Tariffs, Market Volatility, and the Real Risk Investors Face

I want to share my thoughts amid the recent market volatility, which is largely fueled by concerns over escalating trade wars. However, I believe there is important context missing from the broader narrative—context that should be considered by thoughtful investors in this environment. This situation is multifaceted and dynamic, and several potential outcomes must be weighed.

Understanding the Economic Impact of Tariffs

1. Uncertainty Slows Business Activity
   When businesses face uncertainty, they often pause investment and production decisions, a concept known as entrepreneurial uncertainty. Even the fear of rising costs can cause companies to delay spending, hiring, and expansion, which can lead to short-term economic slowdowns. For example, an auto manufacturer relying on steel may delay production if steel tariffs create uncertainty around pricing. Multiply this hesitation across industries, and economic growth can weaken.

2. Protectionist Policies Tend to Reduce Economic Output
   Tariffs, if sustained, will likely slow U.S. economic growth. A Wall Street Journal article by Donald Boudreaux and Phil Gramm (I have discussed such policies with Donald Boudreaux on my podcast - listen here) noted how Trump and Biden’s tariffs slowed economic output in previous years:

“Over the first three quarters of 2018, manufacturing output rose by 2.5%, spurred by tax cuts and deregulation. But as tariffs took effect, manufacturing output declined, falling 4.7% by late 2019. On the eve of the pandemic, 32,000 fewer Americans were employed in manufacturing than a year prior.”

While protectionists claim tariffs create jobs, history suggests they can do the opposite by disrupting supply chains and increasing costs for businesses.

Does This Mean a Recession?

Not necessarily. While tariffs may slow GDP growth, the Trump administration has other pro-growth policies working in its favor, including tax cuts, deregulation, and reduced government spending. These factors could counterbalance the negative effects of tariffs, helping to sustain economic expansion.

Still, I can say with confidence: GDP growth would be stronger if tariffs were removed.

Why Markets Are Reacting So Sharply

Right now, fear of economic slowdown is dominating financial headlines, stoking concerns of a possible recession. But there’s another reason the markets are so volatile right now—high valuations.

As of Friday, February 28, the S&P 500’s price-to-earnings (P/E) ratio stood at 21.62, well above its historical average of around 17.

When markets are overvalued, traders are already looking for an excuse to take profits or short the market. In my view, market volatility is being amplified by inflated valuations, rather than just economic fundamentals. If markets correct, it may have more to do with prices normalizing than with fears of an economic downturn.

A Negotiation Tactic? The Other Side of the Tariff Debate

Much of this analysis assumes tariffs remain elevated, but what if they don’t? The Trump administration has long positioned itself as a dealmaker, and tariffs may simply be a negotiation tool.

There is evidence that trading partners are responding by lowering their own tariffs:

• The EU recently proposed cutting tariffs on U.S. car imports from 10% to closer to 2.5% in an effort to defuse trade tensions. (Financial Times)

• A series of delays and exemptions suggest that the Trump administration is open to negotiations. For example, while writing this article, U.S. Commerce Secretary Howard Lutnick told CNBC:

“My expectation is the president will come to an agreement today that USMCA-compliant goods will not have a tariff for the next month, until April 2. That includes autos.”

These moves indicate a willingness to negotiate, and if more trading partners follow suit, tariffs could come down from current levels.

The Biggest Risk to Investors Right Now

If tariffs are scaled back, markets could snap back quickly, and investors sitting on the sidelines may miss out.

Investors should closely monitor these trade developments. If negotiations lead to lower tariffs, equities could rebound rapidly, leaving cautious investors watching from the sidelines as markets recover.

Staying the Course

At this juncture, I do not see a reason to make drastic changes to our investment strategies. My advice remains:

• Stay patient and disciplined until we have a clearer picture of the direction of trade policy.

• Remember that while tariffs are a headwind, the economy has proven resilient in the past—including during Trump’s first term.

• Keep a close eye on negotiations—if tariffs are lowered, the market’s reaction could be swift and strong.

While tariffs are not good for the economy, we must consider two key scenarios:

1. They may not last long if negotiations succeed.

2. The economy may continue growing despite tariffs, just as it did during Trump’s first term.

Markets hate uncertainty, but thoughtful investors look beyond the headlines. Stay the course, remain informed, and avoid emotional decisions.

Disclosures:

Any opinions are those of Drew Benson and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

S&P 500: This index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. It consists of 400 industrial, 40 utility, 20 transportation, and 40 financial companies listed on U.S. market exchanges. This is a capitalization-weighted calculated on a total return basis with dividends reinvested. The S&P represents about 75% of the NYSE market capitalization.