This thesis, which also appeared on SumZero, became un-actionable within moments of my writing it up, as President Donald Trump announced a 90-day pause on additional tariffs, which meant markets would go up. However, the crux of the thesis remains correct: 10% tariffs remain and tariffs on China have gone up to 125%, validating my argument that tariffs are, at least for the next 90 days, here to stay and that a trade war with China would be the hardest to de-escalate. Oddly, Apple (AAPL), NVIDIA (NVDA), Meta Platforms (META) and other Big Tech firms that are obviously hurt by tariffs on China, all went up by over-10%, suggesting that the market has not properly digested the tariffs situation. Overall, the UVXY proved my best idea to date, with a gain of over 34% in just days.
As I was I researching for my masters thesis on “The Nature of Risk”, the basis for my PhD -when it commences-, I came to have a rather curmudgeonly reaction to phrases like, “upside risk”, or people quoting Warren Buffett”s, “be greedy when others are fearful, and fearful when others are greedy” remark. “Upside risk” does not exist, risk is always and only the downside. As for greed in times of fear, even Buffett sold his airline stocks during the Covid-19 crash, and he has not yet sashayed into the markets, because there is a magnitude of price decline so large that it is, in and of itself, a risk for the holder of a stock and in this revolutionary moment, even a very attractive stock could be decimated on the stock market before an investor sees any positive returns. On Tuesday, I fell for an absurdity. I closed my four-day old position on ProShares Ultra VIX Short-Term Futures ETF (UVXY), certain that markets had duly considered the obvious reality that China would not scale back their counter-tariffs and that this trade war will be long-lasting. I expected a period of calm and the market duly responded with alarm. It was as if I had tacitly admitted to the strong version of the efficient markets hypothesis. That was incredibly silly. My apologia aside, I am reinitiating my position. I will attempt to do three things in this rather long essay: explain why, from a political and then a historic point of view, this period of uncertainty will be elongated, show why investors have rational reasons to reallocate capital away from the stock market regardless of tariffs, and then, why I think the UVXY will do well for longer than usual. The nature of the argument will be novel to analysts who are used to not having to think about politics first and factor in the possibility of years of uncertainty, so my arguments will be fuller than normal, but I think worthwhile. However, such is the ontology of these changes that developed world analysts have to embrace tools more familiar with analysts from the emerging world, and think about the political and historic before making an investment decision.
Tariffs are Strategically Important to the Trump Administration
In discussions with various people, I have been struck by the feeling that this will all be over in a few weeks. When I have suggested a one to two year timeframe, I have faced pushback. Markets seem to be behaving in a similar fashion. There seems to be a failure to treat the Trump Administration’s policies seriously, which has led to a lot of wishful thinking of the, “If markets keep falling, tariffs will have to be abandoned” sort. This is a mistake: as a rule, when a government believes that a goal is of supreme strategic importance, it is willing to incur the maximum possible economic pain to achieve that goal. When Vladimir Putin invaded Russia, he did not back down when Russia was hit with sanctions, because stopping Ukraine’s drift Westwards was that important to him. In my country, Zimbabwe, between 1997 and 2000, the government enacted a series of measures, including forcible and often violent expropriations of land owned by white farmers, that turned a fairly prosperous country into one whose economy halved in size within a decade, and which, even today, is such that a person living in 1950’s Rhodesia (colonial-era Zimbabwe) was better off than a Zimbabwean living today. Those policies have never been reversed because the government is convinced about their strategic importance. In this section, I will attempt to explain why I believe there is no near-term reversal on tariffs, at least with regards to China.
Now, this is not an assessment of the Trump Administration’s efforts. The arguments against tariffs are widely known, and although I think the odds are against their success, there are arguments in favour of them. That, however, is beside the point, my thesis is that these actions are revolutionary, regardless of their outcome, and that they create such uncertainty that investors will feel rationally obliged to dump stocks, U.S. stocks in particular, and, because there are so many shocks ahead, we are in a unique moment in which betting on the UVXY outperforming the S&P 500 over sustained periods of time, is possibly the best investment that anyone can make.
In an article for FRPI, “Obscurity by Design: Competing Priorities for America’s China Policy”, Tanner Greer gives a taxonomy of the Trump world that I think provides a good way to understand the reasons why the Trump Administration will be able to go the distance on tariffs. My reading of this is that there are three major reasons why tariffs matter to the Trump Administration:
First, although globalisation has been undeniably successful in making the world, and the United States, richer, the China Shock, has gutted the manufacturing industries of countries across the globe, and although the proportion of people affected may be relatively small, the social consequences are such that if the concerns of workers are not addressed, the conditions for revolution are created. Again, Zimbabwe provides an interesting analogy: while the country largely prospered between the 1960s and the mid-1990s -at one time richer than Singapore and Luxembourg-, a proportion of workers and peasants were left behind, and this, coupled with the failure to resolve the land issue, resulted in a social movement to retake white-owned land. In a country of 15 million people today, those involved numbered just 1% of the country. A system is unsustainable if it systematically leaves people behind.
