Market Snapshot: Tariff Tantrums TBD

While there is still uncertainty about the full scope of President-elect Donald Trump’s trade policy, tariffs will likely be a cornerstone to address the perceived unfairness of trade imbalances. The U.S. government has a long history with tariffs, with almost the entire federal budget funded by tariffs in the 70 years prior to the U.S. Civil War. For the years post-World War II, the effective tariff rates¹ on U.S. imports have been below 10%. The proposed tariffs from Trump’s campaign trail² were 10% universal tariffs and 60% China-specific tariffs. In addition, he recently announced plans to immediately impose a 25% tariff on imports from Canada and Mexico once he takes office.

The impact of tariffs on stock prices will likely be driven by the perceived potential winners and losers in a trade war. The chart shows the high-level foreign sales component for U.S. stocks based on current index constituents. Given the foreign sales exposure for large cap growth stocks, a trade war would seemingly harm these companies more, while protectionist policies may be good for smaller, domestic producers.

The potential tariff headwinds for U.S. large growth companies versus U.S. small cap companies suggest large caps may experience more risk over the next year. From a valuation perspective, we believe that U.S. small caps potentially offer a more attractive valuation starting point³, which may experience smaller drawdowns should global risks escalate. With the potential headwinds of tariffs for U.S. large caps and the attractive relative valuations of U.S. small caps, we continue to believe that higher quality small caps offer an attractive risk/reward relative to passive large caps.