How Do Tariffs Affect the Stock Market?

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Tariffs and trade wars are in the news. How do they affect your stocks and the market?

The Trump administration began to threaten countries like China with tariffs in 2017. Over the course of the administration, these taxes were threatened and implemented and raised, all in the name of making American businesses more competitive.

Whether they worked as intended is up for debate. What's not up for debate is the effect on the global stock market. For example, as trade tensions heated up in May 2019, the Dow dropped 2.38% on May 13 as the S&P 500 lost 2.14%. This is the worst performance for the start of May since 1970.

The back-and-forth over tariffs between the USA and China are seen as the catalyst. Why? What does this mean for portfolio?

How do Tariffs Work?

When an item is produced in one country and sold in another, it crosses a border. For example, a television manufactured in China is exported from China and imported into the US to be sold in the US.

That television competes with one manufactured in the US (or any other country, really).

If the US government wants to make American goods more favorable to purchase, it can levy an import tariff on the imported item. This could be a tax expressed as a percentage of the price (an ad valorem tax) or as a fixed price per unit (a specific tariff).

Raising the prices of all Chinese-manufactured televisions by 20% (the ad valorem tax) could have the intended effect of making American-manufactured televisions more favorite to American consumers, leading to more sales of the American-manufactured products.

China, of course, wants to export as many goods and services to the US as possible, so they see tariffs as a way of penalizing their products in the market and are likely to retaliate by imposing tariffs on American exports. This means that American goods and services imported into China will be more expensive with the tariffs in place.

What do Tariffs Mean for Consumers?

Tariffs may not apply only to finished goods. They may apply to raw materials and parts and components as well. For example, the Trump administration started its tariff plan by adding taxes on steel imports.

An American consumer may not buy steel themselves, but steel is a big part of cars, trucks, buildings, durable goods such as home appliances, and more. When the costs of raw materials go up, the costs of those finished goods and services are likely to increase too. Even if the intention is to encourage these businesses from buying American steel instead of Chinese steel, the supply of American steel is limited. Higher prices in one part of the supply chain will affect prices throughout.

This means that prices on consumers have the potential to rise. Keep an eye on inflation and the prices of goods and services to see how tariffs affect you and the economy.

It's easy to think about what this means for you:

  • Prices may go up
  • You might have to wait longer to purchase something that's more expensive
  • You might purchase something used instead of new
  • You might not make that purchase at all

All of this factors into the economy as a whole.

What do Tariffs Mean for Investors?

What does this mean for businesses? That depends what they make, who they sell to, and who they buy from.

If you've invested in a business such as Boeing that buys a lot of steel or fuel or anything else that's affected by tariffs, the price of materials has increased, the cost to customers is likely to increase, and the business may make less money.

Because the price you paid for that Boeing stock represents the profit you expect the company to make in the future, any reduction in that profit is likely to be reflected in a reduction in the price of that stock. (Boeing stock dropped 4.88% on Monday, May 13.)

If you've invested in a company that exports a lot of items to the US, expect to see the prices on those items rise with tariffs and sales fall.

If you're looking at the market as a whole, you can think of tariffs and a trade war as multiple governments interfering in the market so as to change the balance of trade between themselves. The long game may be to force the US and China to renegotiate the terms by which items are imported and exported.

Yet no one knows how that will turn out.

What to Expect in a Trade War?

You could think of all of this negotiation as trying to redefine how the market works, and you'd be right.

You could also wonder if anyone could predict how things will turn out. The easy answer is "no". Yet with that said, expecting uncertainty and volatility is worthwhile.

Markets and investors like stability. Tariffs throw out that predictability, and they force you to change the way you think about the businesses you've invested in. Market volatility reflects that. In times of volatility like this, money flows to less risky investments.

Can you profit from this? Yes, if you're careful. A good company is a good company, and a lot of stocks became 2 - 5% cheaper with the drop in the stock market. Maybe that put them within your margin of safety.

For the time being, expect tariffs to continue and a trade war to escalate until China and the US can negotiate a better trade agreement. Who knows how that will change the market? Until then, look carefully at the businesses you want to invest in so that you understand where their items are produced, where they get the materials to produce them, and where they're sold.

This will help you understand the risk of tariffs and trade wars, which makes you a more intelligent investor.

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