Tariff announcements have significantly impacted the equity market. President Trump’s tariffs on Canada, Mexico, and China initially sparked losses, but a one-month delay on Mexican tariffs allowed for partial recovery. These tariffs could moderately impact economic growth and increase prices if fully implemented.
Small-cap and tech stocks underperformed, while the U.S. dollar rallied. Short-term bond yields rose as Fed rate cut expectations diminished, and long-term yields fell as investors sought safety in government bonds. The tariffs’ duration is uncertain, but they aim to initiate negotiations. A long-term investment strategy is recommended.
The U.S. economy is relatively insulated due to lower trade dependence. Thus, tariffs and retaliation will likely have a lesser U.S. economic impact, providing leverage in negotiations. However, prolonged tariffs could increase domestic inflation. Mitigating factors include a stronger U.S. dollar, cost absorption by exporters and importers, product substitution, and supply chain adjustments.
Tariffs act as a consumer tax, potentially causing a moderate inflation increase. This gives the Fed reason to pause rate cuts. While rising goods prices could push CPI to 3%-4%, rate hikes are unlikely as the Fed won’t consider tariffs a persistent inflation source. Services, comprising more of the CPI than goods, will primarily determine inflation.
Economically, higher prices might slightly reduce GDP demand. Previous research suggests the 2018-2019 tariffs minimally increased inflation and slightly reduced growth. The current impact could be larger, but tariff revenue could reduce government deficits. Tax cuts and deregulation could offset economic weakness and stimulate domestic growth.
The trade war creates uncertainty for markets, influencing growth, inflation, and interest rate outlooks. This uncertainty contributed to today’s equity pullback and the U.S. dollar surge, mirroring 2018’s trade tension volatility. Conversely, a 2019 trade truce boosted stocks. Similar sensitivity to trade headlines is expected, but a long-term investment strategy is crucial.
Despite uncertainty, strong fundamentals like rising corporate profits and anticipated 2% economic growth support the markets. Stable unemployment and potential pro-growth policies further bolster this outlook. Diversified portfolios mitigate risk, with certain assets responding differently to policy shifts. U.S. mid-cap companies, mainly deriving domestic revenue, could benefit from stronger domestic growth and lower taxes. Investment-grade bonds offer diversification as safe-haven assets. Value, defensive, and cyclical sectors remain favorable. U.S. autos might face challenges due to reliance on imported parts. However, the broader market index should outperform trade-sensitive sectors and international equities. Barring a recession or renewed Fed rate hikes, a prolonged tariff-induced downturn is unlikely. Short-term pullbacks will likely occur within the bull market.