By: Brent Schutte, CFA
Strong earnings reports and news of more trade deals struck with the U.S. helped stocks continue their march higher last week with all three major indices notching gains. Late last week, the Trump administration announced it had reached a deal with Japan. The deal included promised investments by Japan in the U.S., but the centerpiece of the agreement was setting tariffs at 15 percent on goods including automobiles imported from Japan. Prior to the deal, levies on vehicles imported from the country were subject to section 232 tariffs of 25 percent. That deal was followed by an announced agreement on Sunday with the European Union (EU). Investors reacted to the Japan news and expectations that a deal would be made with the EU by bidding up stocks, as the new tariff rates are lower than the level initially proposed on April 2, when the administration announced what it dubbed reciprocal tariffs. It also was seen as potentially establishing a framework for future deals with major trading partners ahead of the August 1 deadline the administration has set.
To be sure, the deals agreed upon bring the tariff rates on the two countries below levels announced in April, yet they are much higher than the levies that were in force prior to April. These latest deals along with the tariffs still in effect on steel, aluminum and copper bring the average trade-weighted tariff rate on all goods from trading partners around the globe closer to 20 percent than 10 percent—a level that would have been viewed as significant before the first round of global levies were announced. However, the level is largely being met with a shrug likely for two reasons: First, as more deals are reached, uncertainty surrounding what the trade-weighted level of levies has diminished; and second, the impacts of the levies have mostly shown up in survey data and not hard figures such as jobs reports and inflation data.
Where uncertainty remains—and what some investors may be overlooking—is the fact that it is still unclear how the tidal shift in trade policy will ultimately play out in the economy. Last week brought more signs of the higher trade costs seeping into hard data and leading to additional bifurcation in the economy. To date, most of the impact has not shown up on Main Street. It is unclear if that can continue over the long haul.
Several companies have come out this earnings season reporting the effect tariffs are having on financial results. For example, net income for General Motors tumbled 35 percent in the most recent quarter due to $1.1 billion in additional costs due to tariffs, according to the company. Toymaker Mattel has come out with estimates that tariffs will cost the company $100 million for the year. We note these examples not as a judgement of the administration’s trade policies but to highlight that, so far, companies have been willing to bear the brunt of higher costs from imported raw materials and goods. The longer the duties are in effect, the greater the risk is that companies will start to attempt to pass along increased costs to consumers. Additionally, now that more and larger trade deals are being inked, companies that previously had taken a wait-and-see approach before hiking prices may no longer feel the need to hold off.
In the meantime, while inflation has remained relatively mild, soft data shows trade policy is reopening the economic gap between businesses/sectors that are doing well and those that are struggling due to elevated interest rates and higher costs. The latest Purchasing Managers Index from S&P Global, which we detail later in the commentary, shows that manufacturers are facing a steep rise in input costs and that the demand that was pulled forward as customers tried to get ahead of tariff-related price increases has led to weaker demand in the months since. At the same time, we believe absent an abrupt deterioration of the job market, the Federal Reserve will likely be hesitant to cut rates until it has a better understanding of whether tariffs will cause a one-time uptick in prices or a sustained rise in inflation. As such, we believe this will continue to strain areas of the economy, such as real estate, that have already been feeling the effects of high interest rates.
It is possible that as more trade deals are announced, the level of uncertainty that has hovered over business and the economy will ease. Additionally, the impact of final trade deals could be less than originally forecast after the April 2 announcement of reciprocal tariffs. Similarly, easing of regulations and stimulative policies included in the recently passed tax and spending bill, such as immediate expensing of capital expenditures for businesses, are expected to boost growth. Simply put, we believe it may take several more months before investors know for sure the extent to which the administration’s efforts to change the global economy and the role of the U.S. in trade will impact domestic growth. As a result, we still believe it is too early to sound the all-clear.
About the Author:
Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
