This week saw many markets hit bear-market territory
Although Friday isn’t quite over, we’ve seen back-to-back 5% sell-offs in the Nasdaq index to end the week. That puts it, as well as the US small cap index, officially in bear markets now (down 20% from highs).
Most markets around the world fell this week. However, US markets fell more than most – and some others remain up year-to-date.
This week is all about new Tariffs
This week’s sell-off was all about President Trumps new “reciprocal tariffs.”
The impact of these tariffs combined with earlier tariffs is expected to push the US’s effective tariff rate (on imported goods) to over 20%. That’s a big increase from around 3% a few months ago. And it’s the highest tariff rate in 100+ years.
The tariff news wiped out about $2.5tn of market value on Wall Street yesterday, with technology stocks, banks and consumer goods companies suffering the biggest falls on the worst day for US shares in nearly five years. Brent crude slumped amid fears of a global economic slowdown and on the back of an unexpected announcement from the Opec+ countries that they would increase production from next month.
Markets were already down, why did they fall again?
Looking at the first chart, we see that the market had already fallen – in anticipation of the Tariff announcements.
So why was this week so bad?
These Tariffs were much larger than expected
It’s because the market was expecting a lot less impact.
This week was meant to be about “reciprocal tariffs.” Experts expected the US to increase tariffs to match higher tariff rates that some other countries use against the US. As the chart below (blue bars) show… most of those countries are smaller trading partners (to the right and skinny bars) – so the impact wasn’t expected to be all that material.
However, what we got was much larger tariffs across almost all countries.
Rather than match tariff rates by country – instead the new tariff rate is related to the trade imbalance that the US has with each country. Some countries have tariff rates around 50%, and all countries will pay at least 10%. And many of our largest trading counterparties will pay the highest rates.
Not all countries are affected equally
This means a country like:
- Taiwan (who we import a lot more from than we export to) has a high trade surplus with the US = a higher tariff rate
- UK (where trade is more balanced) has a smaller trade surplus = a 10% tariff rate
As the chart below shows:
To summarize them briefly:
- 10% universal tariff for most countries
- Higher tariff rates for the 60 countries (chart below) with the biggest trade surpluses with the US (the US buys more from them than they buy from the US), including China, the EU, and Vietnam
- Canada and Mexico were exempted from new tariffs, as were certain sectors that face their own tariffs or are expected to (steel, aluminum, lumber, chips, pharma)
The main result of this math is that countries in Asia have generally the highest tariff rates (blue bars below).
What does this mean for you?
Tariffs add to the costs of importing goods. But its important to note that the economy has also changed a lot since tariffs were last this high. Back 100 years ago, goods made up almost 80% of jobs. Today that has reversed – with goods making up around 20%.
In addition, many products are made in the USA – so they should be unaffected.
But a lot of commodities and components needed for USA made products may still come from overseas. And some things are imported in finished form. Tariffs on those products will make it more expensive for the companies supplying them. Companies can either:
- Raise prices (which creates inflation for us… and may make us consume less)
- Reduce margins (which reduces profits for companies… which causes valuations (stock prices) to fall)
The chart below shows that Phones, Appliances and instruments might be the worst affected. Cars (a big expense) are also going to be affected.
Early estimates suggest the combined effects of all new tariffs this year will:
- increase inflation by 2.3 percentage points and
- lower real GDP growth by about 1 percentage point.
Some sectors are affected more than others
Looking at returns through Thursday (chart below), we see that some sectors were affected much more than others. Utilities and Healthcare only fell a little, while Staples (things like food producers) actually rose.
But Transport fell a lot (less imports means less trucks moving products around) and Consumer Discretionary fell too (consumers have the “choice” not to buy these products as their prices go up).
Some companies that make a lot of their products overseas fell the most: Like Apple (which makes iPhones in foreign countries) and Nike (which makes a lot of its clothes in Asia).
Markets pricing chance of a recession (or maybe Stagflation)
Markets think even US growth is likely to slow – a lot. That’s why markets are pricing in more than 1% of interest rate cuts this year (it wasn’t that long ago we wondered if the Fed might do NONE!).
Along with this, we saw an uptick in high yield spreads – meaning markets also think companies might me more likely to fail. That’s two signs of a potential recession.
Although inflation expectations also rose, and economic growth is expected to slow. That’s “stagflation” – and is particularly hard for central governments to deal with as the higher rates needed to tackle inflation reduce growth more (and vice versa).
There is still a lot we don’t know
But it’s still too early to call that.
Employment remains strong, and these changes are designed to encourage companies to make more things in the USA, and hire more workers. Local demand for labor could actually increase.
This week’s sell-off was large because the tariffs are large. Companies and consumers are probably not going to continue as they were. Changes to the supply chain, and consumption, will again need to be made.
But it’s hard to say (yet) what the real impact will be. We still don’t know much about:
- How other countries will react – to defend their own industries
- How companies will change – to remain competitive against these higher costs
It’s also important to remember that goods are a small part of the US economy (as the chart above showed). The proportion of workers affected by this might be smaller than headlines indicate.
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