Well, if you needed another clear and compelling reason to ramp up your northwest quadrant alternative allocations sooner rather than later, now you have one! There is so much to write about and so much to ponder with tariff anxiety in the spring air, but since we all have short attention spans these days (me included), I will try to keep this short and sweet. I hope this context will bring some rational order to the recent extreme level of chaos.
Responding to recession risk
Unfortunately, the uncertainty around now implemented tariffs (no surprise that we got higher tariffs on China, but wowza, 25% on autos, 46% on Vietnam and 32% on Taiwan) has increased economic growth risk and market uncertainty.
It would have been much better to lead with the Tax Cuts and Jobs Act (TCJA) extension, give deregulation time to sink in and then incrementally implement tariffs in a clear, precise fashion—but we are where we are.
We have progressed from virtually no risk of recession, and buoyant animal spirits, to fears that a recession is imminent in nearly record time (the pandemic was the only event that moved faster and clearly had a far more detrimental impact), and a complete collapse of business and consumer confidence while corporate transaction volume never had a chance to clear the runway.
From our vantage point, recession risk has increased from virtually nil (barring an exogenous shock like China invading Taiwan) to a large enough slice of the probability distribution (call it 1 in 5 chance to a 1 in 3 chance or 20–33% probability) in a short enough period of time to at least pay attention. Hard economic data (withholding tax growth, initial and continuing unemployment claims, job creation, ridiculous levels of previously announced business fixed investment, ADP private payrolls, etc.) still look strong. The Q1 hit to growth from imports frontrunning the tariff threats will normalize over time. However, other soft data series like consumer and business confidence have deteriorated dramatically and certainly cannot be completely ignored. Furthermore, the magnitude of the implemented tariffs will be devastating to our trading partners.
What should investors do next? Examine the GDP
In times like these, it’s best to revert to contributing factors to gross domestic product (GDP) to get the best read on where we go from here for the economy. Remember, markets in the short term are driven by technical factors as well as economic.
The classic Keynesian or neo-Keynesian framework of GDP = C + I + G + ΔX is an excellent means for getting at the heart of what’s going on, so let’s use that as our road map.
Here we go.
“C”—Consumption
The U.S. economy is primarily a service and consumption economy, which is why the “C” for “consumption” in GDP = C + I + G + ΔX is so important. One of the primary reasons the U.S. economy has become so much less cyclical is the dependence on consumption (68%) and services (72%).
Last year, consumption growth generated 1.87% to GDP growth of 2.8%. Given the modest loosening of the labor market and the depletion of the majority of pandemic excess savings, consumption was always going to be modestly lower this year than in 2024. (And, by the way, to ever have a shot of getting inflation back within an acceptable distance of 2%, it had to be.)
The tariff hit to business confidence and hiring plans—combined with the drop in consumer confidence—is likely to lower this further, but to what degree? To a 1% contributing factor? With incredibly aggressive tariff implementation and another inflation shock, it could perhaps be 50bps. Anything below this would require a substantial deterioration of the labor market well beyond anything seen in hard data so far.
So far so good, but admittedly way foggier today than two months ago.
“I” —Investment
As I have written and spoken about many times, arguably the greatest near-term factor the U.S. economy has going for it is the massive, unprecedented levels of business fixed investment tied to the AI boom.
I will spare you all the details, but the four hyperscalers (Alphabet/Google, Microsoft, Meta and Amazon) clearly telegraphed increased capital expenditure, or CapEx spends; and Apple’s recent investment announcement (perhaps tied to tariff threats, or perhaps not—hard to tell with certainty) should drive an additional 55bps of GDP growth (that’s 0.55% of almost $30 trillion in nominal GDP, or roughly $165 billion more in investment).
When you add in recently announced investment plans by Abu Dhabi, Softbank/Open AI/Oracle, TSMC, Hyundai, etc., the numbers start to get a little goofy. They could represent (key word, could) an additional 70¬bps–89bps of GDP contribution. I say “could” because it’s highly questionable the U.S. economy has the production capability for this much investment over a short period of time (materials, labor, permitting, etc.). But either way, these are huge numbers, and you can at least bank on the hyperscalers and Apple to come through.
To put this in perspective, total gross private sector investment contributed 73bps to growth last year, and total government spending growth only contributed 58bps to growth, so 50bps–60bps from five companies is incredible. However, what we do not know is how much this is offset by delayed investment from the rest of the U.S. economy. See the recent CNBC survey where, “95% of CFOs said policy is impacting their ability to make business decisions, and many said while Trump is delivering on promises, his administration’s approach is too chaotic, disruptive and extreme for businesses to navigate effectively with 60% expecting a recession in the second half of the year.”
The second number is way too high, but the 95% number means future investment will be delayed, at least until the tariff shock recedes. In any event, private fixed investment was on pace to have a banner year and now it is not impossible to see it go flat or down slightly.
