Trading the Tariff Tantrum

Markets are swinging wildly, and policy tweets aren’t helping. In this quarter’s podcast, Chief Investment Officer, Steve Johnson, and Forager International Shares Fund Portfolio Manager, Harvey Migotti, dive into the renewed tariff chaos sparked by Donald Trump’s latest announcements. They explore what it could mean for US exceptionalism, inflation expectations, and global investor sentiment.

From the bond market's sharp reaction, to the larger than expected tariffs and broader questions around corporate confidence and earnings revisions, Steve and Harvey dissect the key themes shaping portfolios right now.

Transcript

EPISODE 35 

[INTRODUCTION] 

[0:00:03]ANNOUNCER: Just a quick reminder that this podcast may contain general advice, but it doesn't take into account your personal circumstances, needs, or objectives. The scenarios and stocks mentioned in this podcast are for illustrative purposes only and do not constitute a recommendation to buy, hold, or sell any financial products. Read the relevant PDFs, assess whether that information is appropriate for you, and consider speaking to a financial advisor before making investment decisions. Past performance is no indicator of future performance. 

[EPISODE] 

[0:00:39]SJ: Hello, and welcome to episode 35 of Stocks Neat. We are recording this podcast on the afternoon of 10 April Sydney time. I'm saying that very, very specifically, because who knows what's going to happen between now, and when you listen to this podcast. The Nasdaq index in the US rallied some 12% last night on a message out of the White House that some tariffs were going to be reversed. Yeah, there could be a lot happen between now and when that podcast gets out to you in a few days’ time. But at the risk of looking stupid, we're going to try and wrap up our thoughts about what's happening in the world. I'm joined for that by Harvey Migotti, Portfolio Manager on our International Shares Fund. How are you, Harvey? 

[0:01:26]HM: I'm very good. Thanks. It feels like we're in end of June, and that's – every day is like a month here. 

[0:01:31]SJ: Very busy time for you. Particularly, lots of late nights trying to navigate what's happening out there in markets. Really, since the inauguration of Donald Trump, it's been a torrent of radical policy changes via tweet, most of them, including very importantly, getting rid of paper straws and shower heads that don't run fast enough for the president to wash his hair. Give us a quick run through of where we sit today, Harvey. 

[0:01:58]HM: Yeah. I think, I mean, obviously, the topic of the juror are the tariffs. He started up with Canada and Mexico back in February, which marked, essentially, the US market peak at that point, all the way through “Liberation Day,” where he tariffed more than the whole world. It was uninhabited island full of penguins, and various other places. That was quite a shock to the system, as we know, and the markets had one of their fastest pullbacks in decades. 

[0:02:25]SJ: Yeah, there was a lot of nervousness and markets were down leading into that day, but I think there was just something about the incoherence of it all that there was a general view that there's got to be some grand plan to this, that there's someone behind the scenes that knows what they're doing and that headed to a sensible place. I think that day when the Liberation Day tariffs came out, the way they were calculated, it was countries, net exports to the US divided by their total exports to the US, divided by two. Then what was it applied by? Domain names in the country, all sorts. 

[0:03:02]HM: Well, that's one of the funny parts, and it's why zero population island filled with penguins like Heard and McDonald got slapped with tariffs. It appears that they weren't broken down by country, but by top-level Internet domain. That's why you had some of these funny ones, like Gibraltar, as opposed to being part of the UK as its own entity on that list, and so forth. 

[0:03:20]SJ: I actually can't stop myself from laughing, so I'd say, it would be hilariously funny that there are days where you just wake up and you can't do anything but laugh. But it is really quite deadly serious, I think, for the world economy. The latest and the reason for the market rally last night is those latest round of tariffs have been put on hold for 90 days, apparently. 

[0:03:45]HM: All but China. Yeah. 

[0:03:47]SJ: The original 10% are still in place and the aluminium and the tariffs that were in place before the Liberation Day stuff came out are still in place. 

[0:03:55]HM: Yes, that’s right. 

