As the results of the 2024 election are confirmed, the possibility of new tariffs and trade restrictions under President-elect Trump are back in the spotlight. Many investors remember the 2018-2019 trade conflict, often called “Trade War 1.0,” which primarily involved the U.S. and China. Now, with global protectionism on the rise, concerns about the impact of a potential “Trade War 2.0” are growing. But what does this mean for the economy, inflation, and stock markets? Here’s a simple look at tariffs and how they could affect investments, good or bad.

What Are Tariffs, and Why Do They Matter?

A tariff is essentially a tax on imported goods. When a country imposes tariffs on imports, it raises the cost of these goods. The goal is usually to protect domestic industries by making imported goods more expensive, encouraging consumers to buy home-grown products instead. However, tariffs can also trigger retaliation from other countries, leading to a “trade war” where each side imposes taxes on the other’s exports.

Key Takeaways from Trade War 1.0

In 2018-2019, the U.S. imposed tariffs on a range of Chinese goods. In response, China imposed tariffs on U.S. goods. The effects were closely monitored, with mixed results that suggest tariffs don’t always spell trouble for the stock market or economy:

1. Stock Market Impact: During Trade War 1.0, the stock market remained surprisingly resilient. The MSCI All Country World Index, which tracks global stock performance, showed that global growth and low inflation helped keep investors calm. U.S. stocks with international sales exposure even outperformed those focused on the domestic market.
2. Inflation Concerns: While tariffs can raise costs, inflation remained steady during 2018-2019. This was partly because companies found ways around tariffs, such as rerouting goods through other countries or negotiating lower prices with suppliers. During Trade War 1.0, inflation stayed around 2%, showing that tariff-related price hikes don’t necessarily result in runaway inflation.
3. Economic Growth: While tariffs can slow growth by making trade more costly, global trade volume actually increased over time. Companies adjusted by diversifying their manufacturing locations, moving operations closer to consumers, or importing through countries unaffected by tariffs.

These results suggest that while tariffs can add complexity to trade, companies and economies have ways to adjust.

Could Trade War 2.0 Be Different?

If a new trade war unfolds, the impact could be broader than Trade War 1.0, affecting not just U.S.-China trade but also trade with the EU and other regions. For instance, the EU recently increased tariffs on Chinese electric vehicles, which could lead to higher costs for European consumers and potential retaliation from China. Still, these scenarios don’t necessarily translate to a crisis. Let’s break down the possibilities.

1. Potential Market Volatility

• Stock markets may see short-term volatility as new tariffs are announced. For example, the largest stock declines during Trade War 1.0 were temporary, with markets typically stabilizing after initial reactions.
• Long-term investors may want to stay focused on their goals rather than making quick moves based on headlines. Stocks of U.S. companies with international exposure actually outperformed domestic-focused stocks during the last trade war.

2. Inflation: Higher Costs but Stable Prices?

• Tariffs could raise the price of imported goods, affecting consumers. However, companies have options—they can pass the cost to customers, absorb it, or find cheaper suppliers. In the past, companies found ways to keep inflation low despite tariffs.
• If a new round of tariffs emerges, inflation could rise slightly, but past patterns show it may remain manageable.

3. Growth and Employment: Mixed Outcomes

• Tariffs can support job growth in industries protected by trade restrictions. For example, more U.S. manufacturing jobs might be created if certain imports become pricier.
• However, industries relying on imported materials, like electronics or automotive, could see higher costs and lower profits if they can’t find affordable alternatives.
• Tariff-related changes could spur manufacturing growth in the U.S. or prompt companies to diversify their supply chains, which can be beneficial for local economies.

What Should Investors Do?

With protectionism rising, some may wonder if they should adjust their portfolios. However, Trade War 1.0 showed that overreacting to trade tensions might not be the best strategy. Here are a few tips:

• Stick to Long-Term Goals: If your portfolio is balanced and aligned with your goals, staying the course could help you avoid unnecessary losses from short-term market swings.
• Diversify for Stability: Diversifying investments across different sectors and regions can help reduce risk if trade restrictions impact one area more than others.
• Focus on Fundamentals: Trade headlines are just one factor in a company’s performance. Look for companies with strong fundamentals that can adapt to changing conditions.

A potential Trade War 2.0 could bring challenges and benefits. Some industries may thrive, while others face new hurdles. But the history of Trade War 1.0 shows that markets, companies, and economies can be resilient. By focusing on long-term plans and understanding the complex effects of tariffs, investors can navigate these changes with confidence.