Tariffs and the Recent Market Movements

Anybody who reads the news knows by now that the markets took a plunge yesterday. The S&P 500 fell 2.98% and is down 5.83% over the past five days. This is a pretty modest drop for a market that was up 17% so far this year, and some analysts were surprised it wasn’t worse, given the startling way the Trump Administration, seemingly out of nowhere, escalated the trade war with China by announcing a new round of tariffs. American voters did not vote for a policy where the country imposes tariffs on every single product that we import from a major trading partner.

There also seemed to be panic that the President doesn’t understand how tariffs work, given his recent (and repeated) proclamation that they are a tax on China instead of the American buyers of Chinese products. But here, the reality is that the President is not totally wrong. Yes, buyers of goods will tend to pay a higher price if the exporting company maintains the same pricing policies that it had in effect before the tariffs were levied. But many exporters will lower the price they demand in order to offset the effectively higher price in the U.S. market, eating some of the tariff’s bite in order to remain competitive. 

An alternative is that the foreign country might depreciate its currency, making its exports cheaper across the board and more than offsetting the impact of the tariff. This explains why China decided to stop defending the value of its currency almost immediately after the tariff announcement, causing the yuan to fall below seven to the dollar. The Trump Administration seemed to be caught off-guard by the move, and immediately branded China as a currency manipulator–a charge that would be hard to prove since the drop was entirely due to the movement of currency markets.

The result of the depreciation is that Chinese products will be instantly cheaper and more competitive around the world, regardless of the impact of U.S. tariffs, while Chinese buyers will have to pay more (in their currency) to buy American products. The Chinese buyers of American products are thus, indirectly, now paying a price for those tariffs.

Does the market drop signal the end of the bull market?  Nobody can say for sure, but it seems unlikely, given that the U.S. economy is still strong and enjoying the effects of a recent Fed stimulus. Second quarter earnings on the S&P 500 (with 387 of the 500 companies reporting) stand at $42.13, which is comfortably ahead of the $40.70 forecast for the quarter. There doesn’t seem to be a catastrophe on the near horizon, though at any moment the long bull market could turn bearish. History has shown that when stocks go suddenly on sale, due to a startling of the investment herd, it’s an opportunity to buy, rather than a good time to sell. But for the next few days, here at Kendall Capital we will be watching the markets, even if there is no plan to take dramatic action.