Aggressive trade wars, government shutdowns, and unexpected disasters can send markets careening to the downside. The short-term damage to investments can be severe. But the key word here is “short.” And therein lies the opportunity for long-term investors like those saving for retirement.
To fully appreciate the phenomenon and why it’s possible for anyone to take advantage of it, you must first understand the concept of “recency.” Derived from studies in behavioral psychology, when applied to finance, it can lead to market extremes. Whether it’s market highs or market lows, recency explains it all.
Recency is defined as the tendency to overweight the most recent data. You see it in “best of all time” sports rankings. Current or freshly retired stars tend to dominate those polls. Why? Because those are the players who are more likely to be in the minds of sports fans.
Similarly, investors gravitate towards stocks that have grabbed the current headlines. When the news on the stock or industry appears promising, buyers gobble up shares. When the news emphasizes the negative, selling increases. Contrarian investors pay attention to these trends. They often move in the opposite direction. Excessive buying leads to overvalued stocks, so it’s a good time to sell. Disproportionate selling leads to undervalued stocks, so it’s a good time to buy.
When bad news strikes the entire market, history shows that’s the best time to buy—but only if you know what you’re buying and why you’re buying it.
Who benefits from a trade war?
At the beginning of February, the sun scared Punxsutawney Phil to dive back into his hole. At the same time, by unilaterally imposing his Mexican and Canadian tariffs, President Trump scared markets to dive into a hole of their own. Unlike the famous groundhog, however, investors didn’t wait six weeks to return. It was more like six hours, as by midday, Mexico and Canada had conceded, and Trump postponed the Tariffs for thirty days.
Did you learn the lesson of that quick roller-coaster ride? Or do you see these short-lived tariffs more as an omen than as an opportunity? With Trump unafraid to wield the tariff stick, how you frame economic policy may also affect how you invest—for good or bad.
“This is difficult to answer as no one has a crystal ball,” says Philip E. Battin, president & CEO of Ambassador Wealth Management in Warrenville, Illinois. Battin believes “an increase in volatility should be expected in the near future as the markets grapple with assessing how this may impact corporate earnings. Tariffs introduce a new risk that needs to be priced into the markets and add uncertainty. Markets generally do not like uncertainty, so increased volatility may be a harbinger of things to come if there is a negative effect on earnings.”
While the market as a whole reacted to the North American tariffs, tariffs targeting other countries may have a greater impact on specific industries and the companies within their product environment.
“Tariffs will increase the cost of nearly all hardware since components are sourced from China and many products are assembled there as well,” says Kevin Surace, CEO at Appvance in Sunnyvale, California. “It’s a little late to mitigate! But moving sourcing out of China has been an obvious choice for a few years. Few did so. But now there is no choice but to scramble.”
What is the best investment strategy during a trade war?
Indeed, if you look at the history of tariffs and their short-term/long-term effect on investments, you’ll see mixed results.
The dominance of American-made full-size trucks in the domestic market today had its beginning with a European tariff on chicken exports in the early 1960s. In 1963, President Johnson retaliated by imposing a tariff on lift-weight truck imports which boosted domestic truck manufacturers. This was supposed to be a temporary tariff. It wasn’t. Today, the top four best-selling models (all American-made) accounted for 90% of all the full-size trucks sold in America (as of Q2 2023).
This isn’t just because of Johnson’s tariff, as other factors come into play. That’s why it’s difficult to determine the long-term implications of tariffs.
For example, in 2002, President George W. Bush imposed a tariff on imported steel. In retrospect, it doesn’t appear to have helped the domestic steel-producing industry. While offering brief short-term benefits, it couldn’t stop the decades-long decline in the American steel industry. If anything, it sped up the decline by encouraging consolidation.
Here’s an interesting twist: wouldn’t the higher steel prices have impacted the auto industry? Yes, but maybe COVID had a greater impact. This is an example of why you can’t rely on tariffs alone to make an investment decision. Still, a short-term overreaction could open a buying window, especially for retirement investors.
“The use of tariffs, and countries retaliatory responses, are likely to cause market volatility in the short term,” says Jason Dall’Acqua, owner of Crest Wealth Advisors in Annapolis, Maryland. “For long-term investors who have decades of investing ahead of them, these dips in the market can provide long-term opportunity to buy in at lower prices. While trying to time an exact entry point into an investment is difficult, having a list of companies you want to own and buying on dips could benefit you over the long run.”
Where to invest during a trade war?
Again, you have to be careful which stocks you pick during an industry-wide sell-off. In 2018, the first Trump administration imposed tariffs on imported solar cells and modules. This had an immediate negative impact on revenues and earnings for companies like SolarEdge Technologies and SunPower. Dependent on imported panels, these companies suffered from project delays and outright cancelations. Companies with less exposure to imports, like First Solar, were able to expand to fill the void.
You could also look at related companies that benefited from this tariff. Technologies like energy storage (batteries), software for solar management, and companies offering integrated solutions and the companies that work on these technologies (like Tesla) stood to reap rewards from these 2018 tariffs.
Again, tariffs are only part of the equation, but they could provide a meaningful nudge when you’re looking at particular stocks. This is all the more true when, like Trump is appearing to do now, tariffs aren’t being employed in the usual economic-policy sense.
“Tariffs can be used as leverage to ‘send a message,’ such as what happened with Columbia to accept the illegal migrants back into their country,” says Battin. “Or put pressure on Denmark to allow either an expansion of our military presence in Greenland, access to rare earth metals, or even an outright purchase. Both are examples of tariff utilization for national security interests, not exclusive to economic benefits, and could lead to less crime domestically and control of shipping lanes in the Atlantic to counter emerging threats from China and Russia.”
And it’s not just tariffs. Any sudden event can cause an exaggerated move in the markets. The secret to success (as always) is to prepare yourself for such occurrences. As Dall’Acqua suggests, you should create a watch list with buy prices, and act on that list when everyone else seems to be running away from the bad news.
One final thought: when can you anticipate the next batch of bad news? The answer is “anytime.” But the more alluring answer is to remember what Trump did with Canada and Mexico. He didn’t cancel the tariffs. He merely postponed them. That means they may rise again in early to mid-March.
Do you know what else is due to come up by the Ides of March? The Continuing Resolution for the budget. And with the Democrats suggesting they may want to force the government to shut down, the markets may be in for a double dose of bad news.
Good thing it’s not hurricane season.
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