[0:03:57]SJ: As we sit here today, what's your view on what all this means? 

[0:04:01]HM: Well, I mean, if we just recap what he's actually done. He moved China tariffs up to 125%. He did signal that further hikes are rather unlikely, which offers some room for negotiation back down if China plays balls that they've been retaliating quite severely relative to most other countries. As you mentioned, the other tariffs have been rolled back to the baseline 10% during this period, this 90-day stay of execution, as we call it. Mexico and Canada remain the exception with tariffs ranging between 10% and 25%, so that's the original stuff announced in February. It depends on whether or not items are covered by the North America Trade Pact. 

He also signaled that he might be launching some additional sector-specific tariffs on the likes of pharmaceuticals, with the intention of bringing back that kind of manufacturing into the US again. All of that obviously has created a lot of turmoil, tension, and fighting between nations and a lot of uncertainty on the ground everywhere, but mainly in the US, I'd say. 

[0:04:58]SJ: Yeah. The stock market had been in turmoil for most of the weeks since the announcement. But I guess, the change on Tuesday was the behavior of the bond market that it really seems, has got his attention. Why is that as important, or more important? 

[0:05:13]HM: If you follow what they've been saying, they've been pretty vocal about getting a long-term bond rates down, and Trump specifically yesterday when he rolled this back and had that conference, he said that the bond market's “very tricky,” and that I was watching it, but if you look at it now, it's beautiful, the bond market right now. But I saw last night, people were getting a little queasy. Clearly, the pain point of getting 30 years hitting 5% marks some pivot points, and that's probably the tool that both other countries have and that the market can use to gauge where the pressure points lie. 

Unlike Trent 1.0 where the market went down a bit, and tweets all of a sudden started changing this. He's shown that he cares a bit less about the equity markets this time around, or almost even doesn't care in the near term at the very least. 

[0:06:00]SJ: Yeah. Why do you think bond markets are more important in terms of his view of the world? I mean, there's been a lot of rhetoric from before inauguration day, really, that they saw long-term interest rates as something that needed to come down. The currency has been something they've talked a lot about as well. Why do you think they are important metrics, rather than, I think, more people would be invested in and familiar with in terms of just equity markets in general? 

[0:06:25]HM: Yeah. Well, I mean, you mentioned one of them, it's the stronger dollar. Trump always complains about other countries trying to devalue their currencies, and that's hurting US exports and the relative competitiveness in the world. Also, US has a lot of debt to refinance, as we know, so the lower the rate, the better for them, from that perspective. I mean, the general impact on the economy, both corporates and consumers, whether it be housing, or just going out and buying a pair of Nike sneakers. Higher rates are worse for that. It's obvious. I think that is always a metric, important metric to watch. Higher rates, because the economy's gone gangbusters is great. Higher rates because of sticky inflation and other things, such as tariffs, not so good. 

[0:07:06]SJ: Yeah. We'll come to our portfolio in the second half of this podcast and how we're thinking about specific investment opportunities, but what's your view – we've had a huge rally last night, half of the drawdown from the peak has been regained in one trading session last night. Where does it leave you in terms of, I guess, just general economic risks? How do you see that US economy over the next 12 months, given he has retracted what seemed like some of the most damaging of the tariffs? 

[0:07:40]HM: Sure. I mean, whatever happens with tariffs, there's no doubt that animal spirits, which we're riding at near all-time highs post the election and everyone's feeling great about life, they're looking worse today than they were post the election, for sure. Consumer confidence has been hit and I don't think that comes back immediately, and consumer confidence wasn't already doing pretty poorly, but it just got magnificently worse. It's hard to remove the damage of some of those effects near term. It's going to take some time. Even if you've fully rolled back tariffs, my view here is that you have negative earnings revisions coming in the US and also, certain global companies. That's bound to happen. I mean, you put that together with US equity valuations, post the bounce, still trading near highs, that's negative combination, to some extent, as you roll forward through the year. 

