PIM / Pure Financial Advisors
For those who have completed the paperwork associated with PIM’s transition to Pure Financial Advisors, thank you. For those yet to do so, we kindly encourage you to complete the DocuSign or paper documents delivered via FedEx at your earliest convenience to ensure continuity. We are aware that in a small number of cases, FedEx was slightly delayed in delivering documents packets. By now, or very soon, most PIM clients who requested paper documents will have them in hand. If you have any questions, please reach out to your PIM financial advisor.
More on Politics and Tariffs
Perhaps more than at any time in our collective experience, politics is a topic of discussion in conversations with you, our valued clients. This is understandable, as the new administration has given the public much to talk about in a short period of time. The number of executive orders discussed, implemented, retracted, or challenged in court is overwhelming, creating confusion and unease.
First, the standard preface; our goal is to make sense of the political environment to the extent that it impacts capital markets and the real economy. Nothing more.
Generally, domestic politics has little impact on the direction of markets or the economy, allowing for the periodic exception of tax policy, regulatory regime, and the federal budget. Unlike some other countries, where the political environment is consistently unstable, investors in the U.S. have never become adept at predicting the impact of political change on markets and the economy. The collective wisdom of the crowd is good at discounting future cashflows, for example, but ineffective at discounting the outcome of government policy.
The recent proposal for tariffs against Mexico and Canada is a great example of this. On the last Friday in January, news broke that the administration was not going to implement tariffs against Mexico and Canada and the market rallied. An hour later the market reversed course after another news story reported that tariffs against our neighbors would definitely be enacted the following Monday. Sunday news stories confirmed the tariff push. In the end tariffs against Mexico and Canada were pushed back another month and the S&P recovered to within 0.36% of where it peaked on January 31st with a fitful 3.2% drop over six trading hours between Monday and Friday. The takeaway is clear; don’t trade on headlines. They have a way of making you look silly.
Tariffs actually enacted, as of February 19th, include 10% on all imports from China and 25% on all steel and aluminum imports. Tariffs proposed but not yet enacted include 25% on imports from Mexico and Canada (10% on energy), and reciprocal tariffs on all trading partners globally.
Reciprocal tariffs mean the US will impose the same tariffs on imports that our trading partners impose on US exports on a product-by-product basis. The idea appeals to the current administration, but actual implementation would be complex and involve hard choices. We suggest that both proposed tariffs will generate a lot of headlines but will never actually be implemented.
History and Analysis
From the end of the Great Depression of the 1930s to 2017, American policy was a steady march towards free trade and deeper supply chain integration with the rest of the world with little regard to trade deficits. That is, if you’re willing to overlook interruptions from the trade spat with Japan in the 1980s and a couple of world wars. Since Trump’s first term, trade deficits are viewed by both Democrats and Republicans as a symbol of the decline of the American middle class and blue-collar workforce as ever more manufacturing jobs move overseas.
Proponents of tariffs suggest that they promote the domestic economy by replacing imports with domestically produced goods. One way to measure the effectiveness of tariffs is through the trade deficit; if tariffs work the trade deficit should fall. Trade deficits are simply the difference between imports and exports. If you’re importing more in goods and services than you export, your country has a trade deficit. If the opposite is true, you have a trade surplus. America runs a huge trade deficit (3% of GDP) because we import a great deal of finished goods. Americans are basically the end consumer for foreign made products.
If tariffs reduce the trade deficit, we should have data from the 2017 tariffs to support this claim. Despite raising tariffs to 21% on 65% of Chinese exports, the trade deficit between the two countries remained stable, at $327 billion in 2016 to $326 billion in 2019. The Biden Administration did not take meaningful action to remove tariffs on goods from China between 2020 and 2024. Instead, additional trade restrictions were added to protect certain industries, mainly automakers. The trade deficit with China stands at $594 billion as of 2023.
The trade deficit with China, on its own, is less meaningful than when contextualized within the global economy and after adjusting for US economic growth.
When we normalize trade data to account for inflation and a growing US economy, there has been no meaningful change in the trade deficit between the US and its global trading partners from 2016 to 2023. So far, enacting tariffs has been akin to pushing on string. They haven’t changed the amount of goods and services the US imports relative to the size of the overall US economy. They just changed where imports arrive from.
