We are now close to the ninth anniversary of an incredible bull market in U.S. stocks that seems to have no end in sight. On March 9, 2009, the S&P 500 troughed at 676.53 and closed on January 26, 2018 at 2872.87, for a return of approximately 425%, not including the impact of dividends.
Clients often ask what will derail this bull market. High valuations, or simply the length of the bull market, are oft-provided reasons that the good times must come to an end. Both are generally insufficient by themselves to stop a bull in its tracks.
However, one important development that should concern investors is the creeping restraint on the relatively free flow of goods and services across national borders. Disturbing well-established trading relationships and having politicians decide winners and losers in a competitive global marketplace is not a recipe for continued prosperity. The world was plunged into the Great Depression back in the 1920s in part due to the imposition of a massive tariff wall, better known as the Smoot-Hawley tariff, which resulted in the seizure of global trade flows. The impact on stock prices was epic.
In response from companies facing difficulty competing with foreign producers, the Trump Administration recently announced the imposition of steep tariffs on washing machines and related machine parts imported from South Korea (the home of Samsung and LG Electronics) and solar panel components from China. Specifically, tariffs of between 20% and 50% will be set on washers and 30% on solar equipment.
This is not to suggest that these actions will lead to another Great Depression. But fostering disharmony in global trade could make investors quite jittery and possibly be the catalyst to interrupt the incredible upward momentum in stock prices.
Unfortunately, many Americans are likely to cheer these efforts to “level the playing field” without truly considering the harmful impacts that such tariffs can impose.
As with many economic concepts, one must consider the “seen” versus the “unseen.” This phrase is attributed to the French classical economist, Frederic Bastiat (1801-1850). Bastiat wrote in Selected Essays on Political Economy (1848) that any economic policy must be assessed, not just by the visible or immediate effects of that policy, but also by its less apparent or delayed effects.
Consider the following example. A protective tariff is placed on the importation of raw steel because it is argued by some that foreign producers are unfairly “dumping” steel on the domestic market and driving domestic steel producers into bankruptcy with the resultant loss of blue-collar steelmaking jobs. The media will report the hardships experienced by workers whose jobs are jeopardized by the cheaper foreign steel. We literally “see” the relatively small number of steelmakers whose jobs may be preserved by impeding the competitive threat from abroad via a protective tariff. The management of the steel company and its political representatives will surely tout the tariff as a necessity to protect against the loss of high-profile manufacturing jobs.
However, what we do not see is the dispersed effects of the tariff. We will not see the faces of employees in steel consuming industries, such as domestic manufacturers of automobiles, appliances, tools, building materials, etc. who lose their job because the cost to make their respective product leaves them less competitive in the marketplace.
The imposition of retaliatory tariffs by our trading partners in non-related industries may spread the adverse impact of preserving a limited number of steelmaking jobs to a wider array of domestic workers. What happens if China slaps tariffs on Boeing aircraft or American beef producers?
But most critically, we do not see the end consumer who may have to pay more for goods that use steel as input, money that could have been invested or spent elsewhere in the economy. A tariff is simply a tax by another name.
This is not some theoretical example. In 2002, the Bush Administration placed tariffs on imported steel ranging from 8% to 30% purportedly to curb a surge in steel imports. The tariffs were deemed illegal by the World Trade Organization (WTO) and were withdrawn only after the European Union threatened retaliatory tariffs on a wide array of U.S. products. A subsequent study found that approximately 200,000 jobs were lost in the U.S. as a result of the tariffs.
It is also interesting to consider that while most Americans may experience a lower income tax as part of the new tax law, a portion of that may be rescinded by making it more expensive for consumers to purchase select imported goods.
We do not become a wealthier society by keeping out goods demanded by consumers. In fact, trade does not occur unless both sides find the transaction mutually beneficial. Cheap goods from abroad help extend our paychecks. Barriers to trade will only make us poorer. The evidence against the use of trade protectionism is voluminous.
Thus far, markets have collectively shrugged off these developments. But vigilance should be maintained. Significant disruptions to global trade flows could quickly reverse the economic optimism that has provided critical support to equity markets.
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