When Twitter first launched back in 2006, its creators probably never imagined that a single “tweet” could make the stock market plunge. But that’s exactly what happened on Thursday, August 1, when President Trump tweeted the following:
“…the U.S will start, on September 1st, putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China into our Country. This does not include the 250 Billion Dollars already Tariffed at 25%...”1
Before the tweet went out, the Dow was up over 300 points. The S&P 500 was also having a good day. By the late afternoon, however, the Dow ended up down almost 300 points.2 That’s quite a swing.
Of course, it wasn’t really the tweet itself that made the markets dip, but the news it contained. As usual, the markets reacted to the announcement of more tariffs with a fit of violent sneezing. So, investors must now ask themselves, “Is this just a brief allergic reaction…or the first symptom of a market cold?”
Let’s break it down.
The “what” and “why” of tariffs
Here’s a quick review of the basics. A tariff is essentially a tax on imported goods. The business doing the importing will pay the tariff, usually as a percentage of the goods’ total value.
Many economists believe, however, that it’s consumers – people like you and me – who end up paying the cost of tariffs. For example, back in 2018, President Trump placed a tariff on imported washing machines. One study found that consumers “bore between 125 and 225 percent of the cost of washing machine tariffs”, mainly because the companies that sold the machines ended up charging far more for them to make up for what they lost in tariffs.3
So, why impose tariffs at all? Some economists argue there are lots of reasons. For instance:
Protecting domestic industries. When imports are more expensive, the thinking goes, consumers – both individuals and other companies – are more likely to buy from domestic companies that produce the same goods at a lower price. For instance, the U.S. has put tariffs on sugar imports dating all the way back to 1789!4
Revenue. Historically, tariffs were once one of the nation’s largest sources of revenue. However, tariffs-as-revenue have largely been replaced by other taxes, especially income and payroll taxes.
Geopolitical negotiating. Tariffs – or at the least, the threat of them – can sometimes be used to drive countries to the negotiating table. That’s probably the single biggest reason President Trump has relied on tariffs so much, as he has persistently used them to persuade countries like China, Canada, and Mexico to negotiate more favorable trade deals.
So, are tariffs good or bad? Some economists claim they’re worth the cost. Others believe tariffs aren’t effective at doing what they’re supposed to do and just end up hurting consumers far more than they help. And, since the American economy is based largely on consumer spending, these economists believe tariffs ultimately do more harm to the economy than good. I’m a financial advisor, not an economist, so I won’t come down on one side or the other. Far more pressing for me – and for all investors – is how tariffs affect the markets.
Tariffs and the markets
Since 2018, President Trump has announced new tariffs on Chinese goods on several occasions. Each time, a market drop has typically followed. You only have to look at the most recent announcement to understand why.
As the President tweeted, the U.S. is imposing a new 10% tariff on $300 billion in Chinese goods. This new list includes everything from smartphones to toys to shoes.5 It’s no surprise, then, that the stocks sold off on August 1 were largely for companies that sell these products. As we just discussed, companies must pay more for the goods they need or sell, which can significantly eat into their profits. This, in turn, can lead to shipping delays, supply chain problems, higher prices for consumers, a resulting loss of business – you name it. All these issues, of course, are then reflected in the stock prices of the various companies affected.
Despite this, each of the market drops I mentioned earlier tended to be mere blips on the screen. Some blips lasted longer than others, but in each case, the market sneezed, then moved on. (Or upwards, as the case has been.) The world we live in moves with astonishing speed, and for the markets, the next bit of news often seems to crowd out the previous bit. Those who have predicted doom and gloom with each new round of tariffs are still waiting. Since the overall health of the economy remains strong, it will likely take more than a few tweets, or even a few hundred billion in tariffs, to make the markets truly sick.
The danger of complacency
All that said, there is a danger here. It’s the danger of becoming so accustomed to these here today, gone tomorrow blips that we forget that it’s the long-term health of the markets that matters.
As always, the long-term is more important than the short. In this case, it’s possible we haven’t actually felt any long-term effects yet, just as we don’t usually feel the symptoms of a cold until the virus has been inside us for some time. Are there long-term effects to come? I don’t know – nobody does. It is important to note, however, that this round of tariffs is a little different than the previous ones. Older tariffs were largely on products like plywood and polyethylene. Important, but not very conspicuous.
