Five Investing Impacts of a Trade War

Let's explore five stock market impacts from the U.S. election and related prospect of a trade war that may be surprising to investors:

Despite the uncertainty posed by a new administration, stocks have posted gains in every transition period from Election Day to Inauguration Day over the past 50 years, unless already in a recessionary bear market.
Global stocks had a neutral reaction to trade war escalations during President-elect Trump's first term.
Stocks with high foreign sales exposure have performed very similarly to those with no foreign sales exposure since President Trump's 2016 campaign.
President Trump's campaign proposals would lift the U.S.'s average tariff rate to the highest in over 100 years and above that of the 1930s Smoot-Hawley Tariff enacted around the start of the Great Depression.
A less extreme trade war scenario of 10% across-the-board tariffs may only slow global GDP growth by -0.1% in 2025.

1. Stocks are off to a typical post-election start

Global stocks are off to a typical post-election start with gains, as tracked by the MSCI All Country World Index. Despite changes in parties and policies, the only two negative presidential transition periods for global stocks (the period from U.S. Election Day to Inauguration Day for a new administration) in the past 50 years were during the recessionary bear markets already in progress during 2000-01 and 2008-09. We expect continued, though subdued, economic growth heading into 2025, similar to transition periods that featured gains for stocks.

Performance of MSCI All-Country World Index from election day to inauguration day

2. Past tariff announcements saw mild stock market reactions

The prospect of additional tariffs on the rest of the world in a second Trump Administration poses downside risks to economic and earnings growth, as well as upside risk to inflation. Yet the stock market reaction to the election and to tariff announcements during Trump's first term were mild. Stock markets, represented by the MSCI All Country World Index, have had an overall neutral reaction to past trade war escalations, as listed in the table below. It appears that broad global growth and low inflation during 2018-19 calmed fears over an escalating U.S.–China trade war.

Stock markets of the U.S. and China, measured by the S&P 500 and the MSCI China Index, responded much the same as the MSCI All Country World Index did in the table above. For example, let's look at the most dramatic market reaction in our table. In response to the U.S. announcement of an increase tariffs from 10% to 25% on $200 billion of Chinese made goods on May 10, 2019, the MSCI All Country World Index fell 1.9%, while the S&P 500 Index fell 2.4% and the MSCI China Index fell 1.2%.

3. Foreign sales exposure did not drive relative performance

During President-elect Trump's first term, companies in the MSCI World Index that had a high percentage of foreign sales performed similarly to those that had close to zero foreign sales, on average. It seems that once companies have visibility on policy, sales and expenses were adjusted and strategy redirected to the best profit opportunities. Although generally, companies can adjust, there are likely to be some businesses with less flexibility. For those firms, there is risk to outsized negative or positive impacts in response to changed policy.

MSCI World constituents have performed similarly despite foreign sales exposure

4. Great Depression 2.0?

President-elect Trump has threatened 60% tariffs on all Chinese imports, 10-20% tariffs on imports from all countries excluding China, as well as +100% tariffs on cars assembled in Mexico, 200% on John Deere tractors assembled in Mexico and 100% on imports from countries that "leave the dollar." Assuming no change in imports, the combination of the proposed the 60% China tariff and 20% across-the-board tariff would lead to an overall U.S. weighted average tariff rate of nearly 26%. This is the highest level in over 100 years and even above the rate of the 1930s Smoot-Hawley Tariff Act enacted around the start of the Great Depression.

Great Depression 2.0?

If implemented as proposed, President-elect Trump's proposed tariffs would likely be met with reciprocal tariffs by trading partners. Countries disproportionately impacted would be the United States, Canada, Mexico, and China, given their relative trade exposures. For example, 83% of Mexico's exports 77% of Canada's exports and 16% of China's exports are to the United States, while 18% of U.S. exports are to Canada, 16% to Mexico, and 8% to China.

