On Wednesday, dubbed “Liberation Day,” the White House introduced a sweeping range of tariffs affecting numerous countries while making exceptions for other countries such as Canada and Mexico, to various degrees. Many of the tariff rates introduced were significantly higher than forecasted.
On Thursday, investors awoke to trade turmoil, fears of stagflation, and a cloud of uncertainty as the markets experienced a broad selloff. The S&P 500 opened Thursday morning 3.5% lower than the previous day’s close, marking the 13th largest downside opening gap in the last 32 years.
Bond yields dropped following the announcement, with the 10-year Treasury yield dropping 14 basis points. The yield curve steepened following the announcement, implying the market’s expectation for stagflation. The recent move in the bond markets, coupled with the Federal Reserve’s “wait and see” approach regarding economic data, has led to an increase in the previously low probability of recession.
Tariffs are generally viewed to be inflationary, as they increase the prices of goods, and are generally headwinds for consumers, manufacturing, and housing, and may hinder economic growth. Indeed, GDP forecasts have been lowered since the beginning of the year. However, tariffs can also be viewed as beneficial to redevelop U.S. manufacturing.
The new tariffs imposed by the White House levy the highest charges on a number of foreign countries that have been key production hubs for U.S.-based companies that outsource production to those countries. Nations such as Vietnam (where both Apple and Nike have key manufacturing facilities) and Cambodia (where various clothing manufacturers have production facilities) saw among the highest tariff rates imposed.
Indeed, clothing retailers such as Deckers, Nike, and lululemon saw significant drops in share price as investors weigh the potential impact of tariffs on the companies’ production and future earnings prospects.
The tariffs will obviously have an impact on other countries’ economic activity, particularly those that are export based. For example, China, who exports a significant amount to the U.S., was slapped with a 54% tariff in the latest round, creating the potential to significantly reduce demand of their goods, and thus, negatively impact their GDP.
The top two U.S. imported goods by dollar value are automobiles (over $200 billion) and petroleum products (over $150 billion), with the latter provided overwhelmingly by Canada. Phones and computers are also among the top five goods imported, supplied primarily by China.
Other industries, specifically those that utilize raw materials from other countries, will also be affected. The home building sector is especially vulnerable to the effect of the tariffs, as imported products such as lumber, aluminum, and other building materials will see significantly higher costs as the tariffs come into play. Additionally, other industries who were generally considered stable now face challenges as the spillover from the implementation of tariffs may be far reaching.
Recent economic releases have also reflected the potential effects of the tariffs. The ISM Services Index, which measures economic activity in the services industry, came in lower than expected as companies reported they are uncertain as to the impact on activity that the tariffs may have.
We are cognizant of the fact that earlier threats of tariffs this year were either suspended, walked back, or modified and recognize that the economic trade picture is fluid and continually changing. We continue to monitor developments regarding this situation.
Our equity investment methodology continues to favor high quality companies with predictable and consistent long-term earnings growth, which are able to weather the gyrations of the market caused either by macroeconomic policy or other developments.
Summary
Despite the recent uncertainty in the current environment, we remain cautiously optimistic with regard to future returns of the stock markets. When factoring in forecasted earnings growth, improving relative valuations, and other macro aspects, we believe the equity market should reward investors going forward in the long-term.
As stated earlier, we will continue to monitor developments regarding tariffs and their impact on the economy to determine the most appropriate strategy from an asset allocation perspective, as well as within specific asset classes.
Sources: BTC Capital Management, FactSet Research Systems Inc., Federal Open Market Committee (Federal Reserve) LSEG I/B/E/S, FTSE Russell (an LSEG Group company), S&P Global, U.S. Bureau of Labor Statistics, U.S. Census Bureau
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
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