Second, if China and the United States ever go to war, the United States is at a manufacturing disadvantage and would essentially have to relearn how to “build things” during such a war. Greer explains this view saying, “If past wars pattern future ones, great power conflict means that both parties will stretch their industrial capacity to its limit. In that day of woe, outmoded industries will matter. Whether a country can smelt steel, refine rare earths, and build ships will decide death or survival. “It is foolish,” one Trump official tells me, “to imagine that the external sources of these goods will not be disrupted or interdicted in a time of global war.” The time to prepare for that possibility is now.”
Third, the classic idea of a division of labour is too static and policy needs to be more alive to the fact that a peer competitor such as China can move from manufacturing to services, competing directly with the United States. Greer observes that,
The first is that winning blue-chip firms do not emerge out of a vacuum. Technological revolutions often require an entire “industrial commons” with crosslinked supply chains and shared talent pools. As Oren Cass, the intellectual don of these quadrants, puts it: “Industrial expertise is not something bought off the shelf, it comes embedded deep within an ecosystem of relationships between educational institutions and firms; experienced workers and new hires; and researchers, engineers, and technicians. What a nation can make efficiently tomorrow depends heavily on what it makes today, which is one reason why saying it doesn’t matter what we make in America is so wrong-headed.” Many of these ideas are grounded in a close study of China’s economic model. It is common for Chinese firms to pivot from one industry to another. Phone companies become electric battery companies; car companies build semiconductor fabs; software companies start to manufacture drones. This is easy for these Chinese firms to do because each belongs to a group of interlocking industries that share skilled labor pools, domestic suppliers, and industrial know-how. In other words, if China has an advantage in manufacturing solar panels and electric vehicles, it is because they first had an advantage in manufacturing liquid-crystal display screens and iPhones. Those who advocate for a manufacturing renaissance argue that what is true of China will also hold true in the United States.
This framing is true not just of China, but of the United States’ major trading partners. Ben Thompson of the marvellous Stratechery blog, said in an article, “Trade, Tariffs, and Tech”,
What I do come back to, however, is what I opened with: there is a scenario within the realm of possibilities that is far more painful than anything Trump proposed; is it better to try and force into place a new economic system that, at least in theory, reduces dependency on China and resuscitates U.S. manufacturing now, instead of waiting for the current system to collapse by literal force? This does seem to be the administration’s goal: simply tariffing China is deadweight loss, leading to rerouting and the fundamental problem of the dollar as reserve currency unaddressed; blanket tariffs, on the other hand, are a valid, if extremely blunt and inefficient, way to meaningfully restructure incentives.
Moreover, even if an invasion never happens, is the current system sustainable, fiscally or societally? Trump’s political success is, in many respects, the clearest manifestation of what happens in a system that pushes the gains to the globalized top while buying off the localized masses with cheap trinkets.”
Global capitalism is the greatest economic experiment of all time. Even Karl Marx recognised its merits, saying in “The Communist Manifesto”, that,
The bourgeoisie, during its rule of scarce one hundred years, has created more massive and more colossal productive forces than have all preceding generations together. Subjection of Nature’s forces to man, machinery, application of chemistry to industry and agriculture, steam- navigation, railways, electric telegraphs, clearing of whole continents for cultivation, canalisation of rivers, whole populations conjured out of the ground – what earlier century had even a presentiment that such productive forces slumbered in the lap of social labour?
Yet, capitalism’s discontents have created revolutionary moments and outright revolutions since it first emerged. The problem for the investor today is not whether or not Trump’s tariff formula is wrong or whether this will lead to the Great Depression, but that these policies are of strategic importance to the Trump Administration and that any change of course will only happen if there are clear signs that the real economy is suffering and that Republicans are headed to electoral wipeout in the midterms.
Tariff Deals and Trade Wars Take Time
There are signs that the U.S.’s leverage is working. Treasury Secretary Scott Bessent has said that more than fifty countries have approached the U.S. for a deal. The European Union’s (EU) president, Ursula von der Leyden, has,
offered zero-for-zero tariffs for industrial goods …Because Europe is always ready for a good deal. So we keep it on the table. But we are also prepared to respond through countermeasures and defend our interests. And in addition, we will also protect ourselves against indirect effects through trade diversion. For this purpose, we will set up an ‘Import Surveillance Task Force’. We will work with industry to make sure we have the necessary evidence base for our policy measures. We will stay in very close contact to minimise effects of our actions on each other.
