What Does a Trade War Mean for Equities?
Tariffs announced this year by President Donald Trump are causing investors to anticipate their impacts on economic activity and the markets, especially equities.
While tariffs can be inflationary in the short term and put downward pressure on stocks, many investors doubt the longevity and viability of the tariffs, many of which have been postponed for the moment.
David Kostin, chief U.S. equity strategist at Goldman Sachs, wrote in a February report that for every five-percentage-point increase in the U.S. tariff rate, S&P 500 earnings per share would drop by 1% to 2%. Tariffs, including a pending 25% tariff on goods from Mexico and Canada and an already-implemented 10% on China, could reduce EPS forecasts by 2% to 3%.
“If company managements decide to absorb the higher input costs, then profit margins would be squeezed,” Kostin wrote. “If companies pass along the higher costs to end customers, then sales volumes may suffer. Firms may try to push back on their suppliers and ask them to absorb part of the cost of the tariff through lower prices. … Although short-term implementations of tariffs would result in smaller impacts on the equity markets.”
Radhika Narang, an investment specialist at Confluence Technologies, wrote that emerging markets in non-tariffed regions are set to benefit during a U.S.-China trade war. This includes markets like India, Vietnam and countries in Latin America.
“The real winers in a renewed tariff war may not be the U.S. economy, but rather alternative markets that capitalized on shifting trade routes, just as India’s tech sector surged amid U.S.-China tensions last time,” Narang wrote. “The question remains: are businesses, investors and policymakers better prepared this time, or are we destined to relieve the same cycle of economic turbulence?”
Still, the possibility of a trade war has not given allocators enough conviction to reposition their equity allocations in response to the tariff threats.
“Most clients that I have spoken with do not have enough conviction around the direction of tariffs to change their equity mix,” says Grant Johnsey, head of client solutions for banking and markets in the Americas at Northern Trust.
Johnsey notes that due to allocators’ investment needs—which are complex and often rely on external managers—changing their equity allocations is a complicated process.
“For many asset owners, it is therefore easier to shift their fixed-income allocation through their managed operating and strategic cash positions,” Johnsey says. “In this environment, liquidity is a big focus across all segments. It comes up [in] almost every discussion I’ve had.”
The Market Response
Tariffs on Canada, China and Mexico were authorized by Trump on March 1 but postponed to April, pending negotiations with each country. When Trump first announced a round of tariffs on Canada, China and Mexico, indices fell nearly 2% on the next trading day, although those tariffs were quickly postponed. However, markets were unmoved and actually rallied after the February 13 announcement of reciprocal tariffs, most likely due to the delayed implementation and the forthcoming negotiations: The S&P rose nearly a whole percentage point following the announcement, up from session lows earlier in the day.
“The tariffs Trump announced over the weekend increase short-term uncertainty and may have a near-term impact on the markets,” said Todd Ahlsten, the CIO of Parnassus Investments, in a February 4 statement. “That said, we think there is a reasonable likelihood that the ultimate impact from these tariffs may be less than expected.”
“Despite the administration’s push for reciprocal tariffs, we expect market resilience, particularly in U.S. equities, as economic growth remains intact,” a February 14 note from UBS stated. “Tariffs on Canada and Mexico are unlikely to be sustained, US economic growth should represent a tailwind for stocks, and we continue to believe that [artificial intelligence] presents a powerful structural tailwind for earnings and equity markets.
Ahlsten pointed to the tariffs as a negotiation tool, a common belief now confirmed by the case-by-case plans for the more recent reciprocal tariffs.
“These tariffs may also represent the first round of an ultimate negotiation, which could reduce their ultimate impact,” Ahlsten said in the statement. “We don’t want to over-extrapolate periods of negative uncertainty, which can represent opportunity as investors.”
Kristina Hooper, chief global market strategist at Invesco, argued in a February report that while tariffs can cause inflation in the near term, they do not result in sustainable inflation, because prices subside as tariffs are removed. They can, however, suppress demand.
The short-term outlook, therefore, is for increased inflation.
“We’re expecting tariffs to have a little bit of upward pressure on inflation,” says Anders Persson, CIO and head of global fixed income at Nuveen. “We do expect that there will be some upward pressure on core [personal consumption expenditures] related to what the final tariff impact is.”
What Happened Last Time?
Trump announced a 25% steel and aluminum tariff this week, even broader than his 2018 announcement of a 25% tariff on steel and 10% tariff on aluminum.
“While the newly announced 25% tariff on aluminum and steel imports may have minimal impact on inflation or domestic growth, they could have detrimental knock-on effects for downstream applications such as autos, manufacturing, and the building and construction space,” wrote Adam Turnquist, chief technical strategist at LPL Financial, in a weekly market commentary report.
According to Confluence Technologies, an asset management software provider, those 2018 tariffs resulted in a decline of Canadian, Mexican and Chinese materials stocks in the short term, while resulting in an increase in the value of U.S. materials stocks.
The follow-on effects, however, for downstream industries and steel producers were negative. Steel producers saw modest job increases during the last wave of tariffs, while users were hit with job losses. According to research from Tufts University’s EconoFact, steel and metals producers saw an increase of 1,000 jobs, while steel users lost 75,000 jobs.
“There is no question that tariffs at 25% level from Canada and Mexico, if they’re protracted, would have a huge impact on our industry, with billions of dollars of industry profits wiped out and [an] adverse effect on the U.S.” said Jim Farley, the Ford Motor Co.’s CEO, in a quarterly earnings call on February 5.
In March 2018, the U.S. trade representative released its findings on Chinese policies which restricted the technology sector. Later that year, in July and August, the Trump administration enacted $50 billion of tariffs, on Chinese imports and intellectual properties.
The result was a decline in the value of Chinese info-technology stocks, according to data from Confluence. The tariffs resulted in a boom in Indian technology stocks, while U.S. tech stocks also rallied.
The tariffs did have economic costs. According to a paper from the American Economic Association, the 2018 tariffs added $3.2 billion per month in added costs to consumers and $1.5 billion per month in deadweight welfare, or losses in market efficiency.
“The 2018-2019 tariff war serves as a blueprint for what could come next under Trump 2.0 and what is currently underway,” Narang wrote. “While protectionist policies aim to strengthen domestic industries, they often lead to higher costs, retaliatory trade measures, and unintended market shifts.”
Cumulatively, according to a report from Goldman Sachs, tariff announcements between 2018 and 2019 resulted in the S&P 500 falling 5.1%, adding up every decline following the announcement of a U.S. tariff. The cumulative return of the S&P 500 when China announced retaliatory tariffs was negative 5.5%. All other retaliatory tariff announcements resulted in a 1.4% decline in the index.
Invesco’s Hooper noted that in 2018, both Chinese and American markets experienced sell-offs and heightened volatility; the S&P 500 fell 4.38% that year, and the MSCI China A Index fell 30.16%. Stocks rose the following year, following resumption of trade talks: The S&P 500 rose 31.49% in 2019, and the China index rose 36.40%.
“In other words, tariffs caused short-term headwinds,” Hooper wrote. “Once markets grew accustomed to them and then a resolution was reached as the Phase I trade deal between the US and China was announced, volatility eased, and financial markets reaccelerated.”
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