The markets are still in 'a state of denial' when it comes to tariffs, says Lazard's Ron Temple

Key Concepts

• Tariffs and their impact on inflation and GDP
• Weighted average tariff
• Retaliation from trading counterparties
• Reconfiguring portfolios
• Non-U.S. investment opportunities (Europe, Japan, Emerging Markets ex-China)
• Mag Seven stocks: Reallocation of capital
• AI and its impact on corporate profitability
• Capital optimization

Tariffs and Economic Impact

• Current State of Tariffs: The markets are potentially underestimating the impact of tariffs. There's speculation of a universal 20% tariff.
• Weighted Average Tariff: On January 19th, the weighted average tariff in the US was 2.7%. With current announcements, it's around 10.9%, an 8.2 percentage point increase. This increase represents unwinding 60-70 years of tariff reductions in just over two months.
• Inflation Impact: Every 100 basis points increase in the weighted average tariff translates to roughly 10 basis points of core inflation. This impact will likely become visible in inflation data around May or June.
• GDP and Corporate Profit Impact: The GDP impact follows the inflation impact. Eventually, corporate profits will be affected as consumers reduce purchases when prices rise significantly at retailers like Walmart, Target, and Costco.
• Risk Assessment: The current equity market doesn't fully reflect these risks, suggesting potential downside.

Market Outlook and Investment Strategy

• Potential Downside: The S&P 500 could experience another 5-10% downside from its current level.
• Reconfiguring Portfolios: Instead of trying to time the absolute bottom, investors should use this as an opportunity to reconfigure their portfolios.
• Non-U.S. Opportunities: Investors are recognizing opportunities outside the U.S., particularly in Europe.
• Europe: While historically not bullish on Europe, the current situation might be the beginning of a significant opportunity. However, it's a long-term story, and investors should do their homework.
• US Equities: There's no rush to buy into US equities right now, as there might be further downside. Good buying opportunities will arise in the US in the long run.

Mag Seven and AI

• Mag Seven Reallocation: While selectively maintaining exposure to the Mag Seven, investors should consider taking capital out of these names and moving it to other parts of the market.
• AI Impact: The next phase of the AI story will involve companies that effectively use AI to improve profitability and competitive positioning.
• Capital Allocation: Reallocate capital down the cap spectrum to companies poised to benefit from AI.

Specific Investment Opportunities

• Japan: Japan presents interesting idiosyncratic opportunities related to capital optimization.
• Emerging Markets ex-China: In the next six months, emerging markets (excluding China) could become attractive. Trade tensions may lead to jobs and manufacturing moving from China to other emerging markets, creating a tailwind for investments in those regions.

Conclusion

The market is currently underestimating the impact of tariffs, which will likely lead to increased inflation and eventually affect GDP and corporate profits. Investors should use this period to reconfigure their portfolios, explore opportunities outside the U.S. (particularly in Europe, Japan, and emerging markets ex-China), and reallocate capital from the Mag Seven to companies that can leverage AI for improved profitability. While the US market may experience further downside, good buying opportunities will emerge in the long run.