How Do Tariffs Impact Investments?

Today, tariffs and trade wars are the topic du jour. Donald Trump put his money where his mouth was and fired the first salvo of the trade war he’s talked about for so long. And markets swooned as investors try to figure out how long they’ll last, how these tariffs will impact their investments, and which stocks will benefit from tariffs…

Well, there’s no telling how long they’ll last, but there is certainty about what they’ll cause…

Inflation’s Resurgence

For those of you who weren’t sure, inflation, a persistent increase in the general price level of goods and services within an economy over a period of time, is a phenomenon that has plagued societies for centuries. 

While often discussed in abstract economic terms, inflation's impact on individuals and economies is profound and tangible. 

For individuals, inflation erodes the purchasing power of their income and savings, making it more challenging to afford basic necessities and maintain their standard of living. 

For economies, unchecked inflation can lead to uncertainty, reduced investment, and, ultimately, economic instability. 

While inflation had been relatively subdued in recent years, a confluence of factors suggests that we may be on the precipice of a resurgence, demanding our attention and proactive measures to mitigate its impact. 

Examining the underlying causes of this potential resurgence is crucial to understanding the dynamics at play and preparing for the challenges ahead. 

Several key factors contribute to inflation, each with its own unique mechanism and implications…

Demand-Pull Inflation: The Pull of Excess Demand

Demand-pull inflation arises when aggregate demand, the total demand for goods and services in an economy, surpasses the available supply that can be sustainably produced. 

This excess demand creates upward pressure on prices as consumers compete for limited goods and services.

• Historical and current examples of demand-pull inflation:

• Post-World War II Era: The end of World War II brought a surge in consumer demand, coupled with supply chain disruptions, leading to a period of double-digit inflation in the United States.
  
  
• The COVID-19 Pandemic Recovery: As economies reopened after pandemic-induced lockdowns, a rapid rebound in consumer demand, fueled by pent-up savings and government stimulus, outpaced supply chains still grappling with disruptions, contributing to the recent surge in inflation. 

This dynamic of demand exceeding supply is an ongoing concern as global economies continue to recover and consumers unleash pent-up demand. 

The current tight labor market, characterized by low unemployment and rising wages, further exacerbates this demand pressure, as individuals with increased disposable income contribute to a surge in spending.

Cost-Push Inflation: The Push of Rising Costs

Cost-push inflation occurs when the costs of production increase, forcing businesses to raise prices to maintain profitability. 

These rising costs can stem from various sources:

• Supply Shocks: Disruptions to the supply of crucial inputs, such as oil or raw materials, can trigger sharp price increases. The 1970s oil crises are prime examples, where OPEC's embargo and subsequent oil price hikes reverberated throughout global economies, causing a surge in inflation and a period of stagflation. The recent conflict in Ukraine has similarly disrupted energy markets and global supply chains, contributing to the current inflationary pressures.
  
  
• Rising Labor Costs: In a tight labor market, businesses often face pressure to raise wages to attract and retain workers. These increased labor costs can be passed on to consumers in the form of higher prices, further fueling inflation.
  
  
• Natural Disasters: Events like hurricanes or floods can damage crops and disrupt production, leading to price increases for affected goods and their derivatives. 

These cost-push factors are persistent concerns. The ongoing conflict in Ukraine, coupled with geopolitical tensions and potential climate change-related disruptions, suggests that supply chain volatility and commodity price increases are likely to continue. 

Similarly, as labor markets remain tight and workers demand higher wages to keep pace with the rising cost of living, businesses will continue to face pressure to raise prices, perpetuating the cycle of cost-push inflation.

Inflation Expectations: The Psychology of Inflation

Inflation expectations play a powerful role in shaping actual inflation outcomes. When individuals and businesses anticipate future price increases, they incorporate these expectations into their economic decisions, such as wage negotiations and price setting. 

Economist Milton Friedman emphasized the role of expectations, stating, "Inflation is always and everywhere a monetary phenomenon."

This perspective highlights the link between monetary policy, inflation expectations, and the resulting impact on prices. If the money supply grows excessively, it can trigger inflation expectations, leading individuals and businesses to demand higher prices and wages to protect their purchasing power, creating a self-fulfilling prophecy of rising inflation. 

Current trends indicate that inflation expectations are becoming entrenched. 

Consumers and businesses, having experienced a period of high inflation, are increasingly anticipating continued price increases, which is likely to influence their future economic decisions and perpetuate the inflationary cycle.

Expansionary Monetary and Fiscal Policies: The Fueling of Demand

Government policies, both monetary and fiscal, can significantly influence inflation.

• Expansionary Monetary Policy: Central banks, like the Federal Reserve in the United States, can lower interest rates to stimulate borrowing and spending. While this can boost economic activity in the short term, it can also contribute to inflation by increasing the money supply and fueling demand. The prolonged period of low interest rates following the 2008 financial crisis and the recent pandemic-induced stimulus measures are examples of expansionary monetary policies that have contributed to inflationary pressures.
  
