After the U.S. financial markets closed on Wednesday, April 2nd, President Trump announced the highest and broadest package of tariffs implemented since the 1950s. On Thursday morning, stock markets around the world plunged, with declines in the U.S. market among the worst. My purpose today is to explain why the prospect of tariffs is driving these market movements, and how we have positioned client portfolios in this increasingly uncertain economic environment.
President Trump’s objective is to make U.S. goods more competitive internationally by lowering trade barriers and to encourage more goods to be made in the U.S. The Trump Administration has articulated two key goals:
- The Administration believes tariffs can be a significant source of tax revenue to partially offset the tax cuts for U.S. individuals and businesses that will be proposed soon.
- The Administration sees tariffs as a powerful bargaining tool to extract concessions from trading partners—not just on trading terms, but also on drug trafficking, border security, and defense spending by allied countries. Of course, any relief from tariffs granted based on concessions reduces the expected tax revenue generated.
Tariffs influence the economy and financial markets through various mechanisms. They directly affect the cost of imported goods, either by raising consumer prices or reducing company profit margins if businesses absorb the higher costs. Both effects are negative for the economy, with sinking consumer confidence reducing both the propensity to spend and the expected profits from companies, which in turn reduce what investors are willing to pay for shares.
These effects are difficult to quantify because the level of tariffs is highly uncertain. But it is clear that the higher the level of tariffs and the longer they are imposed, the higher the negative impacts.
In January of this year, we reduced the allocation to stocks in client portfolios to a conservative, below-average level. We made this decision primarily because U.S. stock valuations were very expensive, but also because this valuation vulnerability was compounded by the uncertainty and potentially negative consequences of the Trump Administration’s trade policies. In mid-March, we further reduced client allocations to stocks to a very defensive level, because the economic and financial outlook had become even more fraught. These moves out of stocks were supported by relatively generous yields that could be earned on fixed income investments.
Since stock prices peaked earlier this year, declines have ranged between 10% for the S&P 500 to 15% for the NASDAQ Index.[*] If an economic downturn occurs or corporate profit margins shrink further, additional declines in stock prices are likely. However, if better trade deals are achieved, tariffs are reduced around the world, and the U.S. economy proves more resilient than currently expected, stocks prices could resume their long-term uptrend. The problem is, no one knows the future. The best we can do is prudently adjust to developments and evaluate evolving trends.
Please contact us if you have any questions or concerns.
David Jordan, CFA
Chief Investment Officer
Trail Ridge Investment Advisors, LLC
This communication contains general information that may not be suitable for everyone. The information contained herein should not be construed as personalized investment advice. There is no guarantee that the views and opinions expressed in this communication will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Trail Ridge Investment Advisors, LLC, and its affiliates do not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
[*] Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
The Standard & Poor's 500 (S&P 500) Index is a free-float weighted index that tracks the 500 most widely held stocks on the NYSE or NASDAQ and is representative of the stock market in general. It is a market value weighted index with each stock's weight in the index proportionate to its market value.
The Nasdaq Composite Index is a market-capitalization weighted index of the more than 3,000 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks. The index includes all Nasdaq listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debentures.