Tariffs Shock Markets! What Now?

Analysis of Trump's Tariff Announcement

Key Concepts:

• Reciprocal Tariffs: Tariffs imposed by a country in response to tariffs imposed by another country.
• Implied Tariffs: A calculated tariff rate based on trade deficit, exports, currency manipulation, and trade barriers.
• Negotiation Ploy: Using tariffs as a bargaining chip to encourage other countries to lower their trade barriers.
• Volatility: The degree of variation of a trading price series over time.
• Algorithmic Trading (Algos): Trading orders generated using automated pre-programmed trading instructions.
• Pricing Power: The ability of a company to raise prices without significantly affecting demand.
• 10-Year Treasury Yield: The yield on a debt obligation issued by the U.S. government that matures in 10 years.

Market Reaction and Initial Assessment

On April 2nd, Trump announced reciprocal tariffs that were "shocking" and "worse than what the market expected." The market reacted negatively, with Dow futures down 1.97%, S&P down 2.69%, and NASDAQ futures down 3.19% after hours. The speaker admits being wrong in his initial expectation that the tariff announcement would be less severe. However, he questions whether the situation is as dire as the media portrays it.

Tariff Details

Trump imposed significant tariffs on various countries: 34% on China, 20% on the EU, and 46% on Vietnam. These tariffs have sparked fears of a trade war, potential global economic slowdown, and market crash.

Intentions Behind the Tariffs

The speaker identifies two main intentions behind Trump's tariff announcement:

1. Negotiation for Lower Tariffs: The primary intention is to pressure trading partners to lower their tariffs and reduce trade barriers, creating a "level playing field." Trump argues that other countries have unfairly imposed tariffs on the US for decades, leading to a trade deficit. The US is now imposing "reciprocal tariffs," matching the tariffs imposed on them. The figures cited are "implied tariffs," calculated using a formula that considers trade deficit, exports, currency manipulation, and trade barriers. For example, the US claims China has implied tariffs of 67% on US goods, justifying the 34% tariff.
2. Lowering Treasury Bond Yields: The second intention is to lower the 10-year Treasury bond yield, reducing borrowing costs and interest rates. This has been observed as the 10-year Treasury yield has fallen to 4.06% following the announcement.

Tariff Implementation Timeline and Potential Modifications

A base 10% tariff rate on all countries will start on April 5th. The additional, higher tariffs based on reciprocation will take effect on April 9th. Trump's White House statement indicates that if any trading partner takes "significant steps to remedy non-reciprocal trade arrangements" and aligns with the US on economic and national security matters, he may "modify, to decrease or limit in scope the duties imposed." This suggests that the tariffs are a negotiation strategy with a deadline.

Potential Responses from Trading Partners

The speaker outlines three potential responses from US trading partners:

1. Negotiate: Lower their tariffs and trade barriers.
2. Do Nothing: Accept the higher tariffs.
3. Retaliate: Increase their tariffs even further.

Mexico, Canada, Japan, Korea, India and the UK are already negotiating. The EU (specifically Germany and France) is considering retaliation. China's response is uncertain. The speaker believes that if most countries negotiate, the EU will eventually follow suit, and the high tariffs will not last long.

Investment Strategy During Volatility

The speaker advises that short-term traders with high leverage could be "screwed" by the market volatility. However, long-term investors (6 months to 3 years) should see this as a "fantastic opportunity" to buy great businesses at discounted prices due to panic selling and forced selling by brokers. He notes that 70% of market activity is driven by high-frequency algos that react to price action, not the underlying value of businesses.

Assessing the Impact on Specific Sectors and Companies

The speaker emphasizes the importance of assessing whether the underlying business of a stock will be directly affected by the tariffs. He primarily invests in consumer discretionary, technology, communication services, financials, healthcare, and consumer staples.

• Materials: Steel, aluminum, and chemicals will be affected (copper is exempted).
• Industrials: Machinery, transportation, and logistics could be affected.
• Consumer Discretionary: Apparel, textile, autos, and furniture will be affected. Nike is the only stock in his portfolio that might be directly affected.
• Consumer Staples: Food products face the risk of retaliatory tariffs and higher equipment costs. Hershey's and PepsiCo could be affected due to input costs like cocoa, sugar, and aluminum.
• Technology: Only the electronics part of technology companies will be affected (semiconductors are exempted). Apple may not be significantly affected due to its strong brand, pricing power, and recurring service revenue.

The speaker believes that most of the companies he owns will not be directly affected by the tariffs and that any price drops will be due to short-term panic or manipulation, creating buying opportunities.

Silver Linings and Portfolio Diversification

The speaker highlights a "silver lining": the decrease in the 10-year Treasury yield, which lowers borrowing costs and benefits assets like REITs. His dividend portfolio, mainly comprised of Singapore-listed REITs, has performed well. He emphasizes the importance of a well-diversified portfolio across different sectors (technology, financials, healthcare, consumer staples) and investment styles (growth stocks, defensive stocks, stocks for capital gains, stocks for dividends, and REITs) to ensure growth under various economic conditions.

Conclusion

The speaker views Trump's tariff announcement as a negotiation strategy and believes that most countries will eventually negotiate, leading to a resolution. While short-term market volatility is expected, long-term investors should see this as an opportunity to buy quality businesses at discounted prices. He stresses the importance of assessing the direct impact of tariffs on individual businesses and maintaining a well-diversified portfolio. He concludes by quoting Winston Churchill: "Never let a good crisis go to waste."