[0:08:29]SJ: Yeah. I think it's something that a lot of people still don't quite have their heads around in terms of how a modern economy works. There's this view that there's just a certain amount of work to be done, and if you don't do part of it, you don't do part of it. Each part of the economy is very dependent on other parts of the economy. 

[0:08:44]HM: For sure. 

[0:08:45]SJ: The confidence piece of it is very important. That was Keynesian economics, I guess, came along after the Great Depression, where this idea that you actually needed to stimulate an economy, sometimes the government needed to do that, but one person's income is another person's expense, and to the extent that everyone tightens, they're built at the same time, then it exacerbates what goes on in an economic downturn. I still think there are significant risks of the behavioral changes, having effects on the real economy here. You imagine EO running a business in the US at the moment, you had plans to expand your operations, you were going to build some extra capacity. You're sitting in a boardroom at the moment saying, “Well, maybe we should just wait and see what happens here over the next six months.” And when you wait that someone else's revenue that was going to do that work for you and they're going to lay off staff and then those people that have been laid off are going to spend less money down at a local shop. It does fade on itself like that. 

[0:09:41]HM: There is that partake we found there. Yeah, for sure. If we just dial it back, companies were never going to move sock and underwear manufacturing back to the US from Vietnam. I mean, it didn't make a lot of sense. The costs are much higher, there's a baseline, labor expenses are higher. I don't think tariffs would have sold for that, so all you end up doing is you just spend less CapEx. If the reciprocal tariffs do come into effect at this, let's say, even 10% level, I mean, you as someone who was going to spend some CapEx in the US prior to this, where you were going to export it, let's say, two-thirds of those products and one-third for the domestic market, the returns on those exported products just got worse. It's obviously not great. 

I would say that many of the things we did like about US exceptionalism do remain in place. Management teams, high caliber, properly incentivized. The indices in the US are home to some of the best run companies in the world, and not just at the max seven level, which you never knows about, but all the way down to the Russell, you have some beautiful compounders, great quality businesses. It's harder to find them in Europe and it's certainly harder to find them in Australia, I'd say. 

[0:10:45]SJ: Yeah. I think they're going to need those skills over the next 12 months. But if I was going to be invested in a country that was going to have to navigate something as difficult as this, I do think just the cultural capacity to change to accept that this is the world that we live in and we've got to make decisions, it's going to happen better there than in a lot of other places. Like you touched on, I think, the management and the capital allocation and all of those things are still there. We recorded a podcast. Must be coming up to, I think it was January 2024. So, a year and a bit ago, just talking about why we had a lot of our portfolio invested in the US, and those reasons are still there. I guess, the frustrating thing about all this is the economy was humming. There was evidence actually that the lower income workers in the US were doing relatively well over the past decade and when wages were going up. To some extent, you'd understand this a little bit more if the US was underperforming the rest of the world and the economy was going bad, there'd be more reason, I think, for what we're seeing in terms of the leadership behavior. 

[0:11:50]HM: Yeah. It's funny, because it's been a view. I mean, if you look at the Trump interviews from the 80s or 90s, he's always had a view that other countries are ripping the US off. In that case, it was Japan. I think he tried to do something in Japan, or US, or exports up to Japan. I don't remember the full story, but he was talking about that already back then. It's hard for Zebra to change their stripes, so to speak. He's just had that view and it's just – he's in his what? 70s, and he's still stuck with it. Like tariffs, we need to tariff countries, because US is getting ripped off. You're not going to change that overnight just because markets are down a bit. 

[0:12:22]ANNOUNCER: Stay tuned. We'll be back in just a sec. 

[MESSAGE] 

[0:12:25]ANNOUNCER: Are you a long-term investor with a passion for unloved bargains? So are we. Forager Funds is a contemporary value fund manager with a proven track record for finding opportunities in unlikely places. Through our Australian and international shares funds, investors have access to small and mid-sized investments not accessible to many fund managers, in businesses that many investors likely haven't heard of. 

