Decoding Markets: Liberation Day

Estimated reading time: 6 minutes

The Big One

The wait is finally over. President Trump’s “Liberation Day” has arrived, with investors braced for the tariff package he has dubbed “the big one.” The impact of these tariffs is uncertain, as is whether there is room for negotiation. One thing is clear however: Global commerce may never be the same.

In just the first three months of the year, the average tariff rate has increased from 2.4% to 6.6%. The political rumor mill on where it would end up has swung between two ends of a spectrum: targeted reciprocal tariffs or a broad universal tariff.

Either outcome (or a mix of each) would push the average tariff rate significantly higher, bringing the overall level to above 15%, and possibly even as high as 32%. Interestingly, investors have appeared more optimistic, with a recent Goldman Sachs Investment Research survey showing investor consensus expected a final tariff rate of 9.3%. 

That could be because they had expectations for an underwhelming announcement or thought that countries would be able to secure exemptions through negotiation. But that consensus raises the risk that the market could be in for a negative surprise with higher tariffs.

Past, Present, Future

Of course, where markets go will depend on how the U.S. economy copes with the global trade upheaval. To state the obvious, this isn’t like your founding father’s economy when tariffs were the primary revenue generator for the government. Still, the past has some useful lessons for us. 

Trade has always played an important role in economies, consistently accounting for a sizable chunk of GDP despite the occasional disruption. Yet as U.S. industries developed in the early history of the country, trade became relatively less important to the economy. With less need for protection from foreign countries, tariffs generally trended lower as well.

That changed when the Great Depression hit and the Smoot-Hawley tariffs were enacted in 1930, raising tariffs on thousands of goods to record levels. That led to boycotts and retaliatory measures from trading partners, which exacerbated the global recession. From 1929 to 1932, total goods traded fell 69% while GDP contracted by 43%. Rough to say the least.

While the current tariff push shares some similarities with the Smoot-Hawley era, they would be occurring in a completely different economic landscape. The biggest difference is that unlike in the early 1930s, today’s global economy isn’t already in the throes of a devastating recession. On the other hand, goods imports account for a much larger share of GDP today than they did in the past (over 11% now versus less than 3% then). Because of how interconnected today’s global supply chain is, inflationary effects from tariffs would likely spread more quickly than in the past.

Trust the Process

How this all shakes out is anyone’s guess. Is it just the mother of all negotiations? One big ploy to try and lower trade barriers with other nations? Maybe. Anything is possible, but it seems like the protectionist genie is out of the bottle. Putting it back in probably won’t be so easy.

When the Smoot-Hawley tariffs were enacted, it wasn’t until a change in government control after the 1934 elections that the Reciprocal Trade Agreements Act was passed and the import taxes began to be lowered.

Moments like this are an important reminder that investing is a long-term game. The market environment isn’t always positive, and stocks don’t only go up. It can be uncomfortable, and sometimes scary, to invest when the world is in turmoil, but part of what investing is about is being compensated for taking on risk. For years, high-flying tech stocks outperformed the broader market during a long period of U.S. dominance, but in times like this, the benefits of diversification become apparent, not only across sectors but regions and factors as well.

International markets are fresh off one of their best quarters relative to the U.S. in many years, while stocks seen as lower volatility and higher quality (i.e. less debt, higher profit margins, steady cash flows, etc.) trounced stocks with the opposite characteristics. It’s possible that this represents the beginning of a longer-term shift in market leadership as investors react to a changing world, but it will take years to know for sure. In the meantime, the most successful investors will likely be those who maintain discipline while strategically adjusting to realities. 

Trust the process.

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