How Will Tariffs Affect the Stock Market?

This is our third installment on the impact of the Administration’s government efficiency and trade policy on the economy and investors. You can find our February article and March webinar at these links. The news flow about tariffs, in particular, has been fast and furious, with changes in direction occurring every other day. While we can’t predict where policy will “land” with any accuracy, we can start thinking about the long-term impact of the policy changes. We will first touch on the current status of the Department of Government Efficiency (“DOGE”). Then we will focus our attention on how we think tariffs will affect the stock market for investors and ultimately, the economy.

Will DOGE Savings Cut the Budget Deficit?

The size of the budget deficit is a problem. Once contained at a manageable level at 3% of economic output (defined as Gross Domestic Product, or “GDP,” for short), the deficit has ballooned to over 6% of GDP the last few years. The government is expected to spend over $1.2 trillion on interest costs from the national debt, which is over 20% of all the taxes collected. 

While the roll-out of DOGE was akin to a bull in a china shop, it was at least encouraging to see attention being paid to the ballooning deficit. Something has to be done about it. So far, DOGE claims annual savings of $160 billion per year. “Better than nothing,” they say. But this amounts to just 0.5% of GDP. 

It’s still early days for DOGE, but we are becoming worried that this effort will peter out without meaningfully cutting the deficit. Prior claims of up to $1 trillion of savings are proving unfounded. Congress is likely to extend the Tax Cuts & Jobs Act, which is great for individual taxpayers but less so for deficit hawks. And there’s talk of increasing defense spending by $150 billion, wiping out most of DOGE savings. 

If these efficiency efforts don’t improve U.S. deficit dynamics, then the worries we had last year about fiscal dominance remain. That would mean higher inflation than what we’ve seen in recent decades, likely higher sustained interest rates, and a constrained Federal Reserve. 

How Will Tariffs Affect the Economy?

The other major policy initiative by the Trump Administration is to address trade imbalances between the U.S. and major trading partners, namely China. The “stick” used to get trading partners to the negotiating table was the announcement of significant tariffs on April 2, 2025. There have since been some concessions to soften some of the blow. But the most important tariff – a 145% levy against China imports – remains. 

Getting resolution on the China tariffs will be very important in the coming weeks. Already, many companies have stopped orders coming from China. The last “pre-tariff” ships that left China before April 2 are due to arrive in US ports in the first half of May. Once those ships unload, there will be few shipments of goods from China until tariffs are resolved. The good news, if there is any, is that companies had been stocking up on inventory ahead of time. 

The longer these exceptionally high tariffs remain on China goods, the greater the potential impact to US consumers. While we don’t expect shortages in toilet paper or food, the coming Back to School season and Christmas may see reduced inventories. Even if the US and China agree to a resolution, it will take weeks and months for supply chains to get up and running again. The month of May will be key to the outlook for the rest of 2025. 

Investment Impact from Tariffs

There has been a lot of volatility in U.S. stock markets since the tariff announcement at the beginning of April. While stocks have recovered somewhat from the lows, they are still down for 2025. Interestingly, international stocks and commodities are in positive territory for the year.

It has been a long time since U.S. stocks were not the leaders in global investment performance. International stocks were already doing better than U.S. stocks in the early months of 2025, and have continued to hold their gains in the face of tariff uncertainty.

Bonds remain positive for 2025 but like stocks, it has been a volatile ride in April. Interest rates rose in the early part of April as hedge funds were forced to unwind highly leveraged trade. But yields have come back down as the market prices in an economic slowdown and more aggressive interest rate cuts by the Federal Reserve.

The most interesting performer in 2025 is commodities. Gold has surged to well-north of $3,000/oz for the first time, but lower oil prices have offset some of those gains. FDS has included an allocation to commodities in client portfolios for the last several years. We view it as an inflation hedge. Stronger relative performance of commodities may reflect investor concerns about the inflation impact of tariffs and de-globalization. 

Will Tariffs Cause International Investing to Make a Comeback?