We have serious skin in the game, too. Meaning, we invest right alongside our investors. For more information about our investments, visit foragerfunds.com. If you like what you're hearing and what we're drinking, please like, subscribe, and pass it on. Thanks for tuning in. Now, back to the chat. 

[EPISODE CONTINUED] 

[0:13:05]SJ: One really surprising thing out of all of this for me, anyway, has just been how much almost executive power he has been able to wield without needing to involve the other arms of politics in the US. This whole concept of checks and balances that you have the three arms of government over there and all three combine to make things work. I mean, he's literally coming out with tweets and putting tariffs on countries. I think there will be challenges to that over the next six to 12 months, and particularly if the economy starts to deteriorate. I think you'll see Congress in the US trying to get more control over this stuff. 

There's already some proposals being put forward to say, well, these tariffs that you're putting in place can only be temporary without Congress approval of them. I think we'll see more around that aspect, but it has been astonishing, given people have talked historically about that being such a strong part of the political system in the US to see one person wielding as much power as he has. 

In any case, let's move on to our portfolios. I want to spend some time talking about how we are navigating this market personally, been pushing very, very hard internally for us to make sure that the next downturn that we go through, we handle better than the last one we went through in 2022. I know you and Gareth and Alex Shevelev on the Aussie fund have been putting a lot of work into that. Maybe kick things off with how we were positioned going into the downturn. You put some nice charts in the quarterly reports showing substantially reduced exposure to the US as a starting point. 

[0:14:35]HM: Yeah, we discussed this in our December quarterly. While tilting slightly more defensive cost us post the election, and some of that run that you had through January and February, that certainly helped today. I think valuations were the main driver of the shift, US relative to the rest of the world. If we were finding some really good value elsewhere, whether that be in Japan, or European banks, and so forth. 

I remember sitting there in mid-February and looking at the economic data started to trickle in, post the initial tariffs in Canada and Mexico and all that chatter. Consumer sentiment was rolling over, industrial data was weakening. Fed GDP now cuts, it started to come through, and that also supported the decision to rotate the portfolio further away and protect us also. We had a very healthy level of cash, the highest one we've had, since I joined here into the end of February. It's all been really good, actually. We're sitting on a pretty good month at the moment. 

[0:15:33]SJ: Yeah. Just to put that into some numbers, I think we were 70% or so of the portfolio invested in the US. 

[0:15:39]HM: In line with index, yeah. 

[0:15:40]SJ: 18 months ago. As of 31st of March, that was down to the low 40s. The first part of this correction that we've seen was more of a shift to the UK and Europe than it was a global sell-off. Although it became a global sell-off later and that certainly helped us. It's not uncommon. I think you often come at things from a macro perspective and it's very, very helpful. I often think more of a micro perspective and we often land in the same place. Where you're finding the opportunities at a stock specific level are also often pockets of macro movement. 

I will be looking at stocks and saying, I'm just not finding a lot in the US that's meeting my return hurdles, and you might be looking at market multiples and where the levels are relative to whoever else and reach the same conclusion. It's not uncommon for us to end up bottoms up portfolio with a macro tilt that is consistent with someone who would be taking the same view from the top-down level. 

I think as of this morning after last night, we’re actually up in Australian dollars for the month in terms of the international funds portfolio performance, and the market’s down 3% or 4%. It's been quite significant outperformance for the month. All of that stuff you talked about has been very helpful in terms of where our portfolio allocation has been. We've also had one micro-cap stock doing very, very well for us. It was doing well on the days where the market was down and particularly well on the days when the market was up. Let's say, the timing on this particular investment, we're talking about Nutex, which we've written up in the quarterly report for anyone who wants to have a read. This is a small micro hospital company in the US, and I'll come to a bit of a description in a moment, but the timing has happened to coincide with a difficult period for markets and has very much helped our performance relatively. 

That's also, I think, one of the benefits of being in that micro-cap part of the market. The stock specific news can move the share price by a lot more necessarily than the economic backdrop and usually more than a larger, well, covered business where there are less surprises on both sides, for sure. But in this case, it's been helpful through what's been a pretty difficult market period. 

