Trouble in Paradise
At the beginning of the year, they stock market was off to a good start, unemployment was low, a new president was in office trying to reduce government waste and overregulation, and the Federal Reserve was lowering interest rates. We saw the economy, and behold, it was good. A few were preparing for trouble in paradise, but not many.
Trade War
Two months after taking office, President Donald Trump initiated what has quickly become a trade war on a scale 
eliciting “shock and awe.”
It started soon after taking office as he announced tariffs against Mexico and Canada. Many people assumed he was just using them as bargaining leverage in trying to stem the flow of illegal drugs and illegal border crossers.
That turned out not to be the case. The president has said he believes that higher tariffs are needed to bring manufacturing back to the United States, lessen the nation’s trade deficit, and counteract high tariffs from some other countries. So, in a shocking move, in one day he announced tariffs against 185 countries, 10% at a minimum plus quite a bit more in many places. Previously, the average tariff on Europe for example was 2.5%.
Since then 60 countries have said they want to negotiate tariffs and we’ll have to see how that plays out. There are conflicting stories even in the White House. Donald loves a deal, but the stock market was pummeled and most economists were not pleased. Not a few investors found themselves in panic mode, others are angry, and given that constitutionally trade authority except in times of real crisis belongs to Congress, people are wondering if this is going to the Supreme Court.
Trade Deficits
When a country imports more (red bars) than it exports (gold bars) it is called a trade deficit. That is a natural result of the trend over the last 50 years to shift manufacturing overseas where it is much cheaper and to make money here by technological innovation and other high-paying professional jobs. Jobs were lost but higher paying jobs have taken their place. We design new products like computer chips, iPhones, clothing styles and such. Then we pay high wages here for software folks, electrical engineers, lawyers, accountants, bankers and such and import goods at low prices because they are made more cheaply overseas.
Look at our unemployment rates. At roughly 4%, unemployment is about as low as unemployment can get. You can’t get zero unemployment because there are always jobs where they can’t find enough skilled workers.
Just because we are not exporting services like accounting, or engineering, or cutting hair, does not mean we aren’t making money from those services. We just consume them here. We have a lot of money and we buy more than we sell. Higher incomes, lower prices, what could be wrong with that?
The Remedy
For those of the protectionist persuasion like our president, whose hero is the 19th century protectionist president McKinley who instituted wide-spread tariffs, the goal is to be both self-sufficient and to bring back those “lost jobs.” The remedy is to enforce a steep tax called a tariff levied on U.S. companies when they import goods made overseas. The tax revenue goes, of course, to the government. The intent is to force the companies to incentivize buying American-made products and see factories built here to make those products widely available.
Two Problems
The first problem is that often there are few or no U.S. companies still manufacturing what is now manufactured overseas and it takes up to 10 years to plan, get approval for, and build factories.
The second problem is this. What will these companies do when it costs them a new tariff tax of 20-30% to import these goods? They will raise prices, of course, probably 20-30%.
Next, what will their competitors who don’t import, if there are any, do when those prices go up 20-30%? They will likely use the cover to raise their prices some too. The result is likely to be the worst inflation since the Arab oil embargo in the mid-1970s when gasoline went from 20 cents a gallon to over a dollar.
There is the strong possibility that people will see inflation like most have not seen in their lifetimes. Since we import 50-75% of our produce, especially during the cooler half of the year, you could see produce prices go up 20-30% in a year. Car prices are projected to go up at $10,000 – $15,000.
The Retaliation Problem
T
he other problem is that countries are already announcing retaliatory tariffs against the U.S. That will make our products more expensive there and lead to lower exports, thus lowering profits and probably leading to layoffs.
Add that to the issue of confusion as corporate America wonders what announcement or about-face is coming next, and whether they want to start building factories when as in the administration that followed Pres. McKinley, tariffs are reversed. They might also recall that there were bad recessions that followed the McKinley tariffs.
Recession is a likely outcome again because of increased costs for some companies, because of reduced exports and reduced business for other companies, and because of the likelihood of consumers pulling back as prices go up sharply and some workers get laid off.
Stock Market
Do you see now why the stock market is down 15% – 20% and going lower again today? We are looking at not only a possible recession but much higher prices. If prices go higher, the Fed will have to choose between stimulating the economy with lower rates and having to raise rates to combat inflation. It would appear that the only short-term winners in all this are companies who don’t need to import goods and the government that collect the tariffs.
Strategy
How am I responding to all this in managing your money? I already have the stock market exposure in most accounts at fairly low levels. I already often have part of that stock market money in a long-short fund that has been more stable than the rest of the stock market.
In the last couple days, I have sold many of our stock funds and replaced them with others that have tended to fall less in market downturns, usually because they have heavy weightings in industries like utilities and healthcare and products people buy no matter what.
I am also buying gold or funds that invest in gold mining companies that typically go up with higher inflation. Gold has pulled back some from a very strong first quarter and given us an opportunity. Gold prices are very sensitive to increased risk of inflation.
How Far Could the Market Fall?
I would say the market would likely not fall more than it did in 2008-2009, which was 50%. The market as of today is down 12-20%, depending on the index, and if goes like last week, we could be halfway to a bottom shortly. On the other hand, there was some talk that the president might entertain a 90-day pause in tariffs and that 50 countries had lined up to talk about lowering their tariffs on U.S. goods. If progress is made on either, that would help the market considerably.
Bottom Line
It is time to play defense as well as I know how. I hate market timing, but I believe in protecting portfolios against heavy losses. I actually started getting more defensive last summer and did more in January. So far, that has paid off as client accounts are generally down much less than the market indexes. Having some investments in bonds helps and so does owning alternative investments in accounts, even some take a minimum net worth and investment size.
We will get through this. If you have questions, by all means, please call me.