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:

1. 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.
2. Global stocks had a neutral reaction to trade war escalations during President-elect Trump's first term.
3. Stocks with high foreign sales exposure have performed very similarly to those with no foreign sales exposure since President Trump's 2016 campaign.
4. 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.
5. A less extreme trade war scenario of 10% across-the-board tariffs may only slow global GDP growth by -0.1% in 2025.

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.

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%.

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.

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.

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.

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.

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.