What the U.S. Tariffs Mean for Investors

What Happened?

Global financial markets started off the week on a weaker tone after the new U.S. administration announced significant increases in tariffs on Canadian and Mexican imports, starting as early as this week. However, markets rebounded Monday after news emerged that tariffs on Mexican goods were postponed until March to allow more time for negotiations between the U.S. and Mexico. The tariffs on Canada also were postponed later Monday.

During this negotiation period, we expect Mexico, Canada and the U.S. to address key issues such as border security and trade policies. Mexican President Claudia Sheinbaum announced that Mexico agreed to reinforce its northern border with 10,000 National Guard troops to prevent drug trafficking, particularly fentanyl, from Mexico to the U.S.

Market Reaction

The S&P 500 Index fell 0.76% on Monday, led by the information technology and consumer discretionary sectors. Stocks in the auto sector, in particular, came under pressure given the risk to their supply chains, which rely heavily on Canadian and Mexican imports.

Bond markets also exhibited increased volatility and the yield curve ended the day flatter. Shorter-dated yields increased by 5 basis points while longer-dated 30-year bond yields declined by 3 basis points. Credit spreads of high yield bonds and investment grade bonds widened marginally, reflecting concerns over the stagflationary impact from the proposed changes in tariffs. The U.S. dollar strengthened against most major currencies, except the yen. The rally in commodity markets was broad-based with North American gas and crude oil market performing strongly on the back of the expected disruptions in the U.S.-Canadian energy infrastructure.

A Muted Market Response

Financial markets have been anticipating tariff actions for months, although there was no clear consensus on what exactly would be announced. We believe that most market participants believed these tariffs were designed as negotiating tools for the new administration and Monday’s market reaction suggests a negative overall impact on growth, with modest upward pressure on inflation and downward revisions to consumer spending.

Given the slim Republican majority in Congress, we think the tariffs are vulnerable to targeted retaliation measures implemented by Canada and Mexico. Evidence of such retaliation has already emerged, targeting export products manufactured in U.S. states with powerful Republican influence, such as South Dakota (home state of Senate Majority Leader John Thune), Kentucky and Tennessee. We believe that the tariff announcement represents the opening round of negotiations which should results in continued volatility in markets. We also expect that trade disputes will ultimately result in revised trade agreements, and therefore can also be resolved quickly.

What can investors do?

We believe the tariffs are likely to be temporary due to several factors. Firstly, we see the tariffs as a negotiating tactic rather than a long-term strategy, similar to the approach taken during the first administration of President Donald Trump. We think the objective is to leverage these tariffs to achieve more favorable trade terms rather than maintain them indefinitely. Additionally, the upcoming Canadian elections create uncertainty about the long-term stability of any agreements reached, making it less likely that the tariffs will be a permanent fixture. Moreover, the effectiveness of retaliatory measures by other countries in the past has shown that such tariffs can prompt swift and significant economic counteractions, which can exert pressure on the executive from within the Republican Party.

Diversification: We anticipate that political uncertainty is likely to remain high during the first few months of the new administration due to lack of policy details announced during and after the election campaign. We believe that diversified portfolios represent an effective tool to shield investors from increased volatility in markets. Investors should seek to identify sectors that are very exposed to tariffs risk and retaliatory measures.

Flexibility: We think investors should maintain a flexible investment strategy that can adapt to changing trade policies. This includes being prepared to adjust asset allocations and investment positions as new information about tariffs and trade negotiations becomes available. It is important to keep an open mind and adjust portfolios swiftly in case of a sudden removal of tariffs.

Quality: Investors may look to focus on companies that can withstand periods of economic uncertainty. Strong organic cashflow generation from diversified products and services as well as strong balance sheets may make these firms more insulated from economic uncertainty and trade disruptions. In addition, historically, stocks of firms with lower stock price volatility have provided strong risk-adjusted returns during previous downturns.

Time Horizon: We think investors should maintain a long-term investment horizon to ride out short-term volatility caused by tariff uncertainties and avoid large asset-allocation decisions based on short-term market movements.