The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.
Trade policy was thrust into the headlines in early March with President Donald Trump’s announcement that he would impose stiff tariffs on imported steel and aluminum. Global markets fell sharply after the announcement, with the globally focused MSCI AC World Index giving up a large chunk of the gains it had clawed back following the volatility in early February.
Markets have risen since then, including on March 8, the day Trump signed the orders to impose the tariffs. But concerns surrounding the tariffs and what they might mean for global trade haven’t necessarily gone away.
So what’s going on here and what should investors focus on?
What’s in a trade war?
A big concern is that the tariffs might be the opening shot in what could become a broader trade war. When one country imposes tariffs to protect its domestic industry, other countries often retaliate. That could hurt U.S. exporters, which would mean reduced production and employment. And trade is a major engine of global economic growth, accounting for more than half of the global economy, according to the World Bank.
“Not every new tariff constitutes a trade war—metals have often been a target of U.S. tariffs with steel tariffs imposed by each of Trump’s recent predecessors in the White House,” says Schwab Chief Global Investment Strategist Jeffrey Kleintop. “However, although small in economic impact, these tariffs are symbolically important.”
Although the import tariffs themselves—25% on steel and 10% on aluminum—are steep, the administration has already exempted Canada, which is the top supplier of U.S. steel imports, as well as Mexico, the fourth-largest supplier. It has also suggested other countries could also get a pass. How all the non-exempt countries might respond remains a question, though.
For example, Brazil, the number two steel suppler behind Canada, signaled it may target U.S. coal exports. South Korea, the third largest supplier, has vowed to make a complaint to the World Trade Organization (WTO), but didn’t mention any specific retaliation. And leaders from across the European Union have threatened they could file a complaint with the WTO and retaliate, primarily focusing on some select U.S. agricultural products. In addition, EU President Jean Claude Juncker cited “tariffs on Harley Davidson, on bourbon and on blue jeans — Levi's” as potential targets of retaliation.
China is another question mark. The U.S. accounts for a relatively small share of China’s steel exports and it hasn’t made any specific comments about retaliating. However, the Trump administration is pursuing a separate investigation into allegations of intellectual property theft.
“This so-called Section 301 probe could raise a much larger risk of a trade war than the metals tariffs,” Jeffrey says. “This investigation could result in tariffs, quotas and investment restrictions.”
The agricultural sector could be particularly hard-hit if trade barriers rise because the United States exports more than it imports—and China is the biggest customer. Financial retaliation is also a risk. If tensions really heat up with China, it could threaten to reduce its holdings of U.S. Treasuries. While it’s unlikely China would dump its Treasury holdings, the mere suggestion that it could do so could be enough to push Treasury yields up. Because the U.S. runs large budget and current account deficits, it needs to import capital from abroad. Rising tensions with trade partners could make that capital more expensive.
Despite the fervor over the new tariffs and threats of retaliation, it’s worth noting that there are signs that the long-term trend toward free trade hasn’t reversed. Eleven Asia-Pacific countries, including Canada and Japan, signaled their commitment to global trade on the same day the tariffs landed by signing the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, a broad trade agreement that the United States pulled out of in 2017.
Why don’t markets like these kinds of tariffs? They tend to drive up inflation and hurt growth. They act as a tax on U.S. consumers, which can slow consumption. Since steel and aluminum are components of many products from beer cans to cars, companies that use these metals will need to raise prices and/or shrink their profit margins. Consequently, consumer prices are likely to rise, pushing up inflation.
And of course the effects are global, as many businesses source and ship materials and finished products all around the world.
“If the coming weeks reveal the start of a broader trade war, the average company in the MSCI AC World Index faces significant risks to profits with more than half of sales coming from international trade,” Jeffrey says. “But that exposure is not evenly shared across the globe, companies in some countries and regions have more exposure to world trade than others.”
“The equity asset class that may have the most to lose from a trade war is emerging market stocks, which tend to be more sensitive to changes in global trade than developed market stocks, in large part due to their greater dependence on overseas demand,” Jeffrey says. “A downturn in global trade volume—usually associated with bouts of global economic weakness—has historically led to emerging market stock underperformance.”
Tips for investors
Regardless of what happens on the trade front, investors should still aim for global exposure in their stock portfolios.
“The uncertainty surrounding trade is likely to leave markets on edge and prone to bouts of volatility in the coming weeks and months. Don’t forget, beyond the tariff questions and China investigation, negotiators are also discussing both NAFTA and Brexit,” Jeffrey says.
“The world has increasingly become one global marketplace in which companies sell and operate,” he says. “To get true global exposure, 25%–50% of the stock portion of your portfolio should be invested outside the United States.”
What You Can Do Next
Changing economic conditions can affect how each component of your portfolio performs. It’s impossible to predict which one will be the top performer in any given year—that’s why diversification is so important. Want to talk about your portfolio? Call Schwab at 800-355-2162, visit a branch or find a consultant.
Watch Schwab experts discuss other market and economic topics in the Schwab Market Snapshot.