Trump’s tariff play: A genius revenue move, or a market misstep? Investors aren’t convinced.
KEY TAKEAWAYS
MY HOT TAKES
Off-putting. So, here we are. T-Day +1, and as I rummaged through the mountains of news sources that ran through the night into this morning, I struggled to find a single headline that did not include President Trump. I suppose it should be expected given all the… um, stuff that is going down. Tariffs, once thought by many to be an empty bargaining threat, became a reality yesterday. By midday, markets looked like a person that just lost their head without fully realizing it yet shining a surprised look. Sorry for the graphic description but that is the best way I could convey it.
I am not going to get into the details of the tariffs and the counter tariffs as I covered them yesterday. You can check out yesterday’s blog post here for more details. I do want to cover how markets unfolded yesterday, the post-market banter, and the President’s Congressional address last night, because details, these days, are important to get the fullest picture. I used the adjective fullest because there is no full, clear picture yet. Let’s first start with a chart. I know it looks a bit complicated but bear with me.
Bloomberg users will recognize this as a COMP chart. It simply compares percent returns in date ranges. Here I show you the returns of the S&P 500, the Dow Jones Industrials, the Nasdaq Composite Index, and the Magnificent 7. Though the graph is distorted by the Mag-7’s rather sizable round trip from 0% to 21% and back to 2.84%, you can still see how the broader indexes had a similar journey since election day, though not as extreme. In a nutshell, the latter half of February saw a melting away of the so-called “Trump bump,” and this week’s trade was pretty much the final nail in the coffin; the Trump bump is no longer.
What caused the Trump bump in the first place? Optimism! Trump’s campaign came with lots of pro-growth policy talk. Tax cuts, regulatory relief, pro-business, pro-consumer, etc. An already hot equity market was fueled further by the potential. Trump is known to use the market as a scorecard, which almost guaranteed that would do nothing to hurt the bull market; the so-called “Trump Put” was back. However, there was some small print that seemed to escape the equity markets at first. All that stimulative policy costs money and promised to swell the ALREADY swollen deficit and the indebtedness that fuels the spending. That reality did not escape the bond markets which ratcheted longer maturity yields higher.
The President was also well-aware of the consequences of the stimulative policy proposals, and he set out to come up with ways of lowering the deficit. Noble. Now, there are only two ways to lower the deficit: cut spending or make more money. Yes, folks, it’s that simple, even though it probably reminds you of a conversation you have recently had with your spouse about your own personal finances. The Government can only make more money through tax collections–no side hustles. Would Trump have the chutzpah to raise personal income taxes? How about corporate taxes? NO WAY! But he can find other tax sources, like, say TARIFFS. That’s right, tariffs.
Last night, in his address to Congress, the President said he was going to make America rich again, through tariffs. Wait, wasn’t yesterday's tariff about fentanyl? Also, I thought tariffs were about onshoring American businesses to create new jobs and protect national security. Wait, I am confused. Yesterday morning, Commerce Secretary Howard Lutnick was on CNBC talking about the tariffs. Seasoned anchor Becky Quick tried her darndest to nail down a straight answer about the goals and side-effects of the tariffs but could not. The confusion from that interview did little to quell the nerves of the market which saw pre-open gains slip into the red further and further.
Now, let’s look back in history. The US used to heavily tax through tariffs. In fact, Alexander Hamilton used tariffs to pay off the nation's Revolutionary War debt. Believe it or not, tariffs are quite common throughout the world. However, they are generally used as a source of INCOME for the taxing governments. They are alternative taxes which can even offset personal income taxes. Wait, we may be onto something. Can’t the US just collect lots of tariffs and then use the proceeds to fund massive personal income tax cuts, thus essentially shifting the tax burden off of you and me to… wait… … this is where it gets tricky. Who pays the tariffs?
I am praying that you know this by now, because I have literally beaten it into you, my regulars. IMPORTING COMPANIES—US companies pay the tariffs to US Customs when imported goods hit the ports. US COMPANIES. That’s right, Target is, as of yesterday paying 25% more for bananas from Mexico. What do you think Target’s margin on bananas is? Del Monte, the importer, makes about 10% gross margin on bananas. Tariffs of 25% will be assessed based on the declared value of the import, which means that Del Monte will suffer a -15% loss on the sale of bananas. That is assuming that Del Monte doesn’t raise its sales price to its customers like Kroger, Walmart, and Target. What do you think Del Monte will do?
Del Monte will raise its prices by… wait for it… wait for it… 25% to continue to enjoy its already narrow 10% margin. Now, Del Monte can choose to take the loss, but I am sure that the market wouldn’t appreciate that. The company only sports an 8.4% gross margin and a 2.9% net margin on all products. So, it is safe to assume that most of those tariffs will be passed on to the retailers. So, what will Target do now that it is paying 25% more for bananas?
Well, Target, while it doesn’t disclose its grocery margin, likely makes around ~10% margins on produce, in line with the industry. The math works the same way for Target as it did for Del Monte. It has a choice to either lose -15% on each banana that it sells, or it can raise the retail price to you and me. This would allow Target to escape the ire of its shareholders. But would Target actually raise prices? Well, according to CEO Brian Cornell in his CNBC interview (he came on before Lutnick), “prices will go up… certainly over the next week.”
So, folks, you are going to pay more for bananas or just about anything that comes from Mexico, Canada, or China. How much? Well, that depends on how much of the tariff that the US companies in the supply chain pass on to us. Now, sometimes, the foreign exporter will eat some of the tariff, but research shows that the brunt of it is borne by US companies and consumers.
Is there any upside here? Well, the US Treasury stands to make a lot of tax revenue FROM US IMPORTERS… and ultimately you and me. The government may indeed become rich again, but not you and me so much. Well, I suppose the deficit will be smaller with more income, then. Ok, but what if we get a well-deserved tax cut? That will simply eat into the deficit once again, though more dollars in the pockets of taxpayers can offset the inflation caused by tariffs, at least a little bit.
Are you buying this? Probably not, and neither was the stock market, based on the last two trading days, if not months. Trump has seen his Trump bump turn into a Trump Dump. So, the real-deal question is, when will the President take notice of the market’s negative response and relent on the tariffs? How much portfolio pain must all of us, including him, suffer before the President becomes more measured in his trade negotiations.
Wall Street insiders ask the question differently: “what is the strike price of the Trump Put?” Meaning at what level of market decline would the President start pumping the markets with more bullish policy talk? Was yesterday enough to get his attention? By the close, it appeared not to be the case, but after the close Commerce Secretary Lutnick hinted that Trump could strike deals with Mexico and Canada today. Has the strike price on the Trump Put been set? Based on Trump’s speech last night, you wouldn’t think so. Today is, alas, a new day and there is no telling what might happen. The market will soon learn that it can only expect one sure thing, more confusion. Stay tuned, this will surely not be the final note on tariffs.
YESTERDAY’S MARKETS
Stocks had a rough session as traders digested the reality that President Trump was serious about tariffs on Canada, China, and Mexico. The first two hit back immediately with their own tariffs on the US and the latter is planning to hit back on… Sunday. Stocks ended off session lows with tech the best of the worst on dip buying, but it wasn’t good enough to stop the bleed. A post-market admission by Commerce Boss Lutnick provided overnight solace to traders with hints that Trump may make a deal today.
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