Tariff Turmoil
The stock and bond markets have been in disarray since President Trump announced his tariffs in the first week of April. The S&P 500 index dropped 18.55% from its high on February 19th to a low point on April 8th before recovering a little. It is now down 11.62% since the high.
Everyone is wondering what will happen next and what to do about it. You can read plenty of material elsewhere about the details of the tariffs and what happened when. I want to discuss the real effect tariffs might have on the economy and how it might affect the markets moving forward.
What is a Tariff?
What is a tariff really? It is a sales tax that the government puts onto imports. The tax is paid by the importer, usually a company which buys products or raw materials overseas. The importer may be selling to other companies or the end consumer and the product or material sourced from overseas may be combined with other materials before being sold in the US. An easy example is an automobile. Ford might have an auto plant in the USA, but maybe it sources its windshield wiper blades from China. If there is a higher tariff on that wiper blade, and it’s the only component from overseas, then Ford might choose to reduce its profit and not pass on the higher component cost. But if 40% of the car’s components come from overseas, then Ford will be forced to raise its prices to protect its profits. In this case it’s the consumer who pays a higher price directly because of the tariff.
Tariffs and the Economy
So, tariffs cause price increases. Another thing they can cause is profit decreases. Manufacturers may choose to decrease their profit margins and eat some of the tariffs. The price of stocks is directly tied to profit margins, and you should not pay as much for a stock which will have lower profits moving forward. If prices increase, people might buy less because they can’t afford to buy things as often. This will reduce profits as well. This is why stocks have tumbled.
The next question is whether tariffs cause inflation or not. Christopher Waller, a member of the Federal Reserve Bank’s Board of Governors has just issued a speech where he says the price rises caused by tariffs are temporary and will probably not be inflationary. I think he has a point, but what does temporary mean? I think it will be some time before the price increases due to tariffs filter through the economy. It’s already causing increases in the price of building materials. I need to replace my roof and roofing manufacturers are talking about a 25% increase in the price of shingles. That is massive. And the roofing material is manufactured in the USA! While that is a one-time thing, think about the rent increases that landlords will need to make because of the cost of building materials. That will take time, probably a few years, to pass through the economy.
The upshot of tariffs is that they will affect inflation and corporate profits. Corporations have not figured out yet how to deal with them and the ever-changing tariff landscape is causing problems with planning. Fearful consumers buy less, profit margins get squeezed and stock prices must go down.
What Should You Do
The next question is what to do about it. Jack Bogle, the index fund pioneer famously said: “Don’t Do Something, Stand There!”. This advice is excellent because it can be very difficult to properly predict stock prices and different parts of the stock market might react very differently. If your timeframe is beyond next year, you might find that stocks went down and then recovered and went higher. International markets may react very differently than US markets. Tariffs are not popular, and President Trump will not be immune to the pressure being applied, even by the rich Americans who funded his presidency. It’s very possible that six months from now the effective tariff rate will not be 50%, but more like 5%.
That said, I think you want to look at the diversification of your investments and make sure you are diversified internationally. It’s likely the dollar will go down. International investments have been far cheaper on an earnings basis than US markets. That may give some tailwinds to international markets compared to US markets. It is also true that value stocks are somewhat cheaper than growth stocks right now. Value stocks have held up better during the recent turmoil (SCHV, a US large cap value ETF is down 3.1% YTD while IWY, a US Growth ETF is down 12.34%). That could continue moving forward.
The stock market is likely to be volatile as the tariff turmoil plays out. It might very well go down more, but temporary down markets are a part of investing. We have gone through some tough times before and the stock market has always returned to growth. Timing the markets can be insanely difficult and if your timeframe is beyond the Trump Presidency, then its likely you will see recovery and growth. The US will adapt to the tariffs and companies will find a way to grow profits. My advice is to stay invested, review your diversification, and make sure you have bonds and other diversifiers to lower the volatility in your portfolio.
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