Considering the potential impact of tariffs

When dealing with an elevated level of uncertainty, it can be helpful to look to history. By understanding what has happened in the past, we can better imagine how things could play out this time around. For tariffs, I find two reference points from economic history helpful, including one that happened recently and another going back almost a century.

• From the recent past: the 2018–2019 tariff increases. Initial proposals in late 2017 and early 2018 were broad in scope and aimed at many trading partners. Over the next year and a half, we witnessed many changes—exemptions, escalations, and de-escalations—as the policy took shape. Ultimately, those tariffs targeted primarily steel and aluminum, which was a more surgical and measured outcome than initial proposals suggested.

• From the distant past: the 1930 Smoot-Hawley Tariff Act. This expansive piece of legislation raised the effective tariffs on imported goods to about 20%.¹ Retaliation from many trading partners followed swiftly, likely worsening the Great Depression that was already underway. While the act was eventually repealed in 1934, to this day, it continues to inform how a severely adverse economic outcome can result from unsuccessful trade negotiations.

As we enter what could be a new wave of tariff negotiations, past experiences can provide helpful context and perspective.

For long-term investors, this means understanding potential volatility that might arise as markets digest the impact of a highly fluid narrative on the future of the international trade landscape.

My reading is that the markets have also been looking back at how the 2018–2019 tariff negotiations unfolded. I say that because until late on Friday, January 31, markets seemed not to have assumed that there would be immediate implementation of 25% tariffs on imports from Canada and Mexico. On February 3, however, with the prospect of the tariffs looming large, large intraday movements suggested that markets were starting to aggressively price in the possibility.

On the currency front, the U.S. dollar appreciated rapidly against the Canadian dollar and Mexican peso. And on the fixed income front, market participants started pricing in a 2-year inflation expectation above 3%, while the longer end of the yield curve seemed to be primarily pricing in lower potential growth. Risk assets, notably equities, also experienced losses, with the shares of automobile manufacturers and homebuilders—industries that would be most directly impacted by the proposed tariffs on Canada and Mexico—leading the way lower. Of course, as further negotiations and timelines were announced, we saw these movements largely reversed.

These intraday movements provide useful insights into:

1. How much markets seemed to deem that the tariffs were unlikely to be implemented as initially outlined.
   
2. How markets may react if the new tariffs turn out to be far broader than those implemented in 2018–2019. 

There are three points worth noting. First, tariff negotiations are ongoing with multiple nations, which leads to uncertainty and fluidity, so volatility could quickly escalate depending on how things develop. For long-term investors, it may be helpful to recall some of the more recent bouts of volatility (for instance, in August 2024 and at various times during 2022). Doing so can help with maintaining both a long-term perspective and disciplined adherence to your strategic asset allocation.

Second, broad diversification, across and within asset classes, will be an important ingredient in weathering potential volatility. Despite the highly fluid and developing situation, our 2025 economic and market outlook remains the same—we’re still in an era of sound money (making bonds a good place to invest) and the equity market continues to be characterized as a tug-of-war between U.S. equities with impressive earnings momentum and more attractively valued international equities.

Last, but not least, for those investing with active managers, outperformance in this type of policy-news-heavy environment may require good judgment in discerning signals from noise and an ability to tactically execute on opportunities that may be short-lived.

Over the long term, the potential changes in the global trading ecosystem could create both disruptions and opportunities. For instance, supply chains have already evolved since the 2018–2019 tariffs, with China now accounting for much less of the market share for U.S. imports than before 2018. These changes, though disruptive, can offer opportunities for new businesses positioned to take advantage and for astute active investors who can identify such businesses early on.