As a rule, tariffs work against the universal economic law of comparative advantage. This law stipulates that economic agents should focus on the production of their most efficient output while simultaneously engaging in trade with their commercial partners, selling their goods or services and buying what they are less efficient at producing.
With transaction and transportation costs in a general downtrend for over a century, the law of comparative advantage is the primary reason for the increasing global trade and the globalization phenomenon, which augment global wealth.
Tariffs reduce economic efficiency. They act primarily as a tax on consumption for the population of the country that imposes it. They reduce demand by making the goods (or sometimes services) more expensive. Tariff costs are largely passed on to the consumer and increase inflation.
By and large, economic agents react predictably to tariffs by trying to circumvent them, which introduces unnecessary costs and inefficiencies to economies
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“To me, the most beautiful word in the dictionary is tariff.”
– Donald Trump
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The Trump administration is keen on using tariffs as an economic and negotiating tool. President Donald Trump has also been quoted as not believing in the economic law of comparative advantage.
The threat of tariffs can be primarily seen as a negotiating tactic, instilling fear and confusion in the minds of the United States economic partners.
The obvious problem is that it cannot be known ahead of time what tariffs might eventually be put in place and when, or even whether there will be any at all. Triasima is assuming that imposed tariffs will represent only a small percentage of the Trump administration’s tariff threats. This time around, compared to 2016, the economic advisers surrounding the American president have more economic and financial knowledge and experience. Common sense may prevail more than is assumed or feared.
In relative terms, Canada’s economy is very open to the rest of the world. The structure of the Canadian equity market and of the S&P/TSX Composite Index naturally differs from the Canadian economy. Actually, equity markets are more influenced by trade flow conditions than the general economy.
The S&P/TSX Composite Index is made up of a combination of services and goods-producing companies.
Many of the index constituents are service-oriented companies and are largely immune from the impact of tariffs since tariffs can seldom apply to services. Many companies derive a significant percentage of their revenues from their operations in the United States, or elsewhere, and are thus unaffected by tariffs imposed on Canadian exports the United States. Yet other companies may produce goods or services but sell them in Canada; again, being immune to the direct impact of American tariffs. A rough Triasima estimate is that approximately 25% of the S&P/TSX Composite Index constituents may potentially be impacted by tariffs.
In addition, the largest Canadian export to the United States is energy, in the form of oil, natural gas, or electricity. We find it very unlikely any kind of significant tariff will be imposed on those exports by the United States, due to the negative repercussions on its own economy and citizens.
Other consequences of tariffs may be a reduction in overall economic activity, a drop in investor confidence, and a degraded sentiment towards stock market investing. This may be of concern and militate in favour of raising cash levels in client portfolios. However, they may be a large opportunity cost in the form of foregone investment performance by being too fearful of tariffs.
Triasima has been incorporating the threat of tariffs into its top-down fundamental thinking. We contemplate alternative scenarios and consult with experts and financial analysts. We evaluate as best we can for each industry represented and each holding present in client portfolios what might the impact be.
The possibility of tariffs increases uncertainty and lowers the appeal of some stocks. As per the Triasima investment methodology, this may lead to decreases in Fundamental ratings for specific companies.
In conclusion, Triasima has been thinking continuously about the impact of possible tariffs on the investment returns of client portfolios for months now. Nonetheless, the issue of potential tariffs imposed by the Trump administration has had, so far, little impact on actual trading decisions and portfolio positioning.
This may change in coming weeks and months as we continue monitoring and analyzing the situation.
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