Tariffs: The Impact on Businesses, Consumers and Equity Markets

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The stock market has a long history of increased volatility and separation from intrinsic value when uncertainty and corresponding speculation is on the rise.  These periods are often a result of captivating “noise” from various outlets and talking heads that eventually peaks before fading away.  A client of mine recently asked about the tremendous attention being paid to the trade scuffle between the U.S. and China.  There is a lot of misinformation being disseminated about the costs of tariffs and who actually picks up the tab. 

President Trump boasts that the U.S. is collecting billions of dollars from tariffs and that China has been paying the bill for many months – that we’re “taxing” China.  Is this true?  Not exactly.  In fact, it’s pretty far from what’s actually occurring but details don’t necessarily sell very well.  When tariffs are imposed on goods entering the U.S., local customs firms classify, verify and value the items being received.  Applicable taxes (e.g., tariffs) are paid in short order to U.S. Customs and Border Protection (CBP), which end up in a general account with the U.S. Treasury Department.  Indeed, these costs are typically paid by U.S. businesses taking ownership of the goods, which are then incorporated into the products sold to consumers.  How much does China pay directly in this equation?  Zero. 

But it’s a bit more complicated than this.  As import costs on Chinese goods increase, U.S. companies scan the global marketplace for these necessities and look to countries such as Taiwan, Vietnam, Indonesia and Malaysia as viable options.  This isn’t always a profitable choice for U.S. firms.  However, identifying some alternative trading partners does place pressure on the Chinese economy as companies are forced to either extend incentives on their exports to the U.S. or lose sales to other nations.  And the economic landscape in China is weakening. 

What does all of this mean to the U.S. economy and stock market?  Is this just volatility-inducing noise or something more ominous?  The trade skirmish is resulting in self-imposed higher costs for U.S. businesses and consumers.  While this is impacting certain sectors of the economy more than others, in aggregate, we’re not seeing signs of inflation that warrant serious worry.  But what about retaliatory tariffs on U.S. exports?  China only accounts for roughly 7% of total U.S. exports.  According to the Bureau of Economic Analysis, 2.4% of the U.S. economy is tied to exports to China that are at risk for tariffs – not exactly the perilous situation that one might imagine based on headlines and recent market responses.  So, in isolation, a slowdown in exports to China shouldn’t immobilize the long-standing U.S. expansion. 

If all of this is true, why do equity markets move 1%+ when a tweet or news outlet suggests an update to trade negotiations?  The U.S. economic expansion may be slowing but fundamentals remain relatively solid by multiple standards.  However, economies outside of the U.S., by and large, are struggling to stay above water.  While the trade tug-of-war may not merit much attention on its own, it being a negative for the global economy raises uncertainty and speculation about future sentiment and business investment, which could be a tipping point into recession.  We’re seeing reflections of this in the fixed income market as treasury bonds, despite historically low yields, are garnering additional demand.  But are these market reactions logical?  Even an inverted yield curve (i.e., yields for longer-maturity treasury bonds being pushed lower than shorter-dated bonds) tends to be followed by a multi-month period of decent economic activity and equity gains.  Recessions don’t tend to materialize for more than 18 months.  So, are “Trump Tariffs” more than short-lived noise for the stock market?  Time will tell but there’s a U.S. presidential election in the not-too-distant future with a sitting president who prides himself on the “art of the deal” and an equity-market scorecard. 

  

Any opinions are those of the author and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no guarantee these statements, opinions, trends, or forecasts provided herein will prove to be correct. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.  International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility.  Investing in emerging markets can be riskier than investing in well-established foreign markets. Prior to making an investment decision, please consult with your financial advisor about your individual situation

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