“G” —Government spending growth
I always try to avoid politics, and there are so many competing theories on the efficacy of government spending restraint or minor cuts here and there, so it’s best to just remember there is federal government spending and state and municipal government spending growth.
Now that the continuing resolution has passed, it is pretty clear that federal government spending growth will be modest—if there is any meaningful contribution at all—but states and municipalities (with the potential exception of California if equity markets decline further) should still be free to grow spending at a reasonable level. In any event, additional federal government spending growth only contributed 16bps to growth, so if it flatlines this year, or even decreases slightly (unlikely given mandatory spending’s share of government spending), it is certainly not going to be a catastrophe. All that being said, if the Republican Senate majority establishes the current tax regime as the deficit baseline for reconciliation, there is scope for fiscal stimulus in the form of additional tax cuts. However, I shudder to think of what this may mean for Treasury issuance and longer dated duration1 over time.
Additionally, if state and municipality spending growth increases at a slower pace (it was 41bps in 2024), we will still more than likely see at least 20bps of contribution.
“ΔX”—The change in exports vs. imports
Delta X or the change in exports vs. imports is where the biggest near-term hit is being taken as companies attempt to front run tariffs.
So, in the near term (Q1 of 2025), not so good, but that should even out over the next few quarters as tariffs are implemented—Atlanta Fed GDP now has trade detracting 4.7% from GDP in Q1, including massive levels of gold imports, and 2.7% when adjusted for gold imports as an unusual one-off.
Additionally, as I wrote about in the last strategy note, if tariffs lead to lower trade deficits over time, economic growth could technically—if, inefficiently for hardcore fans of comparative advantage that have no concern for the hollowing out of the U.S. manufacturing base, including for national defense and the impact on smaller towns in the U.S. heartland—be higher over time since the U.S. has almost always run large trade deficits that tend to grow faster than other contributors to GDP. It is hard to predict the ultimate outcome, but since trade detracted 37bps from GDP last year, given the math of trade deficits, once we get through Q1, the detraction should not be much larger than last year.
How can investors respond?
When you put this altogether, yes, recession risk has climbed enough to track higher frequency macro data more closely than usual—and make sure your portfolio is prepared for that outcome——investors should consider putting asset allocations in place to withstand that outcome (meaning don’t be over your skis with beta for instance).
The benefits of alternative strategies
Which brings us to the most important part of the strategy note: The potential benefits of alternative strategies within an asset allocation model.
Given current levels of uncertainty:
- The more low beta/low duration, high income private credit or commercial real estate lending you own, the more resilient your portfolio can potentially be in an extended market downturn. This is because of the lower volatility and beta in these strategies. Private credit and commercial real estate lending have historically enjoyed less downside in recessions and market sell-offs.
- The more middle market private equity you own via evergreen or drawdown vehicles, the more you may have opportunities for growth without all of the downside volatility you will get in another equity correction or bear market (private equity indexes have historically had less downside in historical bear markets compared to listed equities).
- And by the way, liquid multi-strategy funds continue to demonstrate their resilience in times of market stress.
Put another way, times like these are precisely the reason why institutions and wealth management firms follow asset allocations strategies that include alternatives. They can potentially increase income and/or total return, reduce beta/duration and volatility, and help protect capital in periods like 2022 … or the last several weeks!
Why be completely exposed to the repeated cycles of bust (pandemic onset February–March of 2020), boom (monetary and fiscal policy driven mini bubble of April 2020–December 2021), bust (inflation is gonna be transitory, trust us … whoops of 2022), boom (the world’s not ending and tech earnings are ridiculously good with a little help from AI enthusiasm of 2023 and 2024), and bust (holy cow, Trump is really going to plunge us into a trade war) over the last five years—not to mention the last 25 years which includes the GFC and the horrible dotcom bubble implosion of 2000–2002?
And with fixed income still a less-than-attractive diversification tool and cash not earning any after-tax and after-inflation positive return, alternatives and private markets are clearly complementary to vanilla assets
Coming up next
That was as tight as I could make this, given all the recent turbulence, while hopefully still providing some insight, so thank you for reading. The next strategy note will focus more on the impact (or lack thereof) of the recent tariff angst on all of our favorite alternative strategies. Until then, The Time for Alts is Still Now!
Investing in alternatives is different than investing in traditional investments such as stocks and bonds. Alternatives tend to be illiquid and highly specialized. In the context of alternative investments, higher returns may be accompanied by increased risk and, like any investment, the possibility of an investment loss. Investments made in alternatives may be less liquid and harder to value than investments made in large, publicly traded corporations. When building a portfolio that includes alternative investments, financial professionals and their investors should first consider an individual’s financial objectives. Investment constraints such as risk tolerance, liquidity needs and investment time horizon should be determined.