[0:17:55]HM: Not being part of some of the larger indices, when there's so much index selling and buying, also helps them move to the beat of their own drum, so to speak. 

[0:18:03]SJ: Stumbled across this company, I think it was maybe 1st June or July last year. Did I mentioned it to you? We didn't invest in it until August or September, but at the time that I stumbled across it, the share price was down 99 point something percent. You need a minimum share price to stay listed on the NASDAQ stock exchange. You had to consolidate its stock twice. It was 100 for 1. It had a 100 times less shares on issue by trying to keep its share price up. The time we stumbled across it was about $5 then. I think 12 or 13 by the time we first made an investment. 

The company runs these tiny little 20-bed hospitals in the US. It's got 24 of them at the moment. It had gone through a very, very difficult period, mostly driven by a change in legislation that government had brought in an act called the No Surprises Act, which was meant to stop people getting surprise bills. It gave insurance companies cover to pay hospitals a lot less than they were paying them, and New Texas revenue fell 30% on a pretty fixed cost base that obliterated its earnings, and hence, the share price being down as much as it was. At 20 million market cap at $5 a share, it had a 50 million dollar market cap when we first invested in it, and it's just announced a profit of more than 50 million dollars for the year, and 70 million dollars or so, if you back out some of the write downs and things that were in that result. 

It's made more in profit than the market cap when we first invested in it, and I actually think this stock despite being up substantially since that first investment has got plenty more upside in it, and that's why the share price has doubled since its latest result came out this month. 

[0:19:42]HM: Yeah, I think it's been an incredible investment for us. We obviously visited the facilities back in November. I was personally impressed. I think there’s a point where I said, okay, let's add more, having spoken to some of the doctors and management and got an appreciation for the difficulty of actually doing this. You need a really good team of hardworking people that you incentivize properly to do this. It's the customer service that brings people there. If you look at the Google reviews, it's all five stars, and these aren't bought reviews. They're all reviews, and you compare it to one of the larger hospitals at two, or three stars and complaints about waiting time. 

I mean, if it's a choice of where to go, I know where I would go personally. I’d go to one of these. It's been a great investment, and I think our ability to be nimble there really helped. That set of results last July, August. As soon as that happened, we dotted our Is, crossed our Ts and started buying it, even though it had already doubled from the absolute troughs. I don't think you can always nail the trough, but we saw a lot more upside, and what is it? Up five times since our take? 

[0:20:41]SJ: Yeah. 

[0:20:42]HM: Yeah. It's been phenomenal. 

[0:20:44]SJ: I've been talking nonstop to clients and on our podcast and on the webinars over the past 18 months about the portfolio management aspect of what we do and how important it is. This is another example of us really putting that into practice. It was a tiny waiting, and it should have been a tiny waiting at start. There were lots of risks here. The business was very precarious state, and we had a very low portfolio waiting because of all those risks. In that first paper, we talked about potential upside here that was five and 10 times the share price, but very risky. 

As that risk has reduced, we've been adding to the stock, even though the share price has been up four and five times from that initial purchase price. The company came out in early January and gave an update that didn't have a lot of numbers in it, but said, look, we're winning a lot of these arbitration cases against insurance companies. We're getting a lot more revenue than they were paying us before, because we're being awarded these wins in the arbitration, and again, the ability to add to that. Because we're small, we're able to invest in a small company, but we're also able to change that portfolio waiting quite aggressively. 

[0:21:49]HM: We've doubled down on that. 

[0:21:49]SJ: It’s made a really big difference. 

[0:21:50]HM: Which made a huge difference. Yes, that's right. 

[0:21:52]SJ: Look, we've put a bit of incremental capital to work elsewhere over the past week as well through all of this turmoil. How are you seeing the best places out there to deploy incremental capital at the moment? 

