Although we believe that a favorable resolution of the U.S.–China trade conflict is possible, we continue to monitor it as a potential risk for equity investors. Rising tariffs can have a negative impact on equities for a multitude of reasons.
While the impact on U.S. and Chinese companies is obvious, the risk also affects businesses worldwide. As an example, European auto manufacturers are already feeling pain from higher import tariffs on cars produced in the United States. Among the consequences of tariff hikes are disrupted supply chains. Supply chains have been globalized, so while end products may be made in the United States, sub-components are from all over the globe, with many coming from China and Mexico. Tariffs disrupt this supply chain.
Trade disputes undermine confidence among corporate leaders. The potential for significantly higher tariffs brings a level of uncertainty that can cause businesses to retreat from investing. For example, as a result of the conflict, businesses may focus on restructuring their supply chains rather than building new factories. This is particularly true when they are uncertain about where those factories should be located due to changing supply chains.
We have already seen the effects of tariffs on corporate earnings. For manufacturers, there are more potential losers than winners, as profit margins are vulnerable to cost increases. This is likely a contributing factor in the recent restructuring and layoff announcements from General Motors and Ford.
Globalization over the past 25 years helped to generally reduce costs, improve margins, and expand markets. Tariffs, on the other hand, are a form of de-globalization and have the opposite effects, namely they raise costs, squeeze profit margins, shrink markets, and lead to inflationary pressure. The impact of higher tariffs is similar to that of taxes. They make products more expensive, resulting in fewer purchases. They raise prices and reduce demand.
We’re optimistic that key aspects of the current trade conflict will be resolved and that tariffs will be repealed or, at least, the pending new hikes will be rescinded. But in the event this does not play out and tariffs are ratcheted up and used more broadly, it would be punitive for equity markets.