Why It’s Not Just About Tariffs Understanding Market Volatility: It’s More Than Just Tariffs

Valuation Models Are Flashing Red

Several key indicators suggest the market is overvalued—even without factoring in trade policy uncertainty. For example:

• The Buffett Indicator, which compares total stock market capitalization to GDP, shows stocks are historically expensive.
• The Shiller CAPE Ratio, which tracks prices relative to 10-year inflation-adjusted earnings, tells a similar story.
• The Fed Model and Capitalized Profits Model, which compare stock earnings to bond yields, suggest that the return on stocks—relative to bonds—is at its lowest point since the dot-com bubble.

In short, across multiple models, the market looks stretched.

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📊 The Problem with Index Concentration

Even though these broad indicators suggest overvaluation, not every stock is overpriced. The saying goes, “It’s a market of stocks, not a stock market.”

But here’s the catch: the S&P 500 is extremely top-heavy. Just ten companies make up over one-third of the index’s total market value. That makes it hard for gains in smaller, more reasonably priced companies to offset any major declines among the giants.

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🏛️ Policy Shifts: Long-Term Gain, Short-Term Pain

There’s good news on the horizon. Pro-growth policies—like lower taxes, deregulation, and trimming government bureaucracy—have the potential to boost the economy’s long-term growth rate.

However, we must recognize that the last two decades of economic growth have been artificially inflated by huge budget deficits and ultra-loose monetary policy. As those crutches are removed, we’re likely to feel the discomfort. Think of it as a painkiller wearing off—short-term pain for long-term healing.

This transition will likely result in slower economic growth and weaker corporate profit growth in the near term. But that doesn’t mean we’re headed for a crisis. It means the economy is adjusting—much like it did in the early 1980s under Reagan, whose policies led to a boom after a rough beginning.

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💡 Stay the Course, But Be Selective

The market’s recent dip is not unexpected. For over a decade, investors have been conditioned to “buy the dip” as markets kept climbing. Now, with correction territory in sight, the pullback feels worse than it is—and emotions are running high.

But let’s be clear: tariffs are the trigger, not the root cause.

When Reagan took office, the S&P 500 traded at a PE ratio of 8 and the U.S. had no budget deficit. When Trump returned to the White House 50 days ago, the PE was 28 and the deficit neared $2 trillion. The landscape has changed dramatically.