Tariffs and Possible Portfolio Impacts
The United States has deployed “tariffs” at various points in history to achieve various economic-development goals. In fact, tariffs were actively used at inception of the United States to protect its economy from foreign competition. The current administration is a big fan of using tariffs and, as has been widely reported, has already implemented tariffs on Mexico, Canada & China. In this article, we review the view of tariffs in modern history, what results can be expected and how they may impact investment portfolios.
First off, what is a tariff and what is the general objective? A tariff is essentially a fee charged by a country on goods or services that are imported. It’s notable that the fee is generally not paid by the country of origin but, rather, the company doing the importing. Conceptually, the objective of a tariff is to balance trade among countries. Countries generally do not want to have a substantial “trade deficit” (i.e., a situation where they are importing significantly more goods than they are exporting). This situation is best avoided as economists would suggest that it (eventually) results in economic challenges (e.g., a weaker currency & unemployment). The idea is that, by imposing a tariff, it will encourage companies to find products and product inputs in their own country vs looking to import them.
The counter argument to using tariffs, which has been the prevalent view in modern history, is that better results are achieved without them. The argument is that if the world adopts “free trade” policies where countries can trade without adverse economic consequence it results in a world of specialization thereby lowering the cost of goods and services for all. The modern era is one of rising free trade. The General Agreement on Tariffs & Trade (“GATT”) signed by 23 nations in 1947 was a modern-era legal agreement focused on reducing tariffs. More recently, the World Trade Organization (“WTO”), founded in 1995 and having over 150 participating members, is focused on enforcing free trades rules. One of WTO’s fundamental objectives, as stated on its website, is “to use trade as a means to improve people’s living standards.”
Economists generally agree with the thesis that free trade is good for standards of living. Specialization of duties is a key tenet in economics believed to result in higher productivity and lower prices which is a necessary precursor to gains in living standards. However, many acknowledge the benefits of tariffs as a short-term policy tool to modify existing trade terms, protect vulnerable industries or even improve self-defense capabilities.
Regarding the current administration’s actions, most believe that they are temporary negotiating tactics. Nevertheless, the impact can be significant. Mexico and Canada, for example, have already announced plans to impose tariffs on U.S. imports. The net effect for citizens of these countries, and the United States, is higher prices for some period. Depending on how long the tariffs persist will dictate the pain pushed on to consumers in the form of price inflation.
Broad equity markets generally do not react favorably to tariffs. Tariffs result in either lower margins for affected businesses or higher prices for consumers, which means fewer businesses sharing in available consumer discretionary spending (i.e., lower sales). We would expect each announcement of tariffs to produce volatility for equity markets as the market generally does not like uncertainty, with more severe and lasting impacts in affected sectors.
The U.S. bond market could also experience volatility. Tariff impacts are hard to assess. As such, market participants could view them as inflationary, thereby driving bond prices down, or as an economic depressant, thereby driving bond prices up. To compound challenges, the U.S. Federal Reserve (the “Fed”) has indicated that they are pausing on interest rate reductions, in part, because of the uncertainty around tariff policy. So, tariffs may impact Fed policy and create uncertainty around Fed actions thereby countering Fed desires to mute volatility through “forward guidance.”
While tariffs are likely adverse to consumers in the short term, the volatility created in both equity and bond markets offers opportunity for active managers like Patina. We have had significant rebalancing opportunities along the interest rate “yield curve” in recent years and would welcome similar opportunities in the equity markets and continued opportunities in bond markets.