Tariffs & Market Volatility
Now that the new administration is in place the frenzy has begun in what will surely be a year of dramatic headlines, sound bites and social media posts. In this week's episode, the storyline has been tariffs and the stock market's reaction has been volatile - something we expect much more of this year.
Before we get into tariffs let's first define volatility in the context of investing (because I think we are going to be using this word a lot in 2025). Investopedia defines volatility as "a statistical measure of how large an asset's prices swing around the mean (average) price." We are good with that definition! Think of it like a boat bobbing up and down in choppy water, it's annoying and can cause uneasiness but at the end of the day you are still moving forward just maybe at a slower pace.
Back to tariffs....
What happened?
The announcement of new tariffs once again placed trade policy at the forefront of economic discussions over the weekend and into Monday. As a result, US stock indices opened Monday down - the S&P 500 declined 2% to start the trading day and media headlines ran wild. However, by 10:30AM (which is one hour into the trading day) the tariffs against Mexico were postponed and markets began to regain some of their losses, a few hours later the tariffs against Canada were also postponed. When Monday was all said and done, the S&P 500 finished the day -.8% and the tech-heavy NASDAQ composite index was down 1.2%.
What was announced?
News began to emerge on Friday, January 31st that President Trump intended to implement a 25% tariff on imported goods from Canada + Mexico, with a separate 10% tariff directed towards China. Initial estimates of the economic impact (see: Peterson Institute) acknowledge that the US economy likely weathers this round of tariffs with a marginal effect, while Canada and Mexico are expected to see a potentially deep contraction in economic activity. Analysis by the Peterson Institute suggested that US GDP may be 0.2% short of its full potential whereas Canada and Mexico face the possibility of GDP being 1.5-2.0% less than potential.
What are the impacts?
Stock market: global stock markets initially reacted negatively to tariff announcements. Higher input costs potentially reduce corporate earnings, with Goldman Sachs estimating a continued trade war could lower S&P 500 earnings by 2-3%. Over recent decades, S&P earnings grew 6-7% per annum on average, suggesting that a 2-3% reduction would be meaningful but not disastrous.
Industries: Tariffs are likely to have the largest impact in industries such as auto manufacturing and agriculture. Both countries are heavily involved in the US auto supply chain with a variety of parts and manufacturing plants directly tied to US auto production. Mexico plays a particularly noticeable role in America’s food supply. More than 60% of all vegetable imports come from Mexico and Mexico supplies nearly half of all fruit and nut imports to the US.
Bond market: given the near-term inflationary nature of tariffs, government bond yields were moved higher and prices were falling. In contrast, TIPS securities appreciated on the initial move after the announcement, and we continue to think shorter dated TIPS are an attractive option for those seeking protection against inflation pressure. Currencies: reflecting changing dynamics in monetary policy and growth prospects, currency markets showed relatively substantial moves in the leadup to the Presidential election, which partially softens the impact of tariffs. The Mexican Peso is ~19% lower against the US dollar in the past year and the Canadian dollar was 7% weaker. What Comes Next?The evolving nature of tariff discussions makes it unlikely anyone has a strong purview into what comes next. President Trump previously used tariffs as a negotiating tool to extract wins for the US manufacturing sector. This time around, the president cited illegal immigration, drug trafficking and border security as the primary motivation behind tariffs. Canada and Mexico reached out to the administration to determine ways to avoid tariffs, agreeing to a variety of measures to help secure their respective borders prompting the President to postpone the tariffs for 30 days, we will see where it goes next. We continue to think the long-term impacts to equity markets and investor portfolios from tariffs on Canada and Mexico are modest at this time but will continue to reassess as the trade discussion evolve.
Get this!
Since it took us some time to finish this note, Tuesday's market has closed and guess what....we have an actual tariff war between the two largest economies in the world. At midnight a sweeping tariff of 10% against all imports from China went into effect. China in retaliation said it would implement a 15% tariff on coal and liquefied natural gas products as well as a 10% tariff on crude oil, agricultural machinery and large-engine cars imported from the U.S.. That can't be good for the stock market you might say.... the Dow, S&P 500, NASDAQ and Russell 2000 were all positive on the day. That is volatility!