How Could Tariff Policies Affect the Economy?
MODERNIST’S ASSET CLASS INVESTING PORTFOLIOS ARE STRATEGICALLY INVESTED WITH A FOCUS ON LONG-TERM PERFORMANCE OBJECTIVES. PORTFOLIO ALLOCATIONS AND INVESTMENTS ARE NOT ADJUSTED IN RESPONSE TO MARKET NEWS OR ECONOMIC EVENTS; HOWEVER, OUR INVESTMENT COMMITTEE EVALUATES AND REPORTS ON MARKET AND ECONOMIC CONDITIONS TO PROVIDE OUR INVESTORS WITH PERSPECTIVE AND TO PUT PORTFOLIO PERFORMANCE IN PROPER CONTEXT.
Update! When tariffs were announced in early April, we shared this response from Modernist founder Georgia Lee Hussey:
The current administration has made good on 47’s campaign promises to wield the threat of tariffs on allies and adversaries alike. The administration’s intents purports to be increasing leverage to advance its economic and national security agendas. The administration has said it is prepared to levy hefty taxes on goods coming into the country from its largest and most crucial trading partners, including Mexico and Canada. The frequent developments surrounding the implementation of Trump’s trade policies have left markets oscillating with each headline.
What’s a tariff? A huge tax increase.
Simply put, a tariff is a tax on goods imported into the country. When U.S. retailers and manufacturers purchase goods from other countries, a duty (similar to a sales tax and paid to the federal government) is added to the cost of the goods before delivery. On the surface, the buyers pay the tax.
However, the tariff’s impact likely extends beyond the original buyer. To compensate for the additional cost of goods, the foreign seller may lower their prices, squeezing their own profit margins. As buyers shift toward other supply chains, the currency of the seller falls and thus lowers the effective price (and raises the cost of U.S. exports). Finally, the buyer often passes on the additional cost to the consumer to preserve their profit margins.
Trade hawks argue that tariffs make domestic producers more price competitive. Historically, however, domestic manufacturers have raised their prices in concert with the tariffs, reducing the relative benefit to consumers while increasing their own margins.
are tariffs inflationary?
This is an area where economists disagree. While the expected outcome of an increase in tariffs is higher prices, destructive inflation is generally associated with a persistent increase in price levels rather than a one-time increase. We have a recent historical example from the first Trump administration. In January 2018, the U.S. imposed tariffs on residential washing machines. While the initial reaction was an increase in prices for the U.S. consumer, the long-term deflationary trend in place for household appliances quickly reverted. In our view, the Federal Reserve and most investors will likely overlook these one-time price adjustments.
However, if the initial tariffs are followed by further escalations, the cumulative impact of one-time price adjustments could become undistinguishable from true inflation, compelling the Fed to further slow its pace or even reverse course on interest rate policy.
How should investors be positioned?
Economic policy never happens in a vacuum. The administration has also promised lower corporate and individual tax rates (for the highest brackets while also planning to increase taxes on the lowest brackets thereby reducing cash for working class folks to pay for increased prices) and decreased regulations for businesses (potentially increasing risk to individual consumers, civil rights, and climate risk), which have the potential to offset some of the trade-related pressures.
Given the uncertainty around the magnitude and duration of proposed tariffs, the ultimate impact on corporate profits and economic growth is difficult to assess. Investors with broad, globally diversified portfolios are likely to be positioned to capture returns from regions and sectors that are less sensitive to the effects of tariff policy.