The EU’s counter-measures are likely to be less forceful than predicted, but more targeted, with a seeming goal of inflicting maximum pain on red states. However, there are banal reasons why tariffs, even if the administration does not see them as permanent measures but as negotiating tools, will remain for some time.
There are two tiers of tariffs, with 30 countries having special tariffs, and the rest of the world having a flat 10% tariff, while Canada and Mexico can be said to belong to a third tier whose tariffs were negotiated earlier. Although the U.S. successfully used tariffs to force reforms in Japan in the 1980s and 1990s, tariffing the globe presents obvious problems. First, trade negotiations take time, they are not something that can be finished in a few weeks or a month. The Peterson Institute for Economics found that the U.S. takes an average of one and a half years to negotiate and sign a bilateral trade deal, and three and a half years to get to the implementation stage. Jordan has been the quickest off the mark, taking four months to get a free trade deal with the U.S. and eighteen months to get to the implementation stage, while the free trade deal with Panama took thirty-eight months to negotiate and one hundred and two to get to the negotiating stage. Negotiating thirty to nearly two hundred trade deals within a one-to-two year window, especially with a government reduced in size, seems very challenging to me. Key trade partners such as Japan may be given priority, but this would still leave many countries without a trade deal or even the beginnings of a negotiation, for some time.
Trade wars similarly take time, and this is important with regards to China. To get a base rate for how long trade wars take, I used a list of important trade wars from Wikipedia’s page on the subject. In the pre-modern era, the average length was 222 years, with a sample size of just 5. In the twentieth century, the average length was 19.7 years, with a sample size of just 7. In the 21st century, the average length is 12.6 years, with a sample size of 23. The current U.S.-China trade war has been going on since 2018, without meaningful resolution. When I looked at trade wars from the post-Second World War era involving more than five countries, I found the Chicken Wars in the 60s, which lasted 6 years, the beef hormone controversy which lasted 19 years, the Tuna-Dolphin case that lasted 50 years and the Trump-era trade wars that have been going on for 7 years. Simply, trade wars seldom fade out very quickly, largely because negotiations are protracted and each side sees it as being of such strategic importance to win that a collapse of one counterparty to the other’s terms is highly unlikely.
Consequently, the best case scenario is that definitive trade deals will only emerge within the next two years and that whatever is agreed now will be provisional and therefore changeable. China under President Xi Jinping, long anticipated a need to create a world in which it was less dependent on the U.S. In fact, China’s Great Firewall, which predates Xi, is, perhaps, the greatest example of the success of protectionist policies, leaving China as the only country in the world with analogues to the U.S.’s Big Tech. Xi has broadened and accelerated that attempt to create structures outside U.S. control and influence, and the irony of Russia’s invasion of Ukraine is that it alerted China to how profound its weaknesses were and how sharply they would be exploited, if it entered into conflict with the West. Since President Donald Trump’s first administration, China has assiduously prepared for a heightening of tensions. Today, China feels itself uniquely prepared for this moment. The Economist noted that, not only does Xi not have the space to push through the changes Trump wants, they now believe that they can win a trade war:
Chinese officials may also believe that America will be unable to bear the inflation and economic discontent caused by Mr Trump’s tariffs. Instead of “fighting to the end”, they may only need to fight until American consumer prices begin to rise or employment begins to fall. Senior advisers, government researchers and economists all point to this as the easiest way of bringing Mr Trump to the table. Some talk of finding ways to exacerbate the situation, perhaps by strengthening the yuan. This would be quite a gamble. By the time inflation had picked up in America, Chinese industry and supply chains would be suffering.
An escalating trade war means that Xi Jinping will need to do more to prop up China’s economy. The potential shock is being compared to the global financial crisis of 2007-09, which elicited a stimulus package of 4trn yuan ($590bn). Li Qiang, Mr Xi’s deputy, said in March that the country was preparing for “bigger-than-expected external shocks” and that it was willing to enact policies to ensure economic stability. What this means in practice remains unclear. The People’s Daily, a state newspaper, said on April 6th that cuts to interest rates and banking-reserve ratios could come at any time. The paper has also said that local governments will help struggling exporters to find new sources of demand at home and in non-American markets. Soochow Securities, a Chinese broker, has suggested that China could lower tariffs on the rest of the world, while increasing export subsidies.
All this leads to the midterms. By then, Trump will be hoping to have a series of comprehensive trade victories to announce with a lifting of economic pain, while Xi will be hoping that the pain visited upon the U.S. will be such that Trump will be forced to climb down from his demands in order to save Republicans in the midterms. None of this suggests a quick resolution.
