How Worried Should Traders Be About Tariffs?

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For those of you that took a course on U.S. history in school, you probably remember the grainy photos of Senator Reed Smoot and Representative Willis Hawley shaking hands outside the capital building in 1930 after the passage of the Tariff Act of 1930. This was an important turning point in the U.S. economy because, while the act didn't cause the Great Depression (it had already begun in 1929), the consensus is that it worsened economic conditions and lengthened its duration.

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Comparing the Smoot-Hawley tariffs and the currently proposed 25% tax on imported steel and 10% tax on imported aluminum is admittedly egregious, but, while the scale is clearly much different, the lessons learned from unilateral tariffs are important. Additionally, while the focus of the current tariff talk is narrow, expectations for future trade conflicts can have a larger-than-expected effect on prices and volatility.

Who Benefits From the Tariffs?

The justification for the tariffs is the fact that steel and aluminum is being "dumped" on the U.S. economy, which hurts domestic suppliers. While it's a little complicated, the basic facts are generally true. From there, it's easy to assume that if the cost of foreign steel is increased through a 25% tariff, then domestic producers should do better because they have a cost advantage.

If that assumption is true, then why aren't steel and aluminum producers in the market getting a bigger premium?

The chart below shows the share price of Timkensteel Corp (NYSE: TMST ). The company has lobbied hard for a tariff, and there is no doubt that foreign dumping has hurt the business. However, even with the anti-tariff Gary Cohn leaving his White House position - director of the National Economic Council - investors are not putting much additional value into the stock.

The issue is one of supply and demand. Tariffs do a good job of raising the price of foreign steel, but, on average, domestic producers have historically raised their prices as well to match the cost of imports. There is no reason to believe that it would be different this time. The increased cost of steel hurts the demand side of the industry, and the potential benefits of anti-dumping measures are offset by reduced demand for steel and reciprocal trade tariffs from international partners.

TimkenSteel (NYSE:TMST): Chart source -

This is an oversimplification of the problem, but adding the complexities doesn't improve the picture. Is aluminum that's mined in Western Australia and refined in Brazil subject to U.S. import tariffs if it is a U.S. company doing the mining and refining? Will U.S. producers that export steel and equipment be hurt more by tariffs from international partners than helped by higher prices? What about exports that the U.S. "dumps" (like certain agricultural commodities) on international markets - will those be subject to tariffs internationally?

As usual, the problem is that government isn't good at picking the winners and losers in the economy. Tariffs might theoretically help AK Steel Holding Corporation (NYSE: AKS ), United States Steel Corporation (NYSE: X ) and TimkenSteel, but it will likely hurt Ford Motor Company (NYSE: F ), Harley-Davidson Inc (NYSE: HOG ), Monsanto Company (NYSE: MON ), DowDuPont Inc (NYSE: DWDP ) and others.

This is not an argument about whether export-dumping is fair or not. Clearly, there are real jobs and companies at stake, but, historically, tariffs tend to be a zero-sum game at best. For any jobs saved, there are usually offsetting net job losses.

The Bottom Line

Traders were willing to brush off concerns about tariffs considering the limited scale and assumptions that anti-tariff voices in the White House would persuade President Donald Trump against harsher measures. With Gary Cohn's departure as head of the National Economic Council, the balance shifts a little further towards tariffs and an escalation with U.S. trading partners.

We don't expect the tariffs to be good or bad for steel and aluminum stocks, but they will probably have a negative effect on industrials that use metals for production and those that are reliant on exports.

Because of the limited scope of the current tariff plans, we expect these issues to have a short-term impact on the market by increasing volatility, which could send the S&P 500 back towards its February lows. We plan to take advantage of that volatility in the options market, but price swings may be wider than normal.

You can learn more about identifying price patterns and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.

InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next SlingShot Trader trade and get 1 free month today by clicking here.

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The post How Worried Should Traders Be About Tariffs? appeared first on InvestorPlace .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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