Special Market Commentary: March Madness – Basketball Tournament or Tariff Policy

April 3, 2025

By Brian Andrew, CFA® – Chief Investment Officer

Markets rallied on news that the proposed tariff plan was going to be scaled back before April 2^nd, then the President made it clear that wasn’t his goal. We should know now that focusing on tariffs implemented not bantered about is the best way to determine policy changes and economic impact. Yesterday, new tariffs were announced, and the market’s reaction was one of surprise, more on that in a few paragraphs. The S&P 500 Index was off 3.5% in after-market trading.

What is clear, is that the President believes that tariffs work. In the Administration’s view they will return jobs and manufacturing to the U.S. That manufacturing like steel and aluminum is a matter of national security. That the trade agreements negotiated over the last 20-30 years don’t serve the U.S. well and need to be terminated, re-written or ignored. That other countries have taken advantage of our lack of reciprocal tariffs creating disadvantage for U.S. exports. Finally, that tariffs will create a revenue boon for the U.S. Treasury and combined with a reduction in corporate taxes for domestic production will return the U.S. economy to greater growth.

There is much debate about the benefit of tariffs and starting a global trade war. As investors we can limit our analysis, on tariffs impact on economic growth, inflation and asset prices.

Tariff Example

First an explanation as to why tariffs can initially cause a deterioration in economic growth and higher prices. A tariff on an imported good is a payment made to the U.S. Treasury.

As an example, let’s say we levy a 25% tariff on a BMW motorcycle, made in Germany. When it arrives in the U.S. the North American distributor must pay the Treasury 25% of the wholesale cost of the bike, or $5,000 on the $20,000 wholesale value for simplicity’s sake. The distributor can add the $5k to the $25,000 retail price or reduce the $5,000 profit margin they and BMW would make. Here’s the economic impact. BMW might sell fewer bikes in the U.S. because the price has risen to $30,000. The trade deficit goes down because they sell fewer bikes and dealers will employ fewer people or BMW and the distributors can earn less while trying to maintain sales.

Of course, if prices rise, customers may look for alternatives (though there is no comparison between a BMW 1300 GSA and a Harley Davidson Pan American – please email me to debate!). As consumers and manufacturers look for alternatives, productivity slows, and so does the economy. Using our example, either prices rise or profits fall.

Tariffs concern inflation and corporate earnings. We know earnings drive stock prices so if profit margins decline due to tariffs, stock prices adjust. If consumers pay more for goods that’s inflation.

Measuring The Impact

We can measure the impact of tariffs on both economic growth and inflation. Let’s look at this long-term chart from Goldman Sachs. It shows that the current effective tariff rate in the U.S. is 3%. For every 1% increase in this effective rate, we expect prices to rise by .1%.

Source: Goldman Sachs Global Investment Research

You can see that the base case was 13%. This was before yesterday’s announcement. As announced yesterday, the effective tariff rate would be closer to 25% above Goldman’s worst case on Monday of 18%.

We also can estimate that for every 5-percentage point (pp) rise in that effective tariff rate, we’ll lose .5% of real economic growth. So again, if the base case is correct economic growth would slow by 1% from around 2.5% now to 1.5%. This effect is why some have begun calling for a potential recession.

Of course, with yesterday’s Rose Garden announcement, you might think we know what’s going to happen. Not so fast. While reciprocal tariffs were announced as follows in the chart, their implementation date is still days away and other countries could negotiate for a lower rate.

Preliminary list of U.S. reciprocal tariffs image

Source: The White House

These are big numbers, you might ask why those countries like Laos, Viet Nam and Sri Lanka top the list. Because China uses them to ship goods through to avoid the tariffs levied in 2018. Note, Japan at 24% and the EU at 20%. These all raise that effective tariff rate as described above. Bottom line, uncertainty remains high.

Impact On Asset Prices

Stocks sold off after market when the announcement was made. Understand that as tariffs are levied profit margins and sales, i.e. revenue growth are affected. However, we know that they are more impactful in some industries (Autos over Utilities as an example) than others. We also know that companies who have low levels of debt, high degree of free cash flow and solid businesses will be able to adapt more quickly.

Big tech companies – Apple, Google, Amazon and Microsoft, that’s how they look. However, those companies have led the market for the last two years and so entered 2025 expensive. A good portfolio underweight. It is more likely we’ll find less expensive companies with the same quality characteristics and invest there.

This chart provides evidence of the change in investors’ preference. The chart provides returns on categories of stocks based on their size and whether they are “growth” or “value” stocks. The performance is all relative to the S&P 500 Index which declined 4.5% during the first quarter. You can see large value companies were up 4% while large growth (where those tech stocks are categorized) was down 3.7% more than the S&P 500.

Source: Koyfin

Companies will adapt to the new tariff regime though that will take time. In the interim we’ll find opportunities to buy good assets at a lower price.

What About Bonds

We mentioned above that inflation would be affected by tariff policy. This could cause interest rates to rise. However, they already have, so our starting point for yields is over 4 or 5% not the 1-2% of several years ago. This makes bonds attractive for two reasons. Their total return is more protected if inflation pushes interest rates higher. It also means that our bond portfolio can offset the potential decline in our stock portfolio providing the diversification we want.

Other Options

There are strategies that don’t perform anything like stocks or bonds. In an environment like the one we’re in now, when uncertainty is at its peak, allocating a portion of assets to this type of strategy may offer some benefit, particularly for those with shorter time-horizons. I may not have a successful bracket for the college basketball tournament or determine the future price of a motorcycle. We can use the information herein to manage portfolios through the uncertainty and look for opportunities when they present themselves.