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On Thursday (3/1/2018), investors were caught by surprise with President Trump’s announcement to impose a 25% tariff on imported steel and a 10% tariff on imported aluminum.  Not welcome news.  Tariffs benefit few – yet harm the majority.

“16 US steel stocks market cap up $1B as a result of tariff announcement today. Rest of S&P 500 down $400B. “Making Americans Poor Again.” (H/T Smails).”
– Doug Kass, March 2, 2018

I was at a charity event Thursday night and a building supply executive told me how wonderful (sarcasm) his day had been.  His phones were ringing off the hook with customers freaking out.  Why?  Their metal supply division was told to prepare for significant price increases and to pass along the price hikes to its customers.  Notice the words “pass along?”  Price hikes will be passed along until it hits consumers’ wallets – higher prices.  Economics 101 tells us higher prices lead to lower demand.  Lower demand = less jobs = slower economy.

In a scathing editorial, Thursday, March 1, 2018, the Wall St. Journal blasted President Trump’s decision.  “Mr. Trump seems not to understand that steel-using industries in the U.S. employ some 6.5 million Americans, while steel makers employ about 140,000. Transportation industries, including aircraft and autos, account for about 40% of domestic steel consumption, followed by packaging with 20% and building construction with 15%. All will have to pay higher prices, making them less competitive globally and in the U.S.”

Risks to global economic growth and the prices of risky assets (i.e. stocks) increases if this sets off a trade war and other countries retaliate by socking US exports with tariffs.  Escalation could undo the pro-growth initiatives Trump has put forward since being elected.  Trump is the master of negotiation – is this just a punch in the face to our global trading partners where he uses this to negotiate better trade deals?  We won’t know for some time.  Regardless, right now his move appears STUPID.

Looking at the stock market and the fundamentals:

Stock returns come from 3 sources:

  1. Dividends
  2. Earnings growth
  3. Fear and Greed = what investors pay for #1 and #2

Currently, #1 and #2 still look very good. Earnings are estimated to grow over 10% this year (source: FactSet).  Dividends paid to shareholder are increasing the most since 2014 and over 20% of companies have raised dividends this year (source: S&P Dow Jones Indicies).  Tax-cuts have companies flush with cash which can be used to buy-back stock.  This should be supportive for prices.  However, Trump’s announcement to potentially start a trade war increases uncertainty and reflected in increased fear (#3).  Investors may not want to pay as high multiples for stocks which leads to lower prices.

For now, there is no change in our base case which is that we will not see a recession and we will avoid a bear market.  The bear case, where a trade war escalates and drags global economies into recession, odds have increased.

Either way, “Making Volatility Great Again” seems the theme for 2018.

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Jon Giordani is Chief Investment Officer for PSG.  He provides innovative investment planning strategies to our clients.