  
• Expansionary Fiscal Policy: Government spending programs and tax cuts can also increase demand and contribute to inflation. For example, the large-scale government spending programs implemented during the pandemic, while necessary to support individuals and businesses, also fueled demand and contributed to inflationary pressures. 

The potential for future expansionary policies remains a concern, as governments grapple with economic challenges and political pressures to stimulate growth. 

Such policies, while potentially beneficial in the short term, could further exacerbate inflationary pressures if not carefully managed.

The Impact of Tariffs on Inflation

Recently imposed tariffs by the U.S. are adding to these inflationary pressures.

• Broad-based tariffs are expected to impact prices, increasing costs for both final goods and intermediate goods.
  
  
  
• The potential for increased consumer prices due to tariffs is a concern for investors, particularly those worried about a resurgence in inflation that could deter the Federal Reserve from cutting interest rates.
  
  
• Economists estimate that tariffs can contribute to core inflation and may also have a negative effect on the gross domestic product (GDP).
  
  
• The effects of mega-tariffs on the economy are not fully understood, making it difficult for the Federal Reserve to predict the impact on prices.
  
  
• The imposition of tariffs can lead to a decrease in corporate profits due to increased production costs and retaliatory measures from affected countries.
  
  
• If tariffs appear likely to remain in place for an extended period, it could lead to a sell-off in stocks and other higher-risk assets.
  
  
• The potential for tariffs to drive up consumer prices could disproportionately affect low-income households, which tend to spend a greater portion of their income on physical goods.

Details of U.S. Tariffs

The U.S. has recently imposed sweeping tariffs on Canada, Mexico, and China, leading to significant market turbulence.

• The tariffs include 25% on Mexican and most Canadian imports and 10% on goods from China.
  
  
• Initially, Mexico and Canada won a 30-day reprieve on the tariffs after agreeing to step up efforts to stop drug trafficking. However, the tariffs on China are still set to begin.
  
  
• Canada has announced retaliatory tariffs of 25% on $155 billion of U.S. goods, with the first set of tariffs taking effect soon…
  
  
• Mexico and China have also indicated they will take countermeasures.
  
  
• The tariffs are causing uncertainty in the markets and concern that they will undermine economic growth.
  
  
• The tariffs have caused the Chinese yuan to weaken to a record low, while the U.S. dollar strengthened against the Canadian dollar and Mexican peso. The euro also hit a two-year low…
  
  
• There is a possibility that the tariffs could be temporary because the White House has set general conditions for their removal.
  
  
• The executive order includes a provision for the U.S. president to increase the size and scope of the tariffs if affected countries retaliate.

Federal Reserve Response

Federal Reserve officials are concerned about the inflation risks associated with the tariffs, suggesting that this may delay interest rate cuts…

• Some Federal Reserve officials believe that the uncertainty over the impact of tariffs calls for a more cautious approach to interest rate cuts.
  
  
  
• The Federal Reserve is taking a wait-and-see approach with respect to the tariffs, but some officials are ready to stay on the sidelines…
  
  
• The Fed is being patient and has signaled there is no urgency for interest rate adjustments, given the uncertainty surrounding the impact of the tariffs.

Navigating the Inflationary Landscape: Investing for Resilience

Given the factors discussed, the prospect of a resurgence in inflation is a tangible threat that requires proactive measures to mitigate its impact. Understanding how inflation affects different asset classes is crucial for navigating this challenging economic environment. 

Historically, certain types of investments have tended to perform better during periods of inflation:

• Stocks: While inflation can impact corporate earnings, stock markets have generally outpaced inflation over the long term. Companies with strong pricing power, able to pass on rising costs to consumers, can maintain profitability in an inflationary environment.
  
  
• Commodities: Assets like gold, oil, and other raw materials have historically served as inflation hedges, as their prices tend to rise along with a general increase in prices.
  
  
• Real Estate: Real estate is often considered a tangible asset that can appreciate in value during inflation, and rental income can increase to offset rising costs.
  
  
• Inflation-Protected Securities: Investments like Treasury Inflation-Protected Securities (TIPS) adjust their principal value based on changes in the Consumer Price Index (CPI), providing a direct hedge against inflation.

To learn more about these inflation-resistant investments, what stocks benefit from tariffs, and how to incorporate them into a diversified portfolio, keep an eye out for my next article, where we’ll dig deeper into the sectors and stocks that will benefit from tariffs. 

Or, if you’re ready to make some moves right now, get access to our premium report, "Investing for Resilience: Three Ways to Profit BIG From Inflation’s Second Coming," right here.

Understanding the dynamics of inflation and taking proactive steps to protect your financial well-being is crucial in today's economic environment.