T is for Tariffs

Successful long-term investing is hard enough without having to overcome the inevitable challenges of market volatility. Today, one cannot turn on the TV, get a phone alert, or read the paper (remember those?) without hearing about tariffs and related market volatility. It’s not just the tariff policy but the uncertainty around these policies that introduce additional volatility into the mix. The lack of clarity or clear policy direction surrounding future trade policies creates ripple effects throughout the markets and economy, affecting everything from corporate earnings to consumer prices.

Policy clarity is beneficial for both business leaders and investors. Business leaders may (or may not) agree with trade policy, but knowing the rules of the game makes it easier to run their businesses in search of maximizing profits and long-term planning.

WHAT IS A TARIFF?

At their core, tariffs are taxes or duties a government imposes on imported goods. They can serve multiple purposes, including trying to protect domestic industries from foreign competition, generating government revenue, and influencing trade balances. When a tariff is applied, the cost of the imported goods generally increases, making them less competitive compared to domestically produced or other alternatives. While this may benefit local manufacturers, it can lead to higher prices (inflation), slower economic growth, lower productivity, and friction with global partners.

WHO PAYS THE TARIFF?

Tariffs are often couched as being paid by the firm exporting the goods. The reality is that the cost of the tariff is typically paid by the importer, the company or entity bringing the goods into the country. The foreign company or country does not pay the tax, but the importing company pays the tariff to their own government. To account for this increased expense, importers often pass the increased costs along the supply chain, leading to higher prices for wholesalers, retailers, and ultimately, consumers. Or they may absorb much (or all) of the tariff by reducing their earnings.

Tariffs function as an indirect tax on domestic businesses and consumers who rely on imported goods and materials. Importers may be able to substitute from suppliers outside of the tariff area, but this may take time and often at a higher price that may be inflationary.

WHAT IS THE IMPACT OF POLICY UNCERTAINTY ON THE ECONOMY?

Tariffs have widespread economic implications. When governments hint at imposing or lifting tariffs but fail to provide clear guidance, businesses and investors are in a place of uncertainty. Companies may delay, pull forward, or cancel capital expenditures based on expectations. All can lead to supply chain disruption, with markets becoming more volatile as investors speculate on what might (or might not) happen next.

Policy uncertainty around tariffs also impacts investor sentiment. When markets are unsure about the rules of the game, they often see increased volatility. The recent history of U.S. tariff policy shows how sudden changes—whether through abrupt announcements, executive orders, or international trade disputes—can move markets unpredictably.

WHAT IS THE POSSIBLE IMPACT ON INVESTOR PORTFOLIOS?

The investor impact from tariffs comes down to everyone’s favorite position of “it depends”.

How long will the tariffs be in place? Are there carve-outs or target deals for specific sectors or industries?  Is the tariff policy understood, transparent, and consistently applied? How easy (or not) is it for companies to substitute or re-source the inputs from countries with tariffs. Each industry, sector, and company is different.

Apple illustrates how all of this can work.  Apple received a tariff exemption for imported goods from China during the first Trump administration tariff policies. And since that time, Apple has shifted approximately 10% of its iPhone production to India. If they are not exempted this round, a 10% tariff on Chinese goods would likely lead to higher prices and/or lower Apple earnings.  And likely a bigger shift of production to India.

U.S. Small-Cap Stocks

• U.S. small-cap companies generally have a domestic focus, meaning they generate a larger share of their revenues from within the U.S.  This could make them less sensitive to tariffs because they rely less on international trade.
• But there is more to small cap returns than impacts from tariffs: the interest rate environment, economic backdrop, investor sentiment, and financial health of each company. Small-cap stocks are not monolithic.

U.S. Large-Cap Stocks

• Large-cap companies tend to be more global in nature, often deriving a significant portion of their revenues from non-U.S. markets.
• They may face greater direct exposure to tariffs on exported goods but often have more diversified supply chains that allow them to adjust to changing trade policies, as highlighted previously in the Apple example.
• If tariffs lead to a slowdown in global trade, large-cap stocks may be hit harder than small-caps due to their broader exposure to global economic trends.
• But similar to small-cap stocks, the general economic backdrop, health of the company, sector, etc., can play bigger roles on returns.

HOW SHOULD INVESTORS RESPOND?

• Investors should stay focused on their long-term financial goals and try not to let short-term noise affect their behavior.
• Professional active managers may help navigate and take advantage of any short-term market dislocations.
• Famous investor Benjamin Graham had the great line – “In the short run, the stock market is a voting machine. But in the long run, it is a weighing machine” – meaning the news of the day may cause market volatility, but long-term returns are driven by earnings. Attractive earnings are rewarded.
• Investing is not only about U.S. stocks. A diversified, risk-managed investment approach will include thoughtful allocations to not only U.S. stocks but also non-U.S. large cap stocks, non-U.S. small-cap stocks, emerging market stocks, real assets and a wide range of fixed income opportunities.
• Heightened market volatility and uncertainty both reinforce the need for an investment approach focused on risk management to help improve investors’ odds of meeting their long-term financial goals.