[0:22:05]HM: Yeah. Well, I mean, certainly even post the move yesterday, the valuations are a lot more interesting today than they were in mid-February. While the NASDAQ’s regained half of its lost ground, as you mentioned, the Russell still has been pulverized over the past few months relative. Small and mid-caps, you still find really attractive things in the US. US, Europe, parts of Asia, we're still finding some very interesting companies there. A lot of new ideas. We've turned the portfolio around nicely, I think, and some of the very small end of the range in other countries that hopefully, turn into another Nutex for us over the next couple of years. 

Apart from that, I mean, you have some really good large cap, long-term compounders that are much more sensible valuations today than they were January and February as well. It's across the board. I just think you do want to be a bit careful. You want to try to avoid big question marks, or uncertainties when it comes to potential tariff risk, potential China tariff exposure, significant exposure to massive economic slowdowns, and so forth. You do want to keep a balance and not put all your eggs in some of those baskets. We just don't know how it's going to turn out, so there's no way to predict what Trump tweets next. 

You have some guardrails, but you just don't know where the ball's going to go, so to speak. I think just having a diversified portfolio, being nimble, moving on news where relevant, where it's impacting your companies, but also having the fortitude to buy on the dips, which I think we've been doing in our various names, whether they're in the US or Europe. I think that's helped a lot over the past couple of days. 

[0:23:37]SJ: Yeah. I think a general focus, and this is across both funds on, like you said, less question marks is probably the right way of putting it, and that can be external to the company, or even internal to the company. I think on the Aussie fund side of things, we've been topping up those investments that we've got that are going well, and that we know when market sentiment changes, people are going to want to buy. They're sitting on the sidelines, because they're worried about – 

[0:24:01]HM: That’s right. 

[0:24:01]SJ: - the market, rather than worried about the business. I think those businesses, where there are some question marks, you've probably got more time here. You can get through a couple more results. Maybe some of the question marks go away, or you get more evidence about that. Or if the market recovers quite a bit, then the risk reward in some of those types of opportunities becomes relatively better. It's a similar strategy to what we're deploying in the Aussie fund here is to keep it fairly clearly within the rails for now and use this as an opportunity to top up on the businesses that we really want to own over the next five or 10 years and that we don't see being dramatically impacted by the difficult macro environment. 

[0:24:38]HM: Totally sensible approach. All I'm going to say is that we're going to have an extremely interesting earnings quarter in the US and elsewhere right now. Does a company put tariff impact in? Do they guide ex-tariffs? No one knows what's going to happen. No one knows where the numbers land even with a base 10, it's still not 100% when you calculate the costs that they're going to end up being that. It's going to be wild. I think that the volatility hasn't finished here, so it's going to remain volatile. We do welcome volatile environments. My sleep doesn't, but our returns do. So, hopefully, more opportunities, the market tosses our way, like it has over the past few weeks. 

[0:25:17]SJ: Yeah, I think that's absolutely right. I know that this volatility causes nervousness out there. That's why the share price has move around so much, but it's when we're adding the most value for our clients and it's certainly when I get most excited about the opportunities as well. I think there's every chance that this is four years of this whole presidential term. Who knows? He seems to be angling for a third term as well, so we might have eight years of sleepless nights for you, hardly ahead of this, but there is certainly going to be plenty of ups and downs ahead of us and that's going to be more opportunity than a relatively benign market. 

[0:25:53]HM: Yeah, that's right. We'll perhaps leave you with a few Heard and McDonald penguin tariff memes here on the screen. 

[0:26:00]SJ: You’re going to put those in the video version of this, though. If you're just listening, maybe jump on and watch the end of the YouTube clip, or maybe we can work a few into the webinar next week. 

[0:26:08]HM: Yeah, we probably. 

[0:26:10]SJ: Which has been a lot of very funny, very funny stuff out there. Thank you for tuning in. As always, if you've got any questions, ping us an email, admin@foragerfunds.com. Quarterly report will be out by the time you're listening to this, and don't forget to tune into our webinar next week as well. Thanks for listening. 

[0:26:25] HM: Thanks. 

[END]