Equity Preference Gives Investors Rational Reasons to Reallocate Capital Away from Stocks
A final argument for prolonged stock market mayhem is that, using a measure I call, “equity preference”, which was first developed by the pseudonymously named Jesse Livermore of the Philosophical Economics blog, I determined that, as of the end of Q4 2024, the aggregate U.S. investor had allocated 52.18% of their portfolio to equities, the highest level since the Fed started collecting the component data in Q1 1951. Equity preference is, in essence, a measure of demand for future returns, returns which are relatively inelastic, which is to say, they are less changeable than demand. Ceteris paribus, if supply is relatively fixed, while demand rises, then the price of a thing, in this case, future returns, will rise, even as the supply of that thing declines. Equity preference tells us that future 10-year S&P 500 returns are inversely correlated with equity preference. At current levels, the S&P 500 was already headed to a decade of returns of around 1% a year. An investor who bought the market in Q4 2024 and holds for the decade after, will likely do worse than an investor who buys U.S. Treasuries.
Investors will recognise the truth of this once they concede that the highest returns usually come at the bottom of a bear market, not the top. Or, to use a quote often erroneously attributed to Nathan Rothschild, “the time to buy is when there’s blood in the streets.” Investors have increasingly bought when the streets have been laden with gold. As investors re-examine their portfolios, they will be forced to exit the stock market, and have already done so at record dollar amounts, because the prospective returns are so low. Equity preference would have to fall to something like 45% for the stock market as a whole to be more attractive.
While individual stocks and certain sectors may do well, overall returns will be poor. So even if tariffs magically disappeared tomorrow, investors have started to lose their optimism, and that is not a great formula for a sustained bull market.
Downside Volatility Will Be Sustained
The UVXY is typically used for very short periods. It is, at base, a bet that the market will go down. Typically, this is such an improbable event that, if one held the UVXY from inception to date, one would have lost all one’s money. However, it is the very best instrument out them for profiting on sustained downside volatility. In my initial essay, I said that,
While I suspect that this crash will end up greater than the Covid-19 crash, one can use it as a way of benchmarking expectations. Between March 1 and April 1 2020, the S&P 500 slumped some 16.4%, compared to a rise of 187.7% for the UVXY.
When the UVXY first entered the market October 31 2011, in the wake of the August 2011 stock markets fall, the S&P 500 fell 4.64%, while it gained 21.75%, between October 31 and November 29.
The final analogy is indirect: during the 2008 financial crisis, specifically between 1 August 2008 and 30 July 2009, the CBOE Volatility Index (^VIX) gained 27.6%, while the S&P 500 declined 28.3%.
These are the results of a simple buy-and-hold strategy of an instrument that is typically deployed for very short periods. The results are even greater when the VIX is deployed for shorter periods, before decay sets in as the market recovers. At a base value, I expect to gain 20% over the next month from the UVXY, and higher than that in short bursts.
The combination of the uncertainty created by a set of novel economic policies that defy the median investor’s expectations, and the high equity preference levels, both at the same time, compel investors to exit markets and to do so over prolonged periods of time, with sometimes a glut of sales happening has investors process new information that seems to confirm their worst imaginings. Like the Nixon Shock, it may turn out that this revolution was inspired, but despite the immediate popularity of the measures, with the Dow Jones Industrial Average ((DJIA) going up 33 points the day after the Nixon Shock policies were announced, the aftermath, at least in terms of the stock market, was terrible. It is only in the long run that it has been seen as necessary and brilliant. As this rearrangement of the global economic order is occurring, investors will struggle to answer basic questions, and will retreat to safety. As that is happening, downside volatility will rise, and along with it, the UVXY. At base, I expect that the worst of this will occur in the next three or so weeks, after which, the worst of the downside volatility will be behind us.
Such is the importance of novelty of these conditions that I think that the UVXY will, at a minimum, return to its August 5 height of $61.77 per share, and I am setting that as a target, although, if you believe as I do that this is the greatest series of economic changes in a century, then $61.77 will not only be easily reachable, but will be far surpassed.
Conclusion
Hopefully, I have succeeded in explaining why the Trump Administration is unlikely to lay down arms in the near-term, why even if trade talks are opened today, their ultimate conclusion and the shape of the new economic order is at least a year away, why equity preference levels provide investors with additional reasons to exit the U.S. stock market, and why this combination of factors means that investors should expect prolonged downside volatility. This is true regardless of the final outcome, whether it is the Great Depression Redux or a post-Nixon Shock Prosperity. When investors do not have analytical clarity and that persists for a long time, downside volatility reigns. In such an environment, the most direct way to benefit is an instrument such as the UVXY. I have joked with various friends that, short of Bank of Japan-style direct acquisitions of stocks, I do not think that the Fed has enough tools to bail out the stock market and with inflation a concern, that would be a bizarre turn. Downside volatility will define the market for the next few weeks, at least.