Spring that the markets learned to price

The first quarter of the year closed with the markets having learned the new rules of the trade conflict, and the learning was the quarter’s real story. The quarter had opened with the inauguration, the executive orders, the first tariff announcements and the January sell-off that the uncertainty produced; it closed with the indexes ending the period with gains that the sceptics had not expected, the volatility having been traded, digested and priced. The quarter was the education of the market in the new politics, and the education was expensive, confusing and, for the investors who adapted, profitable; the adaptation is the part that the retrospective coverage will have to explain.

The quarter’s market arithmetic is worth reviewing because the arithmetic contradicts the narrative. The trade conflict, the fear of the inflation, the uncertainty about the policy, all of it was real, and all of it was priced: the January correction, the February recovery, the March swings that the tariff announcements produced. The indexes’ gains over the quarter came from the sectors that the new policies favoured, the energy, the defence, the domestic industrials, and the rotation was the market’s way of saying that the new politics, whatever its costs, had its winners; the losers, the sectors with the international exposure, were sold, repriced and bought back at the levels that the new arithmetic justified. The quarter’s lesson was the market’s oldest one: the policy shocks create the mispricings, and the mispricings create the returns.

The earnings season that ran through the quarter delivered the numbers that the market needed to separate the signal from the noise. The companies with the domestic focus reported the strength that the new policies promised; the companies with the international supply chains reported the pressure that the tariffs imposed; and the guidance, the companies’ own forecasts, carried the adjustment that the new trade environment required. The analysts’ models were revised, the ratings were changed, and the sectors were repriced with the speed that the quarter’s events had taught the profession; the repricing was the market’s education in progress, and the progress was visible in the indexes’ path through the quarter.

The bond market’s contribution to the quarter was the part that the equity coverage underplayed, and the contribution was the market’s most important signal. The yields moved with the inflation expectations that the tariff policy raised, the curve steepened and flattened with the data and the announcements, and the central bank’s statements, delivered in the careful language that the institution uses when it is watching the politics, were read for the hints about the policy path. The bond market’s message through the quarter was the message of the prices: the inflation was expected to rise, the growth was expected to slow, and the trade-off was the new arithmetic that the policy had created; the message was the market’s education in the trade conflict’s economics, and the education will continue into the year.

The quarter’s close left the markets positioned for the year’s central question: whether the trade conflict will escalate into the full-scale trade war that the spring’s announcements threatened, or settle into the negotiated routine that the carve-outs and the exemptions were beginning to build. The market’s position, as the quarter ended, was the position of the hedge: the long positions in the domestic winners, the short positions in the international losers, and the options that would pay off whichever way the negotiations went. The first quarter taught the market the new politics; the second quarter will teach it the new economics, and the teaching will be conducted in the same expensive, confusing, learnable currency that the first quarter minted.