The measures, announced from the White House’s Rose Garden, include a baseline universal levy as well as targeted reciprocal tariffs.
What are the measures?
All countries now face a minimum baseline tariff of 10%, with higher rates applied to individual countries based on the value of their trade surplus with the US.
Corporates in China now face a 34% tariff on Chinese goods entering US shores. This is in addition to the existing 20% tariff already in place. Japanese companies face a 24% tariff, EU companies 20% and UK 10%. There are some exclusions to these rates, such as for steel, aluminium, various energy products and automobiles, which are subject to a separate tariff arrangement.
The tariffs are to be applied to the value of foreign produced content of goods with at least 20% US derived content. If the value of US derived content is below 20%, the full value of the good will face tariffs. Importantly, there are two clauses in the executive order which allow the US to raise tariffs further if a country retaliates; or to lower the tariff. So why would the US do that?
What is the purpose of the tariffs?
The preamble in the executive order, discusses the hollowing out of industrial and manufacturing activity in the US which had led to lower growth, a less diversified economy and greater reliance on imports, especially for a growing volume of critical materials. Recent events, such as the pandemic and the war in Ukraine, have shown just how sensitive global supply chains are. In the view of the US, this is now a threat to national security.
There is some merit to this argument. In economic terms, manufacturing activity is a higher productivity activity than consumption. Over years, the share of consumption in the US (and other developed markets) has increased substantially relative to manufacturing leading to lower growth rates. Additionally, in years past, manufacturing activity has led to higher research & development spending, which in turn has led to more innovation, more products and more growth.
However, there are also some flaws in this view. R&D spending in services can also lead to great innovation, such as in healthcare (drug development) and software (artificial intelligence).
But the overall impetus appears to be to reinvigorate US industrial activity, reduce reliance on imported goods (especially for critical materials in sensitive industries), thereby reducing the US trade deficit with the rest of the world, increasing productivity within the US and thereby lead to a more diversified economy on a more sustainable growth trajectory.
This ambition is commendable, but we do have concerns with the method by which President Trump has chosen to get there.
Changes of this size cannot be done overnight. It will take time to rebuild the US industrial base. With the tariffs are being applied next week, we expect a few things to happen.
First, as we saw with Mexico and Canada, we expect there will now be negotiations between the various countries affected by these US tariffs and the US administration. Other countries may offer some concessions through lowering tariffs, but we expect the sweeter offer will be to buy more US goods. It is almost certain the US will not be able to supply enough goods to balance the trade deficit in the short term. So how US tariffs may adjust is a big unknown. Will they come down through agreement to buy goods in the future or only as US goods are imported, and the US trade deficit is reduced?
Another is retaliatory measures. Indeed, China announced 34% retaliatory tariffs on imports of all US products from Thursday 10th April.
We also need to pay attention to news flow from companies. The only way in which the industrial base will be rebuilt in the US is by companies choosing to build manufacturing capacity there. There have already been several pledges, and we expect negotiations between the US and other countries will involve some “national champions” choosing to invest in the US.
Market implications
As these negotiations take place and as announcements are forthcoming, we expect there will be higher volatility in various markets, both in equities reacting to future growth prospects and bonds reacting to the future mix of growth and inflation.
The longer these high tariffs are in place, the greater the downside impact to economic growth will be and it would be negative for both the US and non-US countries. With inflation, we think this could mean higher inflation in the US and potentially lower inflation outside the US.
For now, we are not jumping to make changes to portfolios. The situation is and will continue to be very fluid over the next several weeks. If we see the rest of the world follow a similar path of negotiation to that of Canada and Mexico, we will likely have a more constructive investment outlook. However, if negotiations get increasingly hostile, it will challenge this stance.
The case for diversification
During times of stock market volatility, it’s important to keep an eye on the long term. Company management teams (and hence corporate earnings) are dynamic and will adjust to the operating environment and maximise profits for that environment. Our globally diversified mix of investments will benefit from these corporate earnings over time, and they are the primary driver of portfolio returns.
Time in the market and diversification have consistently been the foundations of successful investment strategies and that isn’t going to change no matter how much market noise there is.
We will provide further updates in due course, but please feel free to contact your EQ adviser if you would like to discuss any aspect of your investments.
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