Trump tariffs must not be ignored — here’s why

The stock market had a tariff tantrum March 1 in the wake of President Donald J. Trump’s announcement of new tariffs on imported steel and aluminum. The tantrum resumed last Wednesday after the resignation of Gary Cohn, the president’s chief economic adviser, but cooled after further White House modifications last Thursday.

Was the tantrum justified? What effect will new tariffs have on your clients’ portfolios? If the changes amount to just the two tariffs, very little. But if this is the opening salvo in a trade war, the effects on stocks and the economy could be far-reaching.

On March 1, the president announced a 25% tariff on imported steel and a 10% tariff on imported aluminum, which prompted Mr. Cohn’s resignation. But last Thursday the White House announced that Canada and Mexico would be exempt from the tariffs as the U.S. renegotiated the North American Free Trade Agreement.

The U.S. trade deficit — the difference between what we import and what we export — was $566 billion in 2017, the highest level since 2008, according to the Commerce Department. The U.S. runs a modest trade surplus with Canada and a $375 billion deficit with China.

In 2017, the U.S. imported 26.9 metric tons of steel, up from 22.5 million tons in 2016, according to the International Trade Administration. That’s about 8% of U.S. steel imported globally, and less than 1% of all U.S. imports. Aluminum is another story: The U.S. imports about 90% of its aluminum.

index exposure

How does this affect your portfolio? Assuming that tariff talk stops here, not much. Nucor, for example, accounts for just 0.9% of the Vanguard 500 Index fund (VFINX). Alcoa Aluminum isn’t an S&P 500 member, but accounts for only 0.3% of the Vanguard Total Stock Market fund (VTSMX).

Your clients probably do have a lot of stocks in their portfolios that use steel and aluminum, said Tom Essaye, editor of The Sevens Report, a daily market update that goes out to 2,500 advisers worldwide. “Caterpillar doesn’t make tractors out of wood,” he said.

In the wake of Mr. Trump’s announcement, steel and aluminum ETFs jumped while the rest of the market slumped.

“On March 1, when the first shoe dropped, the 16 publicly traded U.S. steel companies saw their market caps increase by $1 billion, while the rest of the S&P 500 lost $400 billion,” said Chris Dillon, an investment specialist for capital markets at T. Rowe Price.

Since then, the market has largely shrugged off the news. “If this is a one-off on steel and aluminum, it’s not a big deal,” said Jim Paulsen, chief investment strategist for the Leuthold Group. “But it’s hard to believe that this is where it stops.”

When trade wars occur, other countries tend to retaliate. In 2010, for example, China imposed a 100% tariff on U.S. chicken feet in retaliation for U.S. tariffs on Chinese tires. The chicken-feet trade to China was a $250 million business that U.S. consumption wasn’t going to replace.

“If you’re the chancellor of Germany, you can’t just let this go, even if it’s small: It’s the principle of the thing,” Mr. Paulsen said. “You can’t just smile and look the other way.”

Should a trade war widen, matters could become more serious quickly. “The European Union is threatening tariffs on everything from Harley Davidsons to agricultural goods,” Mr. Essaye said. “There’s a Pandora’s box on the table. It’s not open, but it’s out of the cabinet.”

During a trade war, the less a company has to do with international trade, the better. But that’s difficult in today’s world, since about half of the earnings of the companies in the Standard & Poor’s 500 index comes from overseas.

“A tariff stock playbook would have to be domestically foused,” Mr. Essaye said. “That would mean regional banks, very specialized retailers and small-cap stocks, which have been outperforming since the tariffs were announced.”

Active management

It might also be a time to look more closely at actively managed funds, said Dan Wiener, editor of The Independent Adviser for Vanguard Investors, a newsletter.

“One of the beauties of using actively managed funds is that you have experienced professional portfolio managers with large research staffs making their own decisions about what the impact of trade wars will be on their portfolios,” Mr. Wiener said. “Presumably they will try to sidestep it.” True, many active managers don’t beat the indexes. His advice: “Don’t buy the average active manager, buy the best ones.”

Bond investors would need to take a defensive position as well, said Charlie Ripley, senior investment strategist for Allianz Investment Management.

“If trade becomes less competitive, you have the potential for higher prices, which would have some effect on bond prices,” he said. Those would not be good effects: Higher prices mean inflation, which the bond market views in the same way a vampire views garlic. Investors would be smart to shorten portfolio durations and look to adjustable-rate investments.