The data suggests that goods the US imported from China before tariffs were enacted in late 2017 now come from Vietnam or Mexico. Imports from Vietnam to the US increased to $115 billion in 2023 from $42 billion in 2016, a 174% increase over the timeframe. America now imports more from Mexico than any other trading partner.
This data makes sense. If you’re running a manufacturing firm or retailer in the US and suddenly a foreign supplier can’t provide supplies/products at the same price due to tariffs, you look to other foreign sources. If you’re a foreign supplier affected by tariffs, perhaps you will move production to another country not impacted by US tariffs. Either way, the goods are still being imported to the US, just through another country.
Manufacturing Jobs
Another test for tariffs is the labor market. If tariffs were an effective tool for promoting US jobs, we should see jobs “re-shore” as manufacturing returns. The data doesn’t show much growth at all. In January of 2016, the Bureau of Labor Statistics says there were 12.3 million jobs in both durable and non-durable manufacturing. In January of 2024 there were 12.7 million. This is a gain of just 400k in eight years while the rest of the economy created over 16 million new jobs. Manufacturing employment as a percentage of overall jobs in the US fell by 0.5% over this timeframe. Other than a wiggle during COVID, the total number of jobs in the sector has been very steady. Tariffs haven’t been effective in bringing more manufacturing jobs to our shores.
Market Impact – The Real Judge
The data points above challenge the assumptions floated by proponents of tariffs to be sure. But trade deficits and the labor market are not the only measures of the impact of tariffs. What do tariffs mean for capital markets? Unsurprisingly, we have data for that too. We can use the comprehensive MSCI US index with the financials, energy and real estate sectors removed. This is done to focus on only domestic companies that would be affected, in theory, by tariffs.
This data shows that operating profits fell from 16% to 13% between tariffs being enacted and the end of 2019. Companies were less profitable as they adjusted their supply chains to the impact of tariffs. A similar decline is also present in the data for companies outside the US. All things being equal, smaller profit margins means less earnings and lower share prices for both US and foreign firms due to tariffs. Economists refer to this as a deadweight loss.
Companies dealing with tariffs have two options: either increase prices by the amount of the tariff to maintain profit margins, or not, and become less profitable. If they choose the former, inflation rates may increase and potentially feed back into the economy through higher interest rates, but with no incremental growth. If they choose the latter, they have less money to hire and grow their business. Neither choice is a good one for employees or the firm.
The inflationary period after COVID allowed firms to recover the operating margin lost to tariffs, and then some, by increasing prices to consumers. This is what analysts expect to happen again, risking another bout of inflationary pressure in the US economy. The CPI (consumer price index), as we suggested in last month’s note might happen, increased more than expected, moving up to 3.2% in the most recent reading. Inflation has been moving in the wrong direction since June and tariffs could make the situation worse.
Tariffs Don’t Accomplish Much
As we discussed in our last note, US equity markets have very high expectations for earnings growth this year and valuations are stretched by any measure. Tariffs are a risk factor that may prevent firms from achieving the results that are baked into their valuations. The frustrating thing about tariffs is that they have a cost, but no commensurate upside. That’s one reason why they haven’t been used as a prevailing trade policy tool in nearly 100 years. Both Democrats and Republicans seem to have lost sight of this fact as they struggle to deal with the loss of American manufacturing.
Closing Thoughts
We have a sneaking suspicion that the tariffs under discussion will not come to pass in their current form. The economic cost, specifically the impact on inflation, appears to be too high for the current administration. The US equity market has largely been in consolidation (sideways) since mid-December. Equity trading volumes and institutional portfolio positioning suggest that investors are unwilling to make “bets” one way or the other. They seem to be stuck in neutral even though we’ve nearly finished another very impressive earnings season from Wall Street.
Uncertainty is the name of the game. If investors aren’t willing to pick a side, we can safely assume that corporate America feels the same way. Uncertainty will weigh on growth as companies delay their business plans. This isn’t necessarily a gloomy outcome, but we should be prepared for more modest equity appreciation. Key to maintaining discipline is muting the noise out of Washington DC. Remember, trading on headlines has a way of making you look silly.