There is no shortage of criticism from the business community directed at President Trump’s decision to impose steep tariffs on steel and aluminum imports.

 

While the U.S. steel and aluminum manufacturers stand to benefit, just about everyone else loses—from construction companies and auto, aero, and appliance makers to consumers, who will end up paying a bit more for cars and trucks, toasters and dishwashers, soda and beer, and anything else surrounded by steel or aluminum. Just as tax reform creates a sizeable tailwind for economic expansion, protectionist trade policies create the opposite, and investors know this, judging by last week’s market response. But trade policy must be played with long-term strategic goals in mind, and here, President Trump may be maneuvering the U.S. into a better position for future trade negotiations. The question now is, how best to position portfolios in case the government follows through with these tariffs and, more importantly, if trade partners respond with retaliatory measures.

 

The president of the United States has remarkable latitude in setting tariffs under Section 232 of U.S. trade law. Merely by citing “national security,” the president can impose tariffs on imports of any good that is deemed to threaten domestic industry. Since it is the essence of imports to serve as cheaper substitutes for production within our own borders, imposing tariffs renders every cheaper foreign-made product uncompetitive at the whim of the president. The temptation to protect a local producer from cheaper foreign alternatives has given rise over the last century to the development of international agreements to maintain comparatively unfettered trade in both goods and services. The latest are the World Trade Organization (WTO) for global trade, and the North American Free Trade Agreement (NAFTA) for promoting the freer exchange of goods and services among the U.S., Canada, and Mexico. These arrangements are by no means perfect. They have certainly caused reductions in or even eliminations of “Made in the USA” products, and claims of an uneven playing field have considerable merit. But they make possible much reduced costs of imports which in turn have allowed manufacturers using those imports and households consuming those imports to enjoy greater gains in economic growth and living standards than would have been possible under more protectionist regimes.

 

The most infamous example of such a regime was triggered by the Smoot-Hawley tariffs, enacted in 1930 in a misguided effort to help the U.S. recover from the Great Depression. It is now understood that those tariffs—and the retaliatory tariffs enacted by trade partners—were responsible for deepening and extending the economic decline of the Great Depression. So a return to a world where countries impose steep tariffs on cheap foreign imports is a return to a world of higher input costs for domestic firms and higher costs of living for households. In short, this is the opposite of the positive “productivity shock” that is tax reform, about which I wrote in a previous commentary. This time around, however, we are unlikely to see the breadth and severity of protectionist measures which were enacted in the 1930s.

 

The direct adverse effects of tariffs on steel and aluminum would most obviously be felt in the costs of products using substantial amounts of these metals, namely, cars, trucks, appliances and airplanes.  Beyond these, we are hearing loud complaints from the oil and gas sector, since the ongoing expansion of the U.S. shale industry requires specific types of steel (some not available from U.S. producers) to build the pipelines needed to carry oil and gas both to domestic markets and to enable now-growing exports. Infrastructure projects (think, bridges) would also suffer, as would commercial and residential high-rise construction. Consumers would, of course, face rising prices of a myriad of canned and wrapped products, but they are a diffuse group and so fail to carry much political weight. The saving grace is that the effects of these tariffs on goods prices will be modest; the estimated impact of higher metal costs on the average car is only about 1%. The more concerning repercussions of this policy move are likely to arise from our trade partners.

 

Canada and Mexico, already reeling from the U.S. threats to abandon NAFTA, are among the largest providers of steel to the U.S. market, accounting for 25% of total imports. China, with which the U.S. arguably faces the most uneven playing field in trade more broadly, is far down the list of steel suppliers at number eleven. A more focused country-by-country approach, if the desire is to pry open borders of countries with high tariff barriers, would likely have better results. South Korea, Germany, and Japan, among our most important geopolitical allies, are also top-10 suppliers of steel to the U.S. and already have comparatively open borders. Our most important trade partners have already threatened retaliatory measures which could take the form of tariffs or quotas (limitations on quantity) on U.S. exports. Boeing has been cited as one potential target and is particularly vulnerable since Airbus offers reasonably close alternatives to Boeing aircraft models. Although countries would be shooting themselves in the near-term foot with such retaliation (by raising costs inside their own countries), trade policy is a strategic, long-term game, and for this U.S. move to go unanswered is not how such games are won.  We will have to see if the retaliatory steps taken by others are as modest as the ones being implemented by the U.S.

 

When political headwinds such as these appear on the horizon, investors do well to look for sources of structural growth that would likely persist despite such headwinds–growth that will take place even through a downturn; growth that will occur because the forces behind it simply cannot be shutoff or paused. Now, perhaps the administration will soften its stance in the face of concerted pushback from industrial business groups and from allies. We have seen the President reverse course in other cases once the opposition puts together a counter argument.   But regardless of whether you think the positives of tax reform or the negatives of protectionism will win the day, portfolio strategy can be adjusted to serve the long-term investor.

There is no shortage of criticism from the business community directed at President Trump’s decision to impose steep tariffs on steel and aluminum imports.