The newest tariffs President Trump has proposed involve more of the things we use on an every-day basis. Smartphones, for instance. Shoes. Clothing. Things we tend to notice and appreciate just a bit more. What happens if they go up significantly in price? Would that mean anything in the long run?
It seems needlessly pessimistic to say that it definitely will. On the other hand, it also seems naïve to say that it definitely won’t.
It’s also possible that older tariffs will become more painful the longer they go on. Some data suggests that many companies have decided to eat the higher costs that come with tariffs rather than passing them onto consumers. But how long will that last?
The point of saying all this is not to suggest that these new tariffs, or tariffs in general, will bring a definitive end to the bull market we have enjoyed for so long. In fact, I think the chances are high that the markets will once again absorb the news, sneeze, and move on. Tariffs, as important as they are, represent only a small portion of the total economy – and the economy still looks strong. And of course, President Trump’s strategy could yet pay off and lead to a new, more favorable trade deal with China.
As this is being written, the U.S. stock markets are undergoing the worst day so far in 2019 . China devalued their currency (the Yuan) last night by 10%, apparently in retaliation for the tariffs. One can argue whether China is a developed economy or an emerging economy. But it's obvious that they have entered the conversation in a big way lately. And it is also obvious to me that they have a desire to supplant us as the number one economy in the world. Furthermore, it appears their tactic is to wait us out because they do not have an election cycle to deal with every two years. The result is a lot of uncertainty – and if there is one thing the markets hate, it’s uncertainty.
As I have blogged in the past, we need to keep the macro view in mind. Since World War II, the United States has been at a competitive disadvantage compared to the rest of the world’s developed economies. We did it purposefully at Bretton Woods in 1944 to help rebuild the economies that were devastated by the war. In my opinion, it is now time to level the playing field because the rest of the developed world no longer needs our support. It appears from my view that the rest of the world will need a nudge in that direction. Will tariffs be the right nudge? Time will tell, but it is obvious that this will not be accomplished without some measure of pain.
So, what are we to do about the turmoil in the markets? Our process here at Petra Financial can be summed up in two words: Risk Management.
Risk management is the process of identifying, analyzing, accepting, and then working to mitigate the risks that come with uncertainty. It’s one of the most important things I do for my clients. All investing involves some risk. It’s impossible to get rid of it entirely –nor would we want to! (It’s a truism that no risk means no reward.) But we can take steps to manage risk, and that’s what we do every day.
I cannot tell you what the markets will do. So, here’s what I can do instead:
Use rules-based investing and a sell-side discipline
These are just fancy terms for something very simple. While many investors practice something called “buy-and-hold”, where they pick some investments and then hold onto them no matter what, we put rules in place that determine when to sell an investment if it falls below a certain price, or is likely to. While we can’t control whether an investment will grow or not, we can take steps to protect from losing the principal. The ancient Greek physician, Hippocrates, had a maxim: “First, do no harm.” I take a similar view. While we wantto help grow our client’s money, we are committed to doing our best to protect their money.
While we cannot know for certain how the Trade War will affect the markets, or whether the economy will veer into a recession, that doesn’t mean we’re sitting idle. My team and I are working constantly to analyze how these headlines could affect our client’s hard-earned money. We’re always working to manage risk.
If this rules-based investment philosophy appeals to you, please do not hesitate to reach out if you have any questions. In the meantime, I hope you continue to enjoy a wonderful summer!
Until next time, cheers!
1Twitter account of Donald J. Trump, August 1, 2019. https://twitter.com/realDonaldTrump/status/1156979446877962243?s=20
2 “Trump Threatens New Chinese Tariffs, Rattling Investors Across Markets,” The Wall Street Journal, August 1, 2019. https://www.wsj.com/articles/trump-to-impose-additional-10-tariff-on-chinese-goods-11564681310
3 “The Truth About Tariffs,” Council on Foreign Relations, May 16, 2019. https://www.cfr.org/backgrounder/truth-about-tariffs
4 “The Taxation of Sugar in the United States, 1789-1861. The Quarterly Journal of Economics. https://www.jstor.org/stable/1882993?seq=1#metadata_info_tab_contents
5 “Trump says he will go ahead with new China tariffs that would hit iPhones and toys,” CNN Business, August 1, 2019. https://www.cnn.com/2019/08/01/economy/new-china-tariffs-threat-trump/index.html