Tariff Day

The ongoing stream of tariff announcements culminated on April 2 with the President’s major initiative to impose broad, across-the-board tariffs on all imports. A 10% baseline tariff on all countries will go into effect this Saturday. Higher rates will be placed on countries based, purportedly, on their trade balance, tariffs on U.S. goods, and non-tariff restrictions. These retaliatory tariffs go into effect next Wednesday. In general, the scope and scale of the tariffs is greater than many expected. As a result, stock markets around the world were surprised by the magnitude of the tariffs and reacted swiftly to the news. The S&P 500 was down as much as 4% this morning. Some foreign markets are performing better, but others are seeing larger moves, especially those countries with high tariffs and trade surplus, such as Vietnam.

Since WWII and the General Agreement on Trade and Tariffs (GATT) in 1947, U.S. tariff rates were generally in a downtrend. Before GATT, the trade-weighted average tariff imposed on imports to the U.S. was above 10%. In recent years the average was in the 2-3% range. Now, with the latest announcement, the average may be as high as 24%, according to Wells Fargo Economics. This dramatic increase will cause significant changes to the global trading system. Supply chains have been built to source cheap goods and components from low-cost countries. With the high tariffs, the administration believes some of this offshore production can return to the U.S., boosting production here, improving national security, and aiding job growth. Even more fundamentally, the President believes there have been unfair tariff disparities and non-tariff barriers imposed by other countries. However, in the meantime, the tariff will be absorbed by someone, either the producer, importer, consumer, or likely all of the above.

For investors, who pays the tariffs matters. If the producer pays without passing on the cost, profit margins can get squeezed. The same can happen with the importer. Walmart sells a massive amount of products produced overseas. They may not want to pass on the cost to their customers, so profit margins could fall. Should the tariff get passed on to consumers, that would boost prices and put pressure on personal budgets. The trade-off for these risks is the eventual return of manufacturing to the U.S. However, it can take years to build factories, though spare capacity could fill some of the gap until new production comes online. Some companies may choose to simply wait out this administration and not reshore production. A secondary benefit is the revenue generated by the tariffs for the U.S. government. Higher revenue would help balance the budget, which, in turn, may ease interest rates.

Markets have quickly responded with large drops in equity prices around the world. Besides the S&P 500, U.S. small-cap stocks were down 6%, Japanese stocks 6%, and Vietnam 11%. Mexico and Canada were not included in the latest tariff announcement as they were both targeted earlier. Those two stock markets are faring better. European stocks, the Euro Stoxx 50, were down about 4%. Other markets are also experiencing large moves. The U.S. dollar is down 2% today, and crude oil is down nearly 8%. This may reflect concerns over economic growth, though OPEC also announced that it would increase output faster. Gold is down just 0.5%. The major market that is up today is investment grade bonds, both treasuries and corporates. High yield, or non-investment-grade, bonds are down on the day.

Economic indicators in the U.S. have been pointing to decent growth, and company earnings were expected to increase roughly 11% this year for the S&P 500. Of note is that 40% of S&P 500 companies’ revenues are generated overseas. The tariff announcement may alter the outlook as the full impact of the moves comes into focus. The U.S. economy has been fairly robust and may absorb some of the tariffs. Ideally, these tariffs will open dialogues with trading partners and lead to more open markets and a reduction in trade barriers. However, retaliation is possible, and a steady stream of negative news could increase uncertainty and weigh on the economy and markets. Here at home, congress and the courts are wildcards, too. There is already some pushback from Congress, including some Republicans, regarding the tariffs. For investors, this episode highlights the importance of preparing ahead of time for volatility by building portfolios that are broadly diversified and aligned with their investment horizons. As we evaluate the potential economic impacts, we will be looking for potential opportunities that may present themselves amidst the heightened market volatility.

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