Since Inauguration Day, a flurry of policy announcements have occurred, including a series of tariff announcements. The sharp rise in policy uncertainty¹, combined with recent softening in business and consumer confidence, has led investors to worry about a potential economic slowdown. What is the investing playbook amidst the trade turmoil? Investors should ensure they have: a variety of assets that can provide defense against multiple types of risks, exposure to quality risk assets to continue to play some offense and a keen focus on valuations and active management.

What happened with tariffs?

• In effect now are 25% tariffs on imports from Mexico and Canada (10% for Canadian energy) and a cumulative tariff increase of 20% on imports from China².  
• At face value, recent tariff announcements have raised the average effective tariff rate on U.S. imports by 7%points to 10.1%³, the highest since 1946.
• Canada, China and Mexico have signaled tariff and non-tariff retaliation, especially with agriculture and energy top of mind⁴.
• Concerns around further restrictions of technology exports to China have also increased. Combined with the ongoing momentum trade unwind, the “Mag 7” have pulled back 13% since their December highs.

What happens now?

• Many practical questions remain around: the duration of these tariffs, their practical implementation at the border, additional tariffs to be announced⁵, any possible exemptions to announced tariffs, and additional retaliatory measures imposed by trading partners.
• Short-term economic impact of tariffs tends to be stagflationary: lowering growth and increasing prices, but how much growth cools or consumer prices rise depend on a variety of factors⁶: other policy responses, import substitution, cost absorption along the value chain, currency depreciation, policy uncertainty weighing on activity and feedback loop from lower global growth.
• Growth seems to be cooling but is not cool: the underlying pace of demand seems to be around 1.5-2%, as consumer spending downshifts from a hot fourth quarter. How much further it cools will depend on the effect on the jobs market, margins and capex. Some comfort from the resilience of the economy and earnings, with underlying 3.1% growth in real domestic final demand and earnings growth of 18% in 4Q.

What’s the investing playbook amidst the trade turmoil?

1. Corrections are a feature not a bug of investing in risk: Large cap U.S. stocks have pulled back 6% from all-time highs, which on average is seen four times a year. As investors find themselves in the thick of the policy fog, the tug-of-war between growth worries, inflation worries and fiscal concerns is set to continue.
2.  Reminder that multiple assets are needed for some defense:
   1. Core bonds have proved their worth during growth shock fears, with the U.S. Aggregate Index up 2.4% since the end of January,
   2. Other diversifiers are needed when inflation and fiscal concerns take the lead again, with real assets, gold, hedge funds and hedging strategies top of mind.
3. For offense, valuations and quality matter: Broadening earnings growth, high expectations and crowded positioning has fueled a broadening out of equity performance within U.S. and global equities (year-to-date,  Mag 7 -9% versus 493 +1.3%). While expectations for U.S. small cap earnings are high, a focus on quality is needed when growth is cooling, suggesting a focus on large/mid caps and the quality factor.
4. Active management to separate winners and losers: Policy impacts are unlikely to be even across the board. With recent U.S. tariffs and retaliatory tariffs, certain industries are at the epicenter: auto and auto parts, retail, groceries and construction, but not all companies will be able to navigate the whirlwind the same.

¹ As measured by the Economic Policy Uncertainty Index: https://www.policyuncertainty.com/.

² This includes an increase of 10%pts on Chinese imports implemented on February 4th and a further increase of 10%pts effective March 4th for a total average effective tariff rate of 31%.

³ This assumes no change in demand, for illustrative purposes.

⁴ Canada imposed a 25% tariff on CA$30bn of U.S. imports effective immediately (25% tariff on another $125bn in 21 days), Canada’s Ontario province announced a 25% tariff on electricity exports, China announced a 10-15% tariff on U.S. agriculture goods and greater scrutiny of U.S. companies operating in China, and Mexico has signaled retaliatory measures will be announced on Sunday, March 9th.

⁵ April 1st and 2nd are key dates to watch for additional tariff announcements related to “reciprocal tariffs”, tariffs on auto, semiconductor, and pharmaceutical import tariffs, and tariffs on lumber and forest products.

⁶ A simple model by the Yale Budget Lab estimates that current implemented tariffs could lower U.S. real GDP growth by 60bps in 2025 (and 30-40bps in the long-run) and raise price levels by 1.0-1.2%pts. “The Fiscal, Economic, and Distributional Effects of 20% Tariffs on China and 25% tariffs on Canada and Mexico”. 

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