Markets have been increasingly volatile over the past few weeks, and one of the reasons has been the introduction of tariffs by the Trump administration. Whether you agree or disagree with the politics, we as investors need to be aware of impact tariffs can have on global markets. Thus far the tariffs proposed have been minor, and the response subdued. Thus, the risk of an escalating trade war is low. However, it is a risk. While some business, such as US steel companies when steel tariffs are introduced, may benefit, the markets overall do not like tariffs and react negatively. Here are three reasons why the markets hate tariffs.
1. Tariffs are a tax
While typically imposed to balance international trade or achieve a political purpose, tariffs are a tax that takes profits out of the hands of shareholders. Quite simply, money going to governments means less money going to shareholders, and that results in lower stock prices.
2. Tariffs increase cost
Tariffs increase costs by creating ‘friction’ in the marketplace. What I mean is that manufacturers can no longer readily and easily use the lowest cost supplier globally. For example, an auto manufacturer may have an increase in the cost of steel to make cars, a cost that they may or may not be able to pass along to their customers. This can be particularly painful for US manufacturers, such as Caterpillar and Boeing, that export globally and compete with global competitors. These global competitors may be able to take advantage of lower costs in the global marketplace not subject to the tariff.
3. International trade suffers
While most analysts and economists believe that the possibility of a trade war is small, even the possibility of retaliatory tariffs can impact future investment. Consider, for example, a company that is trying to decide where to locate a factory. If future costs are unknown, the company may pause on the investment. A good rule is that businesses like stability since stability increases confidence and allows further expansion. The secondary effect of the tariffs is to slow investment.
The United States has historically been one of the least protectionist countries in the world. The introduction of a few minor tariffs does not change that fact. Ironically, some of the countries that criticize the new tariffs, including Europe and China, are much more protectionist in their own markets. Nonetheless, it is not for us to decide whether these actions will be a good decision for the US economy long-term. However, it is important that we recognize that tariffs are a risk for the market in the short-term, and markets can react negatively. Our response, of course, is to be appropriately defensive based on our client's goals, remaining on strategy and on plan.