Key Takeaways from Strategas Research Areas

Investment Strategy

Jason Trennert, Chairman, Chief Investment Strategy

Facts on the tariffs that the U.S. has imposed on Canada, Mexico, and China:

1. President Trump imposed 25% additional tariffs on all imports coming from Mexico and Canada and 10% additional tariffs on all imports coming from China. Energy resources from Canada will see reduced tariff rates of 10%.
2. The administration suspended the “de minimis” exemption for packages valued at less than $800 addressed to individual buyers in the U.S. This exemption has been seen as a boon for Chinese ecommerce retailers.
3. The primary rationale given for the new tariffs is the leverage the administration believes it will give the U.S. to stop illegal immigration and the import of fentanyl and other dangerous narcotics.
4. Secondary justifications given were the impact of illegal immigration on wages, social services, crime, terrorist entry, and human trafficking.
5. Gross trade (imports plus exports) makes up 67% of Canada’s GDP, 73% of Mexico’s GDP, and 37% of China’s GDP. Trade makes up 24% of U.S. GDP.
6. The United States’ total trade deficit is roughly -3% of GDP.
7. Spending on services makes up over 80% of the American economy. Despite being a much smaller portion of the economy, spending on goods and manufacturing makes up a greater share of the volatility of the economy.
8. The value of total imports of goods into the U.S. is about $3.3 trillion. Total personal income in the U.S. is roughly $25 trillion. A 25% increase on all goods imported into the U.S. would be roughly equivalent to a 3% tax increase on all income.
9. Any attempts to retaliate against these tariffs will result in additional tariffs, according to the Trump administration.

Our opinions on the above facts:

1. The Trump administration prefers bilateral trade agreements to large multilateral agreements and is willing to use economic tools to achieve non-economic goals.
2. In the short-term, tariffs are likely to increase financial market volatility, raise long-term interest rates, and lower earnings multiples.
3. Gold’s recent ascent has been sniffing out these moves, serving as a safe-haven asset in times of volatility and as a hedge against currency devaluation.
4. Broader, long-term implications of these tariffs for inflation are difficult to assess due to the potential of U.S. consumers to switch to lower cost domestically produced goods if available as well as currency market fluctuations, and the duration of the tariffs put in place.
5. At the margin, these tariffs should encourage more domestic production of goods in the United States.
6. Small-cap companies with access to relatively cheap funding may outperform large-cap stocks with international operations.
7. On comparisons to the tariffs that preceded the Great Depression, we note that the Smoot-Hawley Tariff Act (1930) came in the context of a steep decline in money supply, greatly increased regulations on business, and higher taxes. Today, there is an attempt to keep taxes low and reduce the regulatory burden; how the Fed will react to the increase in tariffs is yet unknown.
8. Tighter trade policy increases the need for the stated policy cushions of an extension of the 2017 Tax Cuts and Jobs Act (TCJA), lower oil prices, and easier regulatory policy.
9. It also increases urgency for artificial intelligence to show real-world productivity gains in the United States.

Economics

Don Rissmiller, Chief Economist

It seems clear that the new administration won’t be constrained by previous global norms of trade treaty obligations, even with friendly neighboring countries, and is intent on changing the patterns of global trade. At this point, backtracking looks impossible – the ships have been burnt. Yet reducing status quo trade flows quickly can present risk for (elevated) U.S. asset valuations. Having inflation firmly anchored would free up other tools (e.g., monetary policy easing) and could reduce this risk.

1. What happens now? The auto and farm sectors are at particular risk (there’s the potential for retaliation and one-time level price shifts up). However, there are some checks and balances. As noted above, impacted parties will likely bring a legal challenge to use of the IEEPA. In the meantime, tariff (tax) revenue should lower projected Treasury issuance, the debt ceiling-induced liquidity bazooka provides a cushion, and currency markets could offer some built-in offset to tariffs if the U.S. dollar strengthens. Further, local consumers can still substitute non-affected products (for now). Producers may also aim to hold their market share, limiting price pass-through, if they believe the duties to be temporary.
2. Supply chain challenges could create an inflation issue, but slowing rents are likely a limiting factor for now. The rent component of key U.S. inflation metrics like the Consumer Price Index (CPI) has a heavy weight but moves very slowly. The Bureau of Labor Statistics (BLS) also produces a New Tenant Rent Index quarterly. This indicator leads the shelter component in the official data, and it plunged in Q4.
3. The Fed likely wants to gather more data (especially concerning policies they do not control – fiscal, trade, regulatory). In a unanimous decision, the fed funds rate was held unchanged at 4.25-4.50% last week. The FOMC statement offered little guidance on what comes next. Fed Chair Powell noted that he thought policy rates remained “meaningfully restrictive.” He reiterated that the U.S. inflation target is 2%, and that is not going to be up for discussion any time soon. The Fed statement cut a phrase about inflation moving toward the target that had been in previous statements, but Powell noted in his press conference that this was about cleaning up the language of the statement (rather than being intended as a signal).
4. The economic data are likely good enough for a Fed pause, though central banks abroad may see things differently.S. real GDP rose at an adequate, but not gangbusters, 2.3% q/q annual rate in Q4 (it was held back by the volatile inventories component). U.S. initial jobless claims fell last week to 207,000. No problem there in the timely data. The US inflation picture is neutral currently – not quite to the Fed’s target, but not that far off. The PCE deflator (the Fed’s preferred inflation gauge) was +0.3% m/m in December (2.6% y/y). Core PCE inflation was +0.2% m/m (2.8% y/y).
5. The Fed remains in a rate cut cycle, in our opinion, but pausing longer would buy time to gather data. We continue to believe that the next Fed rate cut will be in June.
6. To counter disruptive economic policies, other boosts are needed. Key U.S. government supports available are 1) extended tax cuts (more growth); and 2) lower energy prices (less inflation). Both look necessary. The private sector can also bail out the public sector with productivity gains (more growth and less inflation). Instead of having too much money chasing too few goods, productivity increases the goods. With the unemployment rate low (~4%) there’s little slack in the U.S. economy. With a combination of disruptive policies and cushions, real economic growth could stabilize around potential (which we believe is +2% in the US), and the debate will become what longer-term inflation rate and interest rate accompanies that trend in activity. Growth abroad is at risk more immediately.
7. The U.S. economy has underlying momentum with the unemployment rate low. But domestic “full employment” has been supported by an accumulation of debt. This system may be close to a political inflection point. Absorbing a large disruption to international capital flows – which have supported U.S. assets – could prove disruptive. Valuations would be at risk. There are tools that could help cushion the blow, e.g., monetary policy easing (which is underway), but the Fed’s inflation mandate is a key constraint. Viewed in this light, it makes sense to be certain that inflation is anchored, freeing the Fed to act to support the economy if needed, before disrupting the current trade system too aggressively.