Tariff revenues and the deficit

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Good morning. After Nvidia reported a 69 per cent year-over-year increase in quarterly revenue on Wednesday evening, its shares rose more than 3 per cent yesterday. Have a look at a longer-term chart, though: the super-stock of 2022-2024 has been tracking more or less sideways since last summer. While we were all talking about tariffs, deficits and bonds, something has changed in the stock market. Email us if you know what it is: unhedged@ft.com.   

Tariff revenues and the deficit

Investors woke up yesterday morning to a pleasant surprise: a court ruling in the US invalidated Donald Trump’s reciprocal tariffs. The picture got somewhat more complicated as the day wore on. First another court ruled against the president’s tariffs again. Then yet another court allowed the tariffs to remain in place while the cases proceed. On balance, though, it was a bad day for Trump’s tariffs and a decent day for markets. The S&P 500 closed up 0.4 per cent. Treasuries did better. Ten-year yields (which fall as prices rise) finished the day down 6 basis points.

The mildly positive market response makes sense. The large-cap index has already recovered from the “liberation day” shock. And the tariff fight will go on (we recommend you read our colleagues on this point). Uncertainty is still the main story, both on the tariffs and what they will mean for inflation and growth.

While Unhedged is happy to see sand thrown in the gears of Trump’s tariffs, if their imposition is delayed indefinitely, there could be negative implications for the deficit. 

When the House of Representatives passed the “big, beautiful” bill, many analysts and commentators noted that the attendant increase to the deficit — an estimated $3.8tn over 10 years, and potentially more — would be partially offset by tariff revenues. The range of estimates for those revenues varies a lot. Goldman Sachs puts the potential annual revenues from tariffs at about $200bn per year, for example, while Numera Analytics puts it at around $350bn per year.

Without that revenue, the bill as it stands could add considerably more to the US debt than previously expected, especially in the near-term, when most of the tax cuts are expected (the spending cuts come later, following the long-standing government principle of eating your ice cream before your spinach). Capital Economics forecasts that without the higher tariff revenue, the deficit will go from 6 per cent of GDP to 7 per cent of GDP. When it comes to deficits, a full percentage point of GDP matters.

The implication for the bond market and the US fiscal balance remains far from clear. We don’t know where tariff revenues will wind up, and the removal of tariffs could fuel faster growth, making the deficit trajectory more benign. But take a step back: from the outset, this bill was more spendthrift than markets expected. It now appears even more so.

(Reiter)

South Korea looks cheap

The past nine months or so have been difficult for South Korea: martial law, four heads of state, a presidential impeachment, Trump tariffs. The stock market, while it has advanced somewhat in the past month or so, remains rangebound at best:

This comes on top of a long-standing issue, the “Korea discount”: a lack of corporate transparency and weak shareholder protections that depress valuations. The discount to the US — which narrowed in the 2022-23 global recovery — is particularly wide:

Even companies such as Samsung Electronics and SK Hynix, two of the world’s largest memory-chip manufacturers, are trading at price/earnings ratios of about 11 and 6, respectively; US competitor Micron is at 137, according to FactSet. This has consequences. Big companies like Coupang and Toss have opted to list on US exchanges in search of higher valuations, and domestic investors often prefer US equities. Here’s a closer look at the valuation gap between South Korea and its global peers, from Dan Rasmussen at Verdad Advisers:

Neither stocks nor markets rise simply because they are cheap. There has to be a catalyst for change. In South Korea’s case, it is possible that the presidential election on Tuesday could help bring about the corporate governance and market reforms foreign investors have long sought. There is precedent for this; when old, shareholder-unfriendly practices lost some of their grip in Japan in 2023, Japanese stocks got a meaningful valuation boost.

There have been some minor changes already. The “Value Up” initiative kicked off in February 2024 by now-ousted president Yoon Suk Yeol has fallen short so far — it involves just voluntary reform measures, with no penalties or incentives for compliance. On the other hand, the ban on short selling, which was in place for 17 months, was lifted this March.

Another potential catalyst for change: more households are invested in the stock market. The number of domestic retail equity investors has risen from about 6mn in 2019 to more than 14mn today, according to the Korea Securities Depository. This is significant for a country of 52mn people; there’s now a vocal coalition of homegrown investors waking up to how poor South Korean corporate governance is. That will pressure presidential frontrunner Lee Jae-myung, if victorious, to uphold his promise of market reform, including legislation to extend the fiduciary duty of Korean boards of directors to cover shareholders. 

Changhwan Lee, chief executive of Align Partners, an activist investor based in Seoul, thinks there is potential for meaningful progress:

In my view, this is probably an even bigger change than in Japan. The changes in Japan by the government promoted corporate governance code, strategic code . . . But they never changed the law. But in Korea, the [likely next] president is trying to change the law, and the discount is much more significant compared to Japan, because the conflict of interest between the controlling and minority shareholders is bigger than in Japan’s case.

Better corporate governance doesn’t change the fact that South Korea’s GDP growth turned negative last quarter, nor does it reduce the outsized risks the country faces from US tariffs. But as Rasmussen told Unhedged:

You don’t need a lot of growth. You don’t need a great economic story to get excited. All you need is the balance sheet reform — you just need people to do sensible things from a capital allocation and governance perspective, and that alone can make these stocks double.

(Kim)

One good read

Progress.

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