high profits are not a result of tariffs having no impact, but rather due to other structural forces at play:

• US Government Deficit: The US government's annual deficit of $2 trillion, equivalent to about 7% of GDP, is supporting economic growth.
• Federal Reserve Interest Rate Cuts: The Federal Reserve's interest rate cuts are reducing borrowing costs for businesses and loosening financial conditions.
• High Corporate Profit Margins: Businesses are experiencing record-high profit margins, enabling easier earnings growth and facilitating rapid asset accumulation for shareholders.

These forces are not only driving stocks higher but also all financial assets. This explains why gold and Bitcoin, which are not directly tied to economic growth, have also been rising alongside the stock market. In fact, both gold and Bitcoin have outperformed stocks in terms of growth over the last couple of years.

Risk Management and Future Outlook

The current supportive forces are expected to continue for at least another 6 to 12 months, likely pushing asset prices higher in the short term. However, recognizing the potential for short-term corrections, Braavos Research booked profits and closed a significant portion of their positions on October 9th. This strategy aims to protect accumulated profits and create "dry powder" to re-enter the market during pullbacks.

Braavos Research has already begun redeploying this cash, initiating trades on specific stocks with perceived substantial upside in the coming weeks. They share all their trades and market strategies with clients at bravosresearch.com.