The solid performance of international stocks in 2025 is notable after underperforming U.S. stocks for 15 years. U.S. companies have experienced stronger earnings growth. This is because our stock markets have more exposure to high-growth sectors such as technology. Is international outperformance a real trend, or will U.S. stocks reassert themselves?

The answer to this question may reside in how the U.S. Dollar performs against international currencies. Since the Global Financial Crisis of 2008, the dollar has appreciated against a broad basket of international currencies. This is in both developed and emerging markets. All else being equal, that means US-based investors in international stocks see lower investment returns as international stock prices are translated back into dollars. 

As seen here, there is a tight relationship between the Dollar’s strength and outperformance of US stocks against international stocks. The blue line is an index of the Dollar versus other major currencies, while the yellow line represents the relative performance of US stocks versus non-US stocks.

What’s intriguing to us is how well non-US stocks have done this year as the dollar’s value has fallen. It’s possible this is just a short-term blip in a long-term trend of dollar strength. But when we think about the current Administration’s policy of bringing manufacturing back to the US, a weak dollar certainly has to play a role. A weak dollar makes US goods cheaper to purchase, which increases exports, and supports domestic manufacturing. Having a view on future weakness or strength of the dollar is important.

Long-term Investing Impact of Re-Shoring and De-Globalization

We have been vocal in the belief that the investment regime in the coming decade will look decidedly different from what we’ve seen the last 40 years. Low inflation marked the last 40 years, with declining interest rates and widening income and wealth inequality. But now, labor markets are tightening as Baby Boomers retire. Investment in fossil fuel energy supply has been curtailed in response to environmental concerns. And there is a clear push from US officials to re-think our reliance on international supply chains.

It’s easy to think that the push to re-shore US supply chains is solely related to the Trump Administration. But COVID exposed several weaknesses in our supply chains that other policymakers were already pushing to address. It’s our view that re-shoring and de-globalization is here to stay, which puts a floor under inflation. 

If inflation will sustain at higher levels than we’ve seen the last few decades, then that means interest rates will also remain higher. It’s hard to conceive a scenario where the Federal Reserve is cutting rates to 0% again. Sticky inflation prevents them from doing so. In the coming regime, we think the Federal Reserve will matter much less than it has since the 1990s. Interest policy will remain important, for sure, but the days of relentless “Fed watching” may come to a close. 

Investment Strategy for the Rest of 2025

Tariffs will obviously dominate the investment landscape until they come to some sort of conclusion. But there are other market dynamics worth mentioning. The first is the degree to which large technology companies make up a disproportionate share of the US stock market. An interesting chart from Goldman Sachs came across our desk recently. As you see below, it shows markets more concentrated than they’ve ever been in the last 100 years.

Technology premiums have been “justified” by the explosion of Artificial Intelligence (“AI”) spending. Major tech companies are projected to spend nearly $300 billion PER YEAR for the next three years on the AI build-out. But recent AI advances from China and slow build-up of AI revenues are calling this spending into question. 

We’ve also seen stock valuations for small and medium-sized companies reach 25 year lows compared to large company stocks. [Blue line, below is Mid-cap stock valuations relative to large-cap stocks while the red line is small-cap stocks] This can be attributed to much stronger fundamental earnings performance for large companies. But almost all of this growth has been driven by the same subset of technology companies. 

It’s early to make this call, but tariff-driven de-globalization and slowdown in AI spending could have meaningful implications for investors. For the first time in many years, international stocks and those of small/mid-sized US companies may gain some renewed attention from investors. Investors may finally see diversification working in their favor.

Worried About Tariffs Affecting the Stock Market?

For our clients, we will continue to update you on the progress of DOGE and tariffs. You will continue to hear from us about how it affects our investment philosophy. As always, we’re here to support you with any planning or investing questions you may have.

Maybe you don’t have someone who is staying up on the news and ensuring your plan is on track all year. If you want that kind of confidence, reach out to schedule a free consultation! Our team specializes investment management and executive compensation so that you can retire tax efficiently.