Market Commentary

• Keep in mind that some companies have been diversifying supply chains since the early days of the pandemic or even prior to that.
• Consumers can also blunt some of the effect of potential tariffs. For many products, there are substitution possibilities.

Let’s be clear: We expect tariffs to have some economic cost. We have seen a number of U.S. companies raising prices due to goods or components that would be affected by tariffs on China, Canada, and Mexico, but these price increases appear to be less than the 25% tariff rate on many Canadian and Mexican goods or the 20% on goods from China. Remember, S&P 500 companies have been enjoying operating profit margins well above the 30-year average over the past three years according to Bloomberg data. That means many large companies have some room to absorb a portion of the price increases before passing a portion on to end users.

Beyond higher prices to consumers, lowered consumer confidence and sentiment from the uncertainty about tariffs might lead to headwinds for consumer spending. Given that consumer spending makes up about 70% of U.S. gross domestic product (GDP), we ideally want to see confident, employed consumers going out and spending money on discretionary goods and services like cars, restaurants, and vacations. Some of these concerns can be seen in the equity sector performance so far this year where Health Care and Utilities, two defensive sectors, are among the top three performers. These sectors are considered defensive because their earnings performance is not as tied to the ebb-and-flow of the economy as some other sectors. The potential growth slowdown has caught the market’s attention. We are not suggesting that investors position defensively in equities.

Keep in mind that some companies, but not all, have been diversifying supply chains since the early days of the pandemic or even prior to that. The first Trump administration as well as the Biden administration had some degree of focus on China’s trade practices, and companies that relied on China for the bulk of their supply chain have likely made at least some adjustment by diversifying to factories in other countries — yes, Canada and Mexico but also heavily into other Southeast Asia suppliers.

Consumers can also blunt some of the effect of potential tariffs. As an example, should French wines see 200% tariffs implemented as President Trump has threatened, some U.S. consumers could very well substitute and look to the Napa Valley right here at home for their wine purchases. Or if the Trump administration imposes tariffs on Mexican agricultural products such as avocados and the price increases meaningfully, consumers can choose California avocados and firms may begin to import more avocados from Caribbean and South American suppliers. Bottom line, for many products, there are substitution possibilities.

As U.S. firms diversify their suppliers and U.S. consumers substitute for at least some tariff-laden goods, our belief is that these reactions will blunt and dilute much of the negative tariff impact. Meanwhile, we believe deregulation and an extension of the 2017 Trump tax cuts should benefit the economy more than the tariffs will hurt. We see better economic growth as we move through the second half of the year as central-bank rate cuts begin to impact the domestic and, to some extent, global economy. We suggest investors use the pullback in equities to increase allocations to U.S. mid-cap equities, largely funded by reducing fixed-income exposure in the three to seven year maturity spectrum. 

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