 

While the U.S. steel and aluminum manufacturers stand to benefit, just about everyone else loses—from construction companies and auto, aero, and appliance makers to consumers, who will end up paying a bit more for cars and trucks, toasters and dishwashers, soda and beer, and anything else surrounded by steel or aluminum. Just as tax reform creates a sizeable tailwind for economic expansion, protectionist trade policies create the opposite, and investors know this, judging by last week’s market response. But trade policy must be played with long-term strategic goals in mind, and here, President Trump may be maneuvering the U.S. into a better position for future trade negotiations. The question now is, how best to position portfolios in case the government follows through with these tariffs and, more importantly, if trade partners respond with retaliatory measures.

 

The president of the United States has remarkable latitude in setting tariffs under Section 232 of U.S. trade law. Merely by citing “national security,” the president can impose tariffs on imports of any good that is deemed to threaten domestic industry. Since it is the essence of imports to serve as cheaper substitutes for production within our own borders, imposing tariffs renders every cheaper foreign-made product uncompetitive at the whim of the president. The temptation to protect a local producer from cheaper foreign alternatives has given rise over the last century to the development of international agreements to maintain comparatively unfettered trade in both goods and services. The latest are the World Trade Organization (WTO) for global trade, and the North American Free Trade Agreement (NAFTA) for promoting the freer exchange of goods and services among the U.S., Canada, and Mexico. These arrangements are by no means perfect. They have certainly caused reductions in or even eliminations of “Made in the USA” products, and claims of an uneven playing field have considerable merit. But they make possible much reduced costs of imports which in turn have allowed manufacturers using those imports and households consuming those imports to enjoy greater gains in economic growth and living standards than would have been possible under more protectionist regimes.

 

The most infamous example of such a regime was triggered by the Smoot-Hawley tariffs, enacted in 1930 in a misguided effort to help the U.S. recover from the Great Depression. It is now understood that those tariffs—and the retaliatory tariffs enacted by trade partners—were responsible for deepening and extending the economic decline of the Great Depression. So a return to a world where countries impose steep tariffs on cheap foreign imports is a return to a world of higher input costs for domestic firms and higher costs of living for households. In short, this is the opposite of the positive “productivity shock” that is tax reform, about which I wrote in a previous commentary. This time around, however, we are unlikely to see the breadth and severity of protectionist measures which were enacted in the 1930s.

 

The direct adverse effects of tariffs on steel and aluminum would most obviously be felt in the costs of products using substantial amounts of these metals, namely, cars, trucks, appliances and airplanes.  Beyond these, we are hearing loud complaints from the oil and gas sector, since the ongoing expansion of the U.S. shale industry requires specific types of steel (some not available from U.S. producers) to build the pipelines needed to carry oil and gas both to domestic markets and to enable now-growing exports. Infrastructure projects (think, bridges) would also suffer, as would commercial and residential high-rise construction. Consumers would, of course, face rising prices of a myriad of canned and wrapped products, but they are a diffuse group and so fail to carry much political weight. The saving grace is that the effects of these tariffs on goods prices will be modest; the estimated impact of higher metal costs on the average car is only about 1%. The more concerning repercussions of this policy move are likely to arise from our trade partners.

 

Canada and Mexico, already reeling from the U.S. threats to abandon NAFTA, are among the largest providers of steel to the U.S. market, accounting for 25% of total imports. China, with which the U.S. arguably faces the most uneven playing field in trade more broadly, is far down the list of steel suppliers at number eleven. A more focused country-by-country approach, if the desire is to pry open borders of countries with high tariff barriers, would likely have better results. South Korea, Germany, and Japan, among our most important geopolitical allies, are also top-10 suppliers of steel to the U.S. and already have comparatively open borders. Our most important trade partners have already threatened retaliatory measures which could take the form of tariffs or quotas (limitations on quantity) on U.S. exports. Boeing has been cited as one potential target and is particularly vulnerable since Airbus offers reasonably close alternatives to Boeing aircraft models. Although countries would be shooting themselves in the near-term foot with such retaliation (by raising costs inside their own countries), trade policy is a strategic, long-term game, and for this U.S. move to go unanswered is not how such games are won.  We will have to see if the retaliatory steps taken by others are as modest as the ones being implemented by the U.S.

 

When political headwinds such as these appear on the horizon, investors do well to look for sources of structural growth that would likely persist despite such headwinds–growth that will take place even through a downturn; growth that will occur because the forces behind it simply cannot be shutoff or paused. Now, perhaps the administration will soften its stance in the face of concerted pushback from industrial business groups and from allies. We have seen the President reverse course in other cases once the opposition puts together a counter argument.   But regardless of whether you think the positives of tax reform or the negatives of protectionism will win the day, portfolio strategy can be adjusted to serve the long-term investor.

About the Author

Dr. JoAnne Feeney

Dr. JoAnne Feeney

Dr. JoAnne Feeney is a Portfolio Manager and a member of the investment committee with Advisors Capital Management, LLC (ACM). Prior to joining ACM, Dr. Feeney was senior equity analyst for more than 10 years at boutique sell-side firms including...
About the Author

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