Global equity returns were excellent in 2017. Inflation remained low as central banks like the U.S. Federal Reserve and Bank of England increased borrowing costs only gradually. The economy showed renewed strength in Europe, Japan and many developing nations which in turn increased demand for U.S. products. By November the Labor Department reported the 86th straight month of job gains – the longest on record. In December, the U.S. Tax Cut and Jobs Act was passed, encouraging companies to return $305.6 billion to the U.S. from overseas accounts, while the top corporate rate reduction from 35% to 21% raised expectations for corporate profits and future stock prices.
In November, Goldman Sachs, along with many others in the financial industry, predicted 2018 would be ‘as good as it gets’ with a projected 4% GDP growth and a golden outlook for stocks. But this year’s daily drama over tariffs and the potential for a global trade war has left investors confused, resulting in wide swings in the U.S. and overseas equity markets. While normal market behavior includes fluctuations in daily market prices, the addition of 10% and 25% tariff costs and the threat of more has had a major impact.
Why do tariffs matter so much?
When any government puts a tariff, which is basically a tax, on goods brought into the country it does so with the intention of helping businesses inside its borders. Tariffs cause the cost of imported goods to go up, making products manufactured inside the country comparatively less expensive and encouraging businesses and individuals to buy from a domestic source. In theory, it sounds like an ideal way to influence buying behavior and boost businesses inside a country.
When President Trump ran for office, he promised he would revitalize manufacturing jobs in the U.S. by withdrawing from the Trans-Pacific Partnership, the North American Free Trade Agreement and by imposing tariffs on goods made in China and Mexico. Tariffs have been used as a tool by presidents from both political parties throughout history, as I outlined in my blog in March, but they have rarely benefited the majority.
Problems arise when opposing countries begin setting their own retaliatory tariffs, and collateral damage is done to other businesses when their manufacturing costs climb, their export sales to other countries drop, or the domestic companies they do business with suffer and cancel orders. When global trade expanded over the last decade, companies expanded their sources for raw materials, allowing them to lower their manufacturing costs, increase profits, and keep prices lower. The tariffs implemented May 31st by the Trump administration on steel and aluminum imports from Canada, Mexico and the European Union (EU) are already having an impact on the global economy, and we are just beginning to see the results.
Much attention was focused on Harley-Davidson after its announcement that it was moving some of its production abroad in response to retaliatory tariffs the EU imposed on steel and aluminum imports. The tariffs are expected to increase the price of a Harley by $2,200 for European consumers, while manufacturing the same motorcycle in Europe would avoid the tariffs and keep prices at current levels. President Trump accused the company of using the trade dispute as an excuse to move jobs overseas.
Mid-Continent Nail in Bluff, Missouri laid off 60 of its 500 employees last week because orders dropped 50% when they were forced to raise their nail prices to cover the increased cost of steel imported from Mexico. The company has doubled its workforce since 2013 due to demand for its products, but with the current drop in sales they expect to shut down production by Labor Day. The company filed for a tariff exclusion, but there are currently 21,000 companies in line ahead of them, so their request will not likely be reviewed soon.
Down the road from Mid-Continent Nail is the SEMO Box Company, which regularly shipped a tractor trailer load of corrugated boxed to Mid-Continent every day. Because of the decline in sales Mid-Continent doesn’t need the boxes, so SEMO had to lay off 4 of their employees.
Then there’s the price impact on things we use on a daily basis. According to a 2016 article in MIT Technology Review, assembling an iPhone entirely in the U.S. out of U.S. made components would add $100 to the cost. And that calculation was two done years ago.
All the positive economic developments that came together in 2017 for a rosy outlook may be outweighed by the implementation of tariffs and quotas. More tariffs are being considered on global auto imports and $200 billion of Chinese Imports. Toyota has already weighed in on the debate, while others have provided feedback as well.
U.S. companies receive nearly 40% of their revenue from international sales, and the U.S. is becoming a major oil and natural gas exporter. In the first 10 months of 2017 China was the second largest importer of U.S. crude oil, behind Canada. Amid the China/U.S. tariff fight, the U.S. State Department is asking Asia to open its borders, so U.S. companies can sell their excess natural gas. To quote Francis Fannon, the assistant secretary of the State Department’s Bureau of Energy Resources, “The United States remains resolute in the stance that this competition must be guided by open trade, where economies can compete on the basis of the quality of their goods and services, not the level of pressure or coercion governments are capable of inflicting.”
I couldn’t agree more.
While it’s disappointing to see governments get in the way of a healthy economic expansion, we’ve been through worse over the last 30 years, and have overcome these challenges to help our clients maintain their lifestyles and meet their goals. We can’t influence the Trump administration, but we can use one advantage we have – our disciplined investing approach that uses the market swings to our clients’ advantage.