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Trade War Angst Creates Opportunities for Advisors to Provide Value

Growing trade tensions and new tariffs are driving considerable market volatility as investors increasingly fear that protectionism will throttle the global economy and send equities into a tailspin.

Emerging markets, for example, racked up a nearly 15% decline from their January highs, in part due to fears over the implementation of tariffs and threats of retaliatory measures.

As scary as a potential trade war can be, the emotional reactions over tariffs are an opportunity for advisors to help clients by providing a thoughtful approach to navigating market volatility. At the same time, providing historical perspectives on trade tariffs can help keep emotions in check.

Fears of protectionism have grown in response to President Donald Trump’s attempts to improve the country’s trade deficits by implementing tariffs. Trump had imposed tariffs on a smaller scale earlier in the year, but in mid-February, he imposed a 25% tariff on steel imports and a 10% tariff on aluminum imports that apply to Canada, Mexico, and the European Union.

More recently, his administration has announced a 25% tariff on $34 billion dollars in annual imports from China. His administration is also considering tariffs on additional Chinese goods valued at more than $200 billion. Various trading partners have retaliated with their own tariffs on U.S. products, which has caused an increase in fears that a trade war is at hand.

Markets have reacted. According to an Ariel Investments commentary, the Dow Jones Industrials shed 420 points in March in response to the news of the metal tariffs and then another 570 points in April in response to the tariffs imposed on China.

A historical perspective illustrates, however, that policymakers have favored free markets, which could point to a trade war being less likely than commonly believed. Indeed, Vanguard points out that U.S. tariffs in the 1930s were comparable to 30% of the value of imports.

The rate declined in a fairly steady manner and reached a low of approximately 15% in 1915 before climbing to approximately 20% during the Great Depression. Since then, U.S. tariffs have declined to less than 5%, which illustrates that policymakers, broadly speaking, have been advocates of free markets. That’s true despite the news media promoting the potential for a possible trade wars.

In October of 1985, for example, the cover of Time Magazine showed Uncle Sam with his arm stretched out as if to imply he was blocking trade and a headline said “Congress Pushes for Protectionism.”

In addition to viewing trade from an historical perspective, advisors should also explain to clients that the U.S. economy is still strong and is benefiting from tax reform. First quarter earnings, for example, grew at the fastest rate since the third quarter of 2010 and the Leading Economic Index in June hit a record of 109.8.

The indicator typically leads S&P 500 earnings by at least six months. Those factors have resulted in market sentiment remaining strong, despite fears of a trade war with the S&P 500 having gained approximately 6.26% year-to-date, as of August 3.

Advisors should encourage clients to avoid a kneejerk reaction of selling equities and should instead consider managing risk with a diversified portfolio allocation that could include cash as a buffer against market downturns. Advisors should also consider whether they should increase their clients' portfolio allocations to businesses such as small cap companies that have less exposure to overseas markets.

That strategy has already been a market leader. From mid-February when trade fears increased substantially until August 3, the Russell 2000 Index of small cap companies has generated an 8.76% return, thereby outperforming the 3.9% return of large cap companies as measured by the Russell 1000 Index.

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