A Comedy of Errors, Repeated

Eric Fry By Eric Fry
Macro Strategist

Market Trends

Let’s take a stroll down memory lane and examine the wacky antics of a famous duo from the 1930s. Not Laurel and HardySmoot and Hawley.

It might be easy to confuse these contemporaries. But Laurel and Hardy were famous for their slapstick comedy, whereas Smoot and Hawley became infamous for their economic buffoonery.

Sen. Reed Smoot and Rep. Willis Hawley were two well-intentioned U.S. congressmen who championed tariff legislation during the late 1920s. They culminated these efforts by sponsoring a bill to impose heavy tariffs on more than 20,000 imported goods.

This bill became the law of the land on June 17, 1930. The stock market collapsed almost immediately. Within just two years, the market had plummeted more than 80%.

The Smoot-Hawley tariffs do not deserve all of the blame for this epic collapse, but history has demonstrated on more than one occasion that the stock market is not a big fan of tariffs and trade wars.

The last few weeks have provided additional evidence of the market’s disdain for the opening salvos of trade warfare.

Since the day the president announced his intention to levy tariffs on imported steel, the world’s stock markets have lost more than $1 trillion of market value. Of that total, the U.S. stock market has accounted for about $800 billion of the losses.

That’s a VERY big number. In fact, $800 billion is greater than the annual GDP of either Switzerland or the Netherlands. Clearly, we’d prefer not to shed this much capital every trading day.

On the other side of the ledger, if the tariffs against Chinese goods were to be implemented as proposed, they would raise no more than $15 billion per year. And those funds would flow to the U.S. government, not the private sector.

For additional perspective, $800 billion divided by $15 billion is about 53 – meaning that our stock market losses from the last two weeks would equal about 53 years’ worth of tariff revenue.

That seems like a bad trade… at least from the perspective of a U.S. investor.

Obviously, two weeks of trading in the stock market is not the whole story, nor is it a trend that we can project indefinitely into the future. But the stock market’s trading action is certainly not a promising sign.

This observation is not political. It is empirical: Tariffs up… Stocks down. That has been the pattern in the stock market for generations.

Already, we are seeing firsthand that tariffs can impose very direct and immediate challenges to a “normal” investment analysis. Back in January, for example, the Guggenheim Solar ETF (NYSE: TAN) had just reached a new two-year high and was showing every sign of continuing its upward climb.

But then the president approved tariffs against imported solar panels. The announcement took some of the shine off of solar stocks and knocked the Solar ETF’s share price down a few notches. The ETF still has not recovered all of its lost ground.

One month later, a salvo of new and unexpected tariffs rocked the steel sector. Brazilian iron ore producer Vale (NYSE: VALE) was bouncing nicely from the depths of the February stock market sell-off and had just reached a new 3 ½-year high. The stock’s momentum was strong, and it was outperforming most other stocks.

But that’s when the president unexpectedly announced tariffs on imported steel and aluminum. In the midst of the ensuing chaos and confusion, Vale’s share price bounced a little more, but then started sliding lower.

Perhaps these recent blows to the share prices of both the Solar ETF and Vale will amount to nothing more than fleeting “noise.” But the more that tariffs multiply and grab the financial news headlines, the greater the headwind most stocks will face. And the more that tariffs become our economic weapon of choice, the greater the risk that we will repeat the mistakes of the past.

The Smoot-Hawley tariffs were certainly not the cause of the Great Depression. But most economic historians believe these tariffs deserve a great deal of the blame for contributing to the Great Depression’s severity and duration.

So colossal was the economic disaster that ensued from the Smoot-Hawley Tariff Act that it has become as synonymous with failure as the Maginot Line. And the pain these tariffs imposed on the national economy was so severe that Americans have feared trade wars ever since.

Despite this national sentiment, the American in the White House admits to no fear of a trade war whatsoever. In fact, he believes it would be “easy to win.” Perhaps he is correct about that. But the stock market does not seem to share his confidence and bravado.

My observations are not political. They are financial… and they are empirical.

I am not discussing tariffs in order to advance a Republican or Democratic ideology; I am discussing them because they are injecting a new and potentially threatening factor into our investment calculus.

Whatever benefit a tariff may bestow upon a specific industry, history has demonstrated numerous times that tariffs can become a very toxic remedy for real or perceived economic ills. In other words, they can sometimes do more harm than good.

Often, the resulting harm is the unintended and unforeseen consequence of trying to achieve a specific good. So we need to be vigilant and keep a close eye on this new factor.

China is the target of the president’s newest suite of trade tariffs, but U.S. investors could become the unintended casualties.

Good investing,

Eric