Tariffs Shocking the Markets

By: Troy Noor, CFP®, CFA

It has been a chaotic couple of days in the markets, with the S&P 500 down 9.3% at this writing. As you have no doubt read, this is a consequence of the reciprocal tariffs the Trump Administration has placed on our global trading partners. Why is the administration pursuing this strategy? What are the implications for economic growth, inflation and the Federal Reserve Policy? And more importantly, what should we be thinking about when it comes to positioning our client portfolios in this environment?

The Why

The Administration’s goal is to level the playing field with respect to global trade. The United States consistently runs global trade deficits with the rest of the world, because we buy more of their goods and services than they do from us. Part of this has to do with the voracious appetite of the U.S. consumer, but another contributing factor is the policies of our trading partners. The chart below illustrates the balance of tariffs prior to the implementation of the new tariffs by the administration.

If we were charging tariffs equal to what the rest of the world was charging us, we would be right along the reciprocity line above. As you can clearly see, only a couple of our partners are at parity, with each of us charging 0% on the lower left-hand side of the graph. In all other cases, our trading partners are charging us more than we charge them. This absolutely contributes to the trade deficit. The goods and services we export are pricier overseas than the imported goods and services we buy from those same countries.

Trade deficits are a detractor from GDP, so they have been a drag on our economic growth.   What the administration has done is seek to move us to the reciprocity line.  In a perfect world, there would be no tariffs, and all the diamonds would be clustered at 0%. 

Economic Implications

So, what are the implications of this policy?  They really can be divided into the effects on our economy and the rest of the world.

These policies have already led to a decrease economic growth and will likely lead to an uptick in inflation.  

The Atlanta Fed has already predicted a contraction of .8% in Q1.  Paradoxically, a majority of this has been on the increase in the trade deficit as companies accelerated purchases from overseas in anticipation of the tariffs.  Theoretically, this would be offset by an increase in inventories, but because of the way the calculation is done some of the increase will end up in Q2.  Because of this increase in inventories, J.P. Morgan’s Chief Market Strategist, Dr. David Kelly, CFA is predicting a return to growth in Q2 between 0 and 1%.  The most simplistic definition of a recession is two consecutive quarters of declining growth so by this definition, we are not seeing a recession on the horizon.   To quote Dr. Kelly, “The American economy is so resilient, it can take lickin’ and keep on tickin’.”

If the tariff’s stick, and that is a big if, this would lead to a one-time price adjustment.   In other words, inflation would initially tick up, but then our year-over-year numbers would revert to trendline after the adjustment.

The impact on the rest of the world would be more detrimental.  Because the U.S. consistently runs trade deficits, it means other countries are running trade surpluses.  The reduction in demand from the U.S. could lead to a reduction in several countries’ GDP and might even lead to a recession.  This is what the administration is counting on.  Our trade partners have more to lose in a trade war than we do. The administration believes this will bring them to the table to renegotiate terms. That being said, we have already seen China retaliate with a 34% tariff on U.S. goods.  We are playing a proverbial game of economic chicken, and it is a question of who will flinch first and how soon will they flinch?

This also calls into question the Federal Reserve Policy.  The Chairman of the Fed, Jerome Powell, has made it clear that the economy is strong enough that they would rather error on the side of patience than to risk cutting rates too soon and reigniting inflation.  The bond market appears to disagree already pricing in four rate cuts this year and we have seen the yield on the 10-year treasury move down from 4.8% on January 13th of this year to 3.92% at this writing.   This is substantial and has led to a rapid appreciation in bonds.  Which leads me to the impact on investment portfolios.

Impact on Investment Portfolios

Our portfolios are positioned anywhere from conservative to ultra-aggressive. The bond exposure from conservative to aggressive runs from 80% to 20%. This exposure has acted as a ballast in the portfolio, meaning that as stock prices have declined, bond prices have increased. In other words, the portfolios are behaving exactly as we expect them to behave. A good rule of thumb for bonds is that for every percentage point move down in yield, you multiply that by the duration (years to maturity) to get the subsequent move in price. This has given us an increase in the price of 10-year treasuries of about 9% since January 13th. This does not completely offset the decline in stocks in our moderate to aggressive portfolios, but it has hedged it, and it will give us resources upon which to draw when we see the market turn. We believe we will see this turn once we get a resolution regarding the trade agreements with our trading partners. We cannot predict when this will be, but when it comes, we stand ready to capitalize on this move to the upside.

This also speaks to the importance of having a financial plan. When we have these market-related conversations with concerned clients, we can simply point to their financial plan and show how we’ve planned for events like this to occur in the market, and how it rarely has any long-term impact on their success of retirement. This is the essence of our tagline – Plan with Purpose, Live with Peace.

Know that we are monitoring this situation closely and stand ready to act when the time is right. For now, I would encourage you to stick with the plan.