You might have noticed a bit of market movement over the past week (!!). In case you were lounging on a beach and missed it, over the last several days, the S&P 500 plunged and rebounded, and plunged and rebounded, and is plunging, again, as I’m writing this. The net effect of all these gyrations over the past five business days is a 4.5% drop in the S&P 500.
This might seem unnerving but in the bigger picture, this is a pretty modest drop for a market that was up 17% so far this year. Some analysts were surprised it wasn’t worse given the sudden escalation in the trade conflict with China stemming from the recent announcement of a new, all-inclusive round of tariffs. If these new tariffs go into effect as planned on September 1, the United States will be imposing tariffs on every single product that we import from China.
This alarming fact warrants a quick refresher on how tariffs work and clarification regarding whether they are a tax on China, America, or both.
With tariffs, American consumers pay a higher price if the exporting company maintains the same pricing policies that it had in effect before the tariffs were levied. However, many exporters will lower the price they demand to offset the effectively higher price in the U.S. market, eating some of the tariff’s bite to remain competitive.
An alternative is that the foreign country might depreciate its currency, making its exports cheaper across the board which would also offset the impact of the tariff. This explains why China decided to stop defending the value of its currency almost immediately after the tariff announcement, causing the yuan to fall below seven to the dollar. The Administration cried foul and accused China of manipulating its currency; however, this charge would be hard to prove as the drop was most likely due to the movement of currency markets.
The result of the depreciation is that Chinese products will be instantly cheaper and more competitive around the world, regardless of the impact of U.S. tariffs, while Chinese buyers will have to pay more (in their currency) to buy American products. The Chinese buyers of American products are thus, indirectly, now paying a price for those tariffs.
So, to answer the question: Who’s paying for the tariffs—Chinese, Americans, or both? You now know the answer is both!
Does the market drop signal the end of the bull market? Nobody can say for sure, but it seems unlikely, given that the U.S. economy is still healthy and enjoying the effects of recent Fed stimulus (a drop in the Federal funds interest rate). Second quarter earnings on the S&P 500 (with 387 of the 500 companies reporting) stand at $42.13, which is comfortably ahead of the $40.70 forecast for the quarter. There doesn’t seem to be an apocalypse on the near horizon, though at any moment the long bull market could turn bearish for anywhere from a few quarters to a year or two.
History has shown that when stocks go on sale suddenly due to a startling of the investment herd, it’s an opportunity to buy rather than a good time to sell. Our client portfolios are built and monitored to achieve their goals, not to react to short-term market movements (regardless of their source). To be sure, the markets will have our attention but the political drama we’re seeing unfold in the markets does not warrant any investment drama on our part.
We’re happy to answer your questions about this or any other excitement in the market and to clarify its impact on your portfolio and the goals you hold dear.