Broker Check

Tariffs, Midterms and Volatility, Oh My!

| October 17, 2018

We’re certainly not in Kansas anymore, but where are we headed with all this tariff talk? Protectionism is in full force under the Trump administration, creating uncertainty and adding to market volatility.

Tariffs are a tax on foreign goods aimed at encouraging the consumption of home-made goods. Yet there is also a cost to the country setting them. As recounted in The Economist in regards to U.S. levied steel tariffs,

 “No doubt some American steel-company executives are pleased with Mr. Trump’s 25% tariff on imported steel. But domestic companies that buy steel to make higher-value products are miffed.”[1]

Clearly this isn’t just about steel tariffs, but a much wider array of tariffs; a large portion of which is earmarked on Chinese imports. It’s not yet clear who really pays the brunt of the tariffs. If China lowers prices for goods to access the U.S. markets, then its China who incurs the cost. However, if China does not lower prices it may be the U.S. consumer who incurs the cost.

As The Economist notes, “Around half of the products threatened with tariffs are intermediate goods, used by companies to make other stuff.”[2] These goods serve as a piece in a complex supply chain which may still result in a product sold domestically, but at a higher price.

While rising prices are a concern, there are no signs yet that tariffs are creating a surge in prices or creating a drag on economic growth domestically.[3]

In addition, some good news was announced on September 30th as Canada joined a post-NAFTA agreement, the United States-Mexico-Canada (USMCA) agreement. This is an encouraging sign that reconciliation with foreign nations can be reached.

Many investors are also wondering what the midterm elections mean for the markets. Years that include midterm elections have historically been more volatile and provided below average returns.[4] However, the last two months of the year following midterm elections have provided an average return of 4.24% for the S&P 500 Index[5].

In addition, regardless of whether government control is partisan or divided, returns and GDP growth have historically been positive. On average, greater market returns have been realized under Republican control while greater GDP growth has been realized under the control of Democrats.

 

What do tariffs and midterm elections have in common? Uncomfortable market volatility? Well yes, but why? Markets dislike uncertainty, and both tariffs and midterms are creating a lot of uncertainty lately. How do we address this uncertainty?

We believe the answer to this question is to have a plan with a long-term focus that allows us to tune out short term noise. This doesn’t mean we turn a blind eye to changes in the political landscape, but more so that we should view these changes through the lens of whether they’ve changed the fundamentals of our underlying investments.

While we acknowledge that uncertainty exists and there are risks worth watching, we don’t believe that these changes have resulted in a shift in how we view the long-term investment strategy for clients. We do believe however, that it’s a good time to review portfolio risk, time horizon and cash needs as we don’t anticipate much near term respite from stock market volatility.

[1]https://www.economist.com/the-economist-explains/2018/07/31/why-tariffs-are-bad-taxes

[2]https://www.economist.com/united-states/2018/09/08/who-pays-for-tariffs

[3]https://am.jpmorgan.com/us/en/asset-management/gim/protected/adv/insights/whats-going-on-with-trade-tensions

[4]https://am.jpmorgan.com/us/en/asset-management/gim/protected/adv/insights/do-midterm-elections-matter

[5] Source: FactSet, as of 9/30/18