Understanding Tariffs and Trade Wars

Since late January, talk of tariffs and a burgeoning trade war has resulted in greater market volatility. The Trump administration’s more recent announcement of higher tariffs and the subsequent international response has evolved quickly, taking investors along for the ride as news surrounding tariffs has been met with large market fluctuations.

In such an environment, one might be tempted to make investment decisions based on which way they think the ongoing trade talks will go or even decide to sit out of the market entirely until things settle down.  

At Truepoint, we believe the best approach is to not panic and remain disciplined. Eventually, companies will adapt, and markets will look beyond any potential drawbacks of tariffs. Despite a pickup in market volatility when Trump enacted his first tariffs back in early 2018, the S&P 500 index is up over 100% since March of that year.  

However, it is helpful to understand why tariff discussions are causing market volatility and how our team manages portfolios through volatile periods like this. 

Understanding Tariffs and their Effects on Markets   

Tariffs (taxes charged on goods imported from other countries) are imposed for many different reasons—to subsidize certain industries, to preserve certain jobs for a nation’s citizens, or to protect national security interests.  

For example, the U.S. has frequently imposed tariffs on imported steel and aluminum to make U.S.-produced steel and aluminum products more attractive to businesses and consumers. In theory, these tariffs encourage U.S. businesses to remain in raw material industries, which means the country will have its own supply of raw materials during times of war or international tension. Such tariffs also protect the jobs of U.S. workers employed in these industries.  

In the long-term, most economists agree that tariffs can do more harm than good. By making goods more expensive and limiting trade, they can disrupt how markets work, leading to less efficiency and lower productivity. When imported products cost more, people and businesses may spend and invest less, which can slow down the economy. On top of that, if businesses aren’t sure what tariff rules will be in the future, they may hold off on investing, which can further weaken long-term growth. 

However, there can be short-term, strategic benefits to tariffs. Import taxes generate revenue that the government can reinvest in the economy, and they can encourage consumers and businesses to buy domestically produced goods, supporting local industries and jobs. Tariffs can also be used as a bargaining tool in trade agreements, helping to secure better deals for domestic producers and workers into the future. Nevertheless, if threats of tariffs continue to dominate the news, we can expect market volatility to continue.  

Capitalizing on Volatility 

All of this reminds us that headlines can often cause short-term swings in the market, but it’s important to note that these swings can go both ways.  

Just as quickly as markets fall due to rumors of new tariffs, they can rebound quickly in hopes of an impending deal. This is why it can be dangerous to try to time the market in hopes of avoiding a potential market decline. In fact, market corrections are often short-term in nature. The S&P 500 Index has posted a positive return in 34 out of the past 45 years despite an average intra-year decline of 14.1%.  

At Truepoint, our clients’ portfolios are built by considering their individual financial goals combined with an understanding of how markets work—so that they can confidently weather any market storm, no matter the duration.   

There is no crystal ball to help us predict the future. Fortunately, that’s not necessary for investment success. At Truepoint, we see down markets as an opportunity to add value. Here are some of the ways our team capitalizes on market volatility:  

• Portfolio Rebalancing – Trading investments to maintain the target allocation, often selling bonds to buy stocks in market downturns.
• Tax-Loss Harvesting – Selling investments to intentionally realize a loss to offset gains or income while simultaneously reinvesting in similar investments to maintain market exposure.
• Investing Excess Cash – This can be an opportune time to invest idle cash. As the saying goes, buy low, sell high!

Additionally, in times of higher market volatility, the value of having a diversified portfolio is more noticeable. Holding a portfolio with not only U.S. stocks, but also international stocks and bonds, helps to reduce the risk of having too much exposure in one area and lessens the impact of negative returns from a particular asset class. Bonds often hold steady when the stock market is down, which has occurred so far this year. But there has also been a measurable difference in the performance of international and U.S. stocks, with international stocks providing positive returns since the start of the year while the U.S. is negative. Also, geographic diversification helps protect the portfolio against uncertainty surrounding the eventual outcome of trade and tariff renegotiations. 

We do not make investment decisions based on short-term, economic events. We are long-term investors who gain comfort from decades of data that show that, although trade wars might temporarily disrupt markets, remaining consistent and patient is what matters in the long run.  

If you are interested in additional commentary on market volatility and how Truepoint capitalizes on it, check out “When Markets Change Direction.”