How Increasing Tariffs May Affect the Stock Market

Stock Market

President Trump escalating the trade war with China has weighed pretty heavily upon U.S. stock markets during the first two days of this week. How big of a deal is this?

Donald Trump’s engagement in the ongoing trade war with China took an abrupt turn for the worse on Sunday, with the president tweeting that he is planning on dramatically ramping up tariffs on Chinese imports. This was met by a devaluation of U.S. stocks on Monday, and although by the end of the trading day this loss was for the most part regained, Tuesday saw us give up even more room.

Late Tuesday. we were off about 700 points compared to Friday’s close, although a 200-point rally in the last 15 minutes trimmed the net loss since all this was announced to about 500 points, or about 2%. A 2% loss so far is far from something we should be too concerned about, unless you are a trader, and if so, you love markets like this because it’s easier to make money trading in these more volatile trading environments.

Some analysts are telling us that this is a good time to add more, taking advantage of this dip, and given that we are on an upward trajectory, that advice seems pretty sound. However, this is not so much about how this may affect our expectations of moving higher this year, which still seems reasonable, it’s more about assessing the risk involved.

There is a certain segment of the market that trades short-term momentum, and this is the group that drives moves forward or backward in a lot of cases where we get news and it is traded upon. It is the price action that tells the true story here, both in its response to events and to how the situation evolves from there.

We can just watch the charts though and see things unfold, but many want to look deeper into the matter, and in particular, what real effects that something like this trade escalation may have upon future stock prices, and it’s always about the future, whether that be a few minutes from now or a few years.

This momentum acts upon the market in various ways. There are different types of trends, the initial reaction to news for instance, over the first day or two, the nearer term, several days after, the more medium term, like the next few months, and longer-term trends like the 10-year bear market that we are in. It is important to focus on the market trends that match our own time frames, and therefore it makes no sense for an investor to worry very much about any of these events or anything that only sets us back a couple of percent, but those who trade shorter trends may need to pay attention to these things.

Looking Into What Is Behind All This

Charts tell us a lot about what is going on with these trends, but that doesn’t mean that there aren’t other things that we may consider in forming our opinions about stocks and the market. The best approach is to consider all evidence, but to do our best to maintain an understanding and perspective of what the information we look at really means.

A lot of this occurs at the reactionary level we could say, and these new developments in the trade war are a perfect example of this. Trump speaks, people sell, and they may not even be thinking all that much about why, much like Pavlov’s dog salivated at the sound of a bell. When we hear the bell and are tempted by it, we should at least consider what is really going on enough.

Trade restrictions are by their very nature inefficient, and both businesses and stock markets prefer more efficiency, not less. They actually have little to do with stocks though, at least in an intrinsic sense, but if investors and traders perceive a bigger effect here, this is what we will end up seeing.

It therefore is actually pretty academic to look at what we think should be happening, whether right or wrong, because stock prices are actually subjectively determined, and completely so in fact. If the market thinks that stocks should go down by a certain amount after a certain news item gets released, this is exactly what will happen, regardless of how much sense this makes.

U.S. tariffs, in themselves, can only serve to help American companies. Even though they may not help by very much, but this does place domestic goods in a better position theoretically at least. Foreign tariffs on U.S. goods are a different matter though, and you can pretty much count on that happening in response. This is the actual bell that is ringing, one that may leave your stocks with reduced earnings potential.

Earnings themselves don’t have any intrinsic influence on stock prices, but decreases in earnings does make the bell ring for a lot of people and the response to such stimuli is to want to reduce or exit their stock market exposures.

The two are therefore somewhat correlated, although there is plenty between the stimulus and response in this case, the human mind, which can respond in different ways as human minds often do. We buy stocks that lose a lot of money, and we also sell stocks that are doing very well, depending on our mood.

Earnings are actually quite optional at times for people to want to buy, and a company may be bleeding money, like Lyft for instance, who just booked a quarterly loss of over $9 a share with a stock valued around $60 these days, but people still form a line to buy such things, even though this may not make much sense..

This does bring to light just how forward-looking stock prices are, and is how a company who doesn’t even have a good plan out there to make money can be worth a good amount of money. Some people see some gold at the end of this rainbow and they are betting money on it.

The Effects of Tariffs

Tariffs themselves do have a contractionary effect upon the economy, although this is not anywhere as dramatic as people assume, at least with tariff levels of the moderate degrees that are being thrown around these days between the U.S. and China. Interestingly enough though, tariffs are inflationary, because they involve consumers spending more on things, and the price of things is what we use to measure inflation.

If companies are the ones putting up the prices, then they get the benefits of this extra spending, but this money is instead sucked out of the economy and into government’s coffers, since they are the ones collecting the extra money. This is where the real contraction comes from.

There’s also the threat of these things heating up inflation enough to provoke a response from central banks, even though it actually takes quite a bit more inflation than this could produce to cause such a thing. There is also talk by some of this being a reason for the Fed to lower rates, and there may be a little truth in this, but it’s only if growth declines enough that they would ever do such a thing.

As we saw last year, tariffs don’t really slow down growth all that much, and in fact it actually went up last year during this trade war. Should we start to see this number drop enough though, that could prompt the Fed to act. If this happens, this current mess could end up being a blessing for the stock markets, although the Fed isn’t keen on playing Santa Claus to it if they don’t have to.

The latest shot from Trump’s cannon only has value as a negotiating tool, and is bad for the economies of both the U.S. and China if just left to stand. What we need to be doing here if we are concerned about such things is to assess the risk of this happening, or worse, and the risk has definitely gone up now.

This is not unlike a schoolyard argument where words are exchanged, and then the parties start shoving each other around, and Trump just shoved the Chinese pretty hard. Aside from shoving back, this also tends to anger opponents and makes them less willing to extend their hand, especially if they feel that they are being intimidated.

If this gets worse, more investors will hear the bell ring, and the chances of this happening just went up. This is not anything to be alarmed about though, especially if you are a long-term investor with no current plans of selling as well has having a high threshold for the sort of pain people feel when markets drop.

Longer-term, beyond the current scuffle that we get a glimpse of here and there, it is simply better for the United States, China, the rest of the world, the economy, consumers, and stock markets that this gets settled in a positive fashion. This means less restrictions upon trade, not more, like we caught wind of on Sunday.

Even President Trump would benefit, given that he has married himself to the stock market so much and is now clearly playing the role of villain. If his main claim to fame is how much he has helped the markets, and this is a big plank of his, breaking this board will only leave a big hole in his campaign.

This issue clearly bears watching, as its potential to affect markets is much greater than just what the fundamental issues should cause, as this bell ringing more loudly could cause a lot of dogs to salivate.