Equity Outlook  |  Q2 2018

Trump, tariffs, and trade: The impact on stocks

Elizabeth C. McGuire

Elizabeth C. McGuire
Portfolio Manager of Putnam Capital Opportunities Fund

Trump, tariffs, and trade: The impact on stocks

Worries over a potential trade war contributed to equity market turbulence in the first quarter. Investors responded negatively when the Trump administration imposed tariffs on aluminum and steel in early March, followed by a proposal for additional tariffs on Chinese imports. Trade war rhetoric escalated after the close of the quarter, with China announcing tariffs on U.S. goods, further rattling equity markets. While the investor reaction is understandable — free trade has been a key contributor to economic growth — we believe these developments may be less damaging than some headlines suggest. However, we are carefully considering implications for the equity market and specific companies.

Tariffs may increase already surging prices, but inflation isn't always bad

We are cognizant of the inflationary impact of tariffs on U.S. businesses and consumers. Prices for raw materials were already soaring before President Trump's announcements. U.S. steel prices, for example, are at levels we haven't seen since 2011, and are 30% higher year over year, due to economic recovery and growth in markets worldwide. This inflation could accelerate with new tariffs in place and pressure profit margins of U.S. companies. Auto manufacturers, for example, are facing higher costs for imported steel.

Raw material inflation, however, can also be good for businesses over the long term. In positioning portfolios in the industrials sector, we are focused on high-quality companies that we believe have pricing power. That is, businesses that can pass inflation on through higher prices for their products without compromising demand. For these companies, we see promising long-term growth prospects, although they may experience short-term earnings weakness due to tariffs.

One uncertainty is the effect of inflation on sentiment. Will consumers hold off on purchases if price increases are too steep? While we remain generally bullish about fundamental business strength and global economic trends, these uncertainties could pose a risk to the current recovery cycle.

Trade flows rebalance over time

While tariffs and threats of restrictions are inevitable, trade flows in global markets tend to rebalance over time. In agriculture, for example, investors were unnerved by China's plan to impose tariffs on U.S. soybeans. The world's top buyer of soybeans, China buys approximately 30% of U.S. production, so restrictions would be disruptive in the short term to U.S. farmers. However, while supply chains may change and trade war concerns may cause short-term volatility, the global demand for soybeans will remain intact, and U.S. farmers will find new markets for soybean sales. I believe disruptions from new tariffs are likely to have a negative near-term impact, but it will settle down over time as trade flows rebalance.

Next: Working to avoid a "hard Brexit"

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