Fortunately, there are reasons to believe the extreme tariff scenario won't be implemented in full. Despite the President-elect's threats of implementing across-the-board tariffs on China and ending a trade agreement with Mexico and Canada during his first presidential term, Trump not only forged a Phase One trade deal with China but also successfully renegotiated the United States-Mexico-Canada Agreement (USMCA), formerly the North American Free Trade Agreement (NAFTA). He also renegotiated existing free trade agreements with South Korea and Japan. If history is any indication, the extreme tariff threats may be negotiation tools leading towards agreements with China and other countries, with the potential to be much less disruptive to economic growth, inflation, sales, and operations of multi-national corporations.

5. Potentially mild economic impact of a less extreme trade war

The latest World Economic Outlook from the International Monetary Fund (IMF), published in late October, takes a deep dive into the growth and inflation impacts of a potential trade war in 2025. They examined a trade war scenario that assumes 10% U.S. tariffs on all imports, plus full-scale retaliation by Europe and China equivalent to 10% tariffs on U.S. exports, and on all trade between China and the European Union implemented in mid-2025. In this scenario, the IMF projects that the tariffs would result in a reduction of only -0.1% for global economic growth Gross Domestic Product (GDP) growth in 2025, lowering the base case growth forecast to 3.1%. The estimates also include a larger, but still modest, -0.4% hit to U.S. growth, but negligible drags on Chinese and European growth in 2025. Why so small? Trade isn't a huge component of GDP. For example, despite China being viewed as an export economy, exports make up 19% of China's GDP and exports to the U.S. account for about 15% of the total, so this equates to just 2.8% of China's GDP tied to U.S. exports. When accounting for a related increase in trade policy uncertainty, the IMF finds that the negative impact on global GDP growth would be slightly larger. This scenario probably entails higher tariffs than would actually be implemented if history is any guide. But even so, the magnitude of the impact would not be near enough to tip any major economies into a recession in 2025. These overall numbers may be important to keep in mind should some trade-impacted companies, such as European automakers for example, grab headlines with dire warnings.

GDP impact from trade war

Tariff takeaways

The trade war of President-elect Trump's first term had muted impacts on stocks, economic growth, inflation, and global trade volumes. But any future negative impacts could be amplified, given the proposal of much higher and broader tariffs and overall trade policy uncertainty impacting both domestic importers and multi-national businesses. We believe that over the intermediate-term, companies can adjust their business activities in response to what are likely to be at least modestly higher tariffs and policy uncertainty. However, shorter term stock market volatility could be prevalent as threats of more extreme tariffs accompany the negotiation process.

Michelle Gibley, CFA®, Director of International Research, and Heather O'Leary, Senior Global Investment Research Analyst, contributed to this report.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Please note that this content was created as of the specific date indicated and reflects the author's views as of that date. It will be kept solely for historical purposes, and the author's opinions may change, without notice, in reaction to shifting economic, business, and other conditions.

All corporate names and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security.

Performance may be affected by risks associated with non-diversification, including investments in specific countries or sectors. Additional risks may also include, but are not limited to, investments in foreign securities, especially emerging markets, real estate investment trusts (REITs), fixed income and small capitalization securities. Each individual investor should consider these risks carefully before investing in a particular security or strategy.

Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk, including loss of principal.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.

Investing in emerging markets may accentuate this risk.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Schwab does not recommend the use of technical analysis as a sole means of investment research.

The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly. For more information on indexes, please see schwab.com/indexdefinitions.

Currencies are speculative, very volatile and are not suitable for all investors.

This information provided here is for general informational purposes only, and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, you should consult with a qualified tax advisor, CPA, Financial Planner, or Investment Manager.

BLOOMBERG^® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively "Bloomberg"). Bloomberg or Bloomberg's licensors own all proprietary rights in the Bloomberg Indices. Neither Bloomberg nor Bloomberg's licensors approves or endorses this material or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

1124-6HZ1

A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our most recent market outlooks.