“As history has repeatedly proven, one trade tariff begets another – until you’ve got a full-blown trade war. No one ever wins, and consumers always get screwed.”
– Mark McKinnon, US political adviser
What are tariffs?
Tariffs are taxes levied by governments on imports. They aim to raise revenue, protect domestic industries, correct a trade deficit, impose political pressure on other states or deliver a combination of these goals. They may benefit governments that gain revenue and domestic producers that face weaker competition in their home market.
Why is everyone suddenly talking about tariffs?
Free trade brought the integration of global economies, which increased output and economic wellbeing in aggregate. However, these disproportionately benefited global companies and high-skilled workers. Lower-skilled workers in developed economies experienced stagnant (or falling) incomes when manufacturing shifted to lower cost emerging economies.
This discontent has been reflected in the economic agenda of US President-elect Donald Trump. While policy details continue to evolve, tariffs of 10 per cent–20 per cent on all US imports, with an additional 60 per cent–100 per cent on those from China are being discussed.
The new administration has indicated that it intends to use tariffs to narrow America’s trade deficit and secure critical supply chains. It will also use them as a negotiating tactic to improve US companies’ access to overseas markets and encourage the relocation of manufacturing into the US – both of which could support US economic growth, jobs and wages.
How do tariffs impact economies?
Higher US tariffs may mean consumers pay more. Either the price of imported goods rises when tariffs are added to the retail price, or customers switch to a domestic substitute whose price has now become relatively more attractive.
This could lead to higher inflation, which might be transitory, but may be sustained if an economy is running at full capacity and it brings higher wage demands. This would raise interest rate expectations, government bond yields and the currency.
How do tariffs impact stocks?
Forecasting sector or stock impacts is tricky; policies can change rapidly, as governments and businesses lobby intensively for more favourable market access.
However, it is likely that should higher interest rates result, they will impact most companies, but especially those more highly geared and with weaker credit ratings.
Manufacturing companies exporting into the US may be forced to reduce their export prices to maintain retail prices after adjusting for tariffs, impacting margins and earnings.
US tariffs may bring a contraction in the total addressable market size of China’s exporters. This could shrink further if other major economies adopt a similar approach.
Manufacturers in emerging economies (e.g. Mexico) may face steeper US tariffs, while higher US interest rates and a strong US dollar may impact their borrowing costs.
What should investors do now?
Tariffs don’t mean investors shouldn’t hold global equities, but they should be thoughtful about what they hold because:
– Uncertainty usually brings elevated market volatility.
– Exporters of goods to the US, which have close substitutes and whose demand is highly price-sensitive, e.g. mass-market European or Japanese autos, may be forced to absorb the cost of tariffs to maintain retail price levels in the US, thus squeezing their margins.
– Companies that optimise and automate factories have an exciting opportunity as manufacturing production is onshored to higher cost regions.
– Companies with strong balance sheets, positive cash flows and which are able to grow earnings throughout the economic cycle may outperform if interest rates stay high.
– A strong US dollar may help US equities outperform global peers.
– Companies that export services rather than physical goods may be less impacted by tariffs.
Tim Richardson, investment specialist, Pengana Capital Group
