Editor’s Note: This article was updated to include an additional exhibit.
Tariffs sparked the current downturn, but they are not its root cause.
To explain that statement, I will show an example. Since late February, technology stocks and bitcoin have declined, mostly in unison. Meanwhile, Berkshire Hathaway’s BRK.B equity and intermediate-term Treasury notes have slightly increased. The illustration below charts each asset’s performance from Feb. 24 through this past Monday, March 10.
Four Performances
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The common explanation for recent investment performance is that US equities have suffered because tariffs may hurt the economy. The concern about tariffs is warranted; they are financially dangerous. For investors, free trade and international harmony are better than taxes and political squabbles.
However, there are two major problems with the tariff narrative.
Problem Number One: The Wrong Timing
Excise taxes are scarcely a surprise! President Donald Trump repeatedly promised to impose tariffs during his campaign, then reiterated that intent shortly after the election. Despite his proclamations, stock prices soared from August through December.
Consequently, there’s no feasible argument that, in late February, investors were suddenly splashed with the cold water of impending tariffs. One need not genuflect to the efficient-market hypothesis to doubt the argument that three months after Trump was elected president, investors would collectively mark down technology stocks by 15% because, at long last, they got around to doing the tariff math. That claim is just not credible.
Problem Number Two: The Wrong Lines
Also sabotaging the tariff explanation is the chart’s evidence. If tariffs were the key factor, then one would see a different pairing of the lines. The technology index and Berkshire Hathaway would have declined at least somewhat in unison, as both are US equities that are sensitive to changes in the US economy. Neither investment is entirely cyclical—as with, say, automobile manufacturers—but both face sales headwinds when the economy slows.
For comparison’s sake, during the 2008 recession, Berkshire Hathaway’s stock suffered three fourths the losses of the Morningstar US Technology Index–32% as opposed to the index’s 42%. During the current downturn, though, Berkshire is up, while tech stocks are down. That discrepancy signals that, despite the headlines, today’s investors aren’t anticipating another recession. (Yes, I know that Berkshire Hathaway holds a large cash stake. It did in 2008 as well.)
Technology Stocks vs. Berkshire Hathway
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In contrast, Treasury notes and bitcoin would have each weathered the storm. Government debt, of course, always meets its obligations; the US can print money as required. For its part, bitcoin makes no payments that a stumbling economy can threaten. In fact, given its position as an alternative currency to the dollar, one could argue that American struggles should help bitcoin.
As we saw, though, the lines on the chart defied those expectations. They did so because the tariff controversy was not the main reason for recent performance. If it had been, the lines would have behaved as expected.
Instead, the lines followed a different logic. The successful assets were those that deliver cash today, while the losers were those that either provide cash later (technology stocks) or never at all (bitcoin). In short, what separated the market’s recent winners and losers was not economic exposure, as the tariff explanation implies, but instead perceived risk. This was a flight to safety.
“Once the risk-on, risk-off process is complete, the investment community will once again operate rationally. When it does, perhaps it will decide that the damage from tariffs will not be so dire, after all.”
John Rekenthaler, former vice president of research
Speculators and Cautious Investors
To explain, I must first outline the distinction between speculators and cautious investors.
Speculators buy assets that produce little to no cash. Yes, many technology companies are highly profitable, but because they are so dearly valued, they currently supply only modest earnings per share. In contrast, cautious investors seek the bird of cash in hand, rather than the prospect of two future birds. Consequently, the certainty of government debt appeals to them, as does the low price/earnings ratio of Berkshire Hathaway’s equity.
Speculators have their way until they do not, in which case they quickly reverse course. That is, the “animal spirits”—to borrow John Maynard Keynes’s term—that speculators infuse into the marketplace inflate asset prices until something blocks their path. Their holdings then nosedive, as investors switch to safer assets. (As evidenced by Berkshire Hathaway, which pays no dividend, assets need not distribute cash to qualify as relatively safe. Generating it will suffice.)
Risk On, Risk Off
That is what just now occurred. By any measure—either relative to their own history, or to other countries’ equities—US stocks were costly entering 2024, and they became even more so as the year progressed. That held especially true of the priciest and most glamorous issues. A surge in cryptocurrencies in late 2024 confirmed the strong suspicion that the speculators were in charge.
Their leadership made the marketplace precarious. Success emboldens speculators—but also more exposes them to greater losses should asset prices reverse. Their trigger fingers therefore become twitchier. Game theory exacerbates the tendency, because speculators realize that, when a downturn occurs, the first person out the door will perform better than those who wait.
Modern investment professionals have reworded Keynes’s dictum by calling this behavior “risk on, risk off.” In its most basic form, risk on, risk off means that when investors are optimistic—that is, when they are possessed by animal spirits—all speculative assets rise, regardless of the existing economic forces. And when investors are spooked, those same assets fall.
That formulation sounds primitive! Ironically, though, it was developed—or at least promulgated—by researchers at the University of Oxford, who were responding to the failure of fancier computations during the global financial crisis. Such models failed to recognize that investors behave differently when normal conditions turn extreme. At such times, asset prices “cluster.” In other words, that which went up together will now go down together.
Looking Forward
The precept of risk on, risk off reveals unavoidable instability within the financial markets. Over long periods of time, asset prices are usually fair. Although valuing items that lack cash flows, such as commodities or cryptocurrencies, is more of an art than a science, financial securities obey logical rules. Stock prices grow along with the profits of their corporate issuers, while bond prices are governed by prevailing interest rates. Periodically, though, this rationality is punctured by bouts of risk on, risk off.
That volatility is unpleasant. However, there is potentially a bright side to the dark news. Because current performances owe to the marketplace disruption that arises from risk-on, risk-off conduct, rather than a careful assessment of the economic impact of tariffs, the downturn could be brief. Once the risk-on, risk-off process is complete, the investment community will once again operate rationally. When it does, perhaps it will decide that the damage from tariffs will not be so dire, after all.
Of course, it could also decide otherwise. My point, however, remains: Speculative assets have been sliding not because investors have determined the true cost of tariffs, but instead because the marketplace has suffered one of its periodic bouts of risk on, risk off.
The author or authors do own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
Correction: (March 15, 2025): A previous version of this article misattributed the term “animal spirits.” The phrase was coined by John Maynard Keynes.
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