Tariffs are here and in a big, big way, much bigger than anyone expected. And the levels shared by President Trump aren’t really reciprocal tariffs. The calculation of new tariff rates is based on the trade deficit the US has with each country and has nothing to do with actual tariffs other countries charge on US goods.
Here’s how the calculations were done. Say a country exports $10 of goods to the US and imports $6 of goods from the US. That’s a trade deficit of $4 the US has with the country, or 40% of their exports. Boom! They get charged a 40% “reciprocal” tariff to make things “fair.” BUT, the administration wants to be seen as lenient, and so they’ve halved that rate from 40% to 20%. Still, the minimum rate is 10%.
This calculation is why the island of Norfolk (population 2,188 and 1000 miles of the coast of Australia) got slapped with a 29% tariff—they export about $655,000 of goods to the US (mostly leather footwear). Meanwhile, Australia gets slapped with a 10% tariff.
The highest tariff rate imposed on any country is 50%, on goods from the tiny African nation of Lesotho (also one of the poorest). Lesotho imposes a tariff rate on US-made goods that is similar to other countries in the Southern African Customs Union (SACU). But Lesotho is charged 50%, whereas other members get hit with a lot less, including 30% for South Africa, 21% for Namibia, and 37% for Botswana. That’s because Lesotho exported about $237 million of goods to the US in 2024 (mostly diamonds and Levi’s jeans), while they imported only about $7 million worth of products from the US (they can’t really afford to buy a lot of American products). As calculated, that’s (237-7)/237 = 97%, and halving that gets close to 50%.
South Korea, which has a free trade agreement with the US, and near 0% tariffs on US goods, gets hit with a 25% tariff. Meanwhile, serial tariff user, Brazil, just gets 10%.
China gets hit by a 34% tariff under this calculation, but that’s above the already announced 20% tariffs on Chinese goods, which means tariffs on China are now at 54%.
Then we also have tariffs on autos, steel and aluminum, and upcoming tariffs on things like lumber and pharmaceuticals.
There’s Not Much Room for Negotiation Given US Goals
This bilateral deficit-based tariff calculation is going to make it hard to negotiate with the US. How do you reduce your tariff to zero if it’s practically zero already, as in South Korea’s case? You’d have to “promise” that the bilateral trade surplus with the US will fall to zero. But how do you do that without completely retooling your economy towards consumption instead of manufacturing? Even if it happens (which is very, very, very unlikely,) it’s going to take ages in my opinion to actually happen.
This is the problem with focusing on bilateral trade. A country may have a surplus with the US but an overall trade deficit. So how does it go about reducing its trade surplus with the US to zero without simultaneously adjusting trade with everyone else? Meanwhile everyone else is trying to do the same thing.
These tariffs are slated to go into effect on April 9th, which leaves barely a week for negotiations. And if other countries retaliate, as several have suggested they will, we could see the administration dial up these tariffs even more. Interestingly, China has been relatively quiet with respect to the tariff issue, with no meetings scheduled at least until June.
On top of that, the administration has also torn up the USMCA (the trade agreement between the US, Canada, and Mexico). President Trump himself touted the USMCA as a great deal back in 2019 (the USMCA replaced NAFTA). That tells other countries there’s no certainty here that the US sticks to its end of any negotiated deal.
It also gets to the point that these tariffs have several incompatible goals. On one hand, the goal is to bring back manufacturing to the US. Let’s be clear, this would happen by import substitution, i.e. making foreign goods much more expensive and forcing Americans to buy slightly less expensive US goods (but still more expensive than current prices). Keep in mind that this has major implications for household consumption, especially durable goods (like cars, furniture, appliances, TVs, etc.). The last 30 years, following NAFTA and China’s entry into the WTO in 1999, saw a steady pullback in durable goods prices (the chart shows the personal consumption expenditures index for durable goods). Covid broke that streak, as supply chains cracked, but over the last two years, it was looking like the downtrend in prices resumed. But now, the goal is to willfully break those same supply chains, which means we could be at the end of an era of durable goods deflation.
On the other hand, another stated goal is to raise 100s of billions of dollars of revenue from tariffs (to perhaps pay for tax cuts), but in that case you don’t want import substitution and reshoring of manufacturing. Then you have the tech-adjacent folks close to the administration saying these tariffs are meant to be negotiated down so that globalization can happen on a “level playing field,” i.e. zero tariffs everywhere. But that means accepting trade imbalances.
Uncertainty Is Going to Hurt, Whether or Not These Tariffs Are Kept in Place
Ultimately, we have no idea whether these tariffs will be permanent. And that’s going to be a problem for businesses.
If you’re looking to build a plant to manufacture, say leather footwear in the US (perhaps taking away share from the Norfolk Islands), what if the tariffs are removed a few months from now, or three years from now, and the previously calculated return on investment no longer makes sense. That uncertainty is going to reduce capital investment here in the US.
Real private nonresidential investment, i.e. business investment, was already slowing in Q4 2024 before this shock. Companies sitting back without making investments is going to be a bigger drag on GDP going forward. Now, we did have a trade war in 2018 – 2019 and didn’t see a big collapse in business investment but that time had two things going for it: 1) a huge corporate tax cut, and 2) a Federal Reserve (Fed) that started to reverse tight policy. That’s not the case today.
There’s also the problem of stranded assets for US companies. What do you do with a foreign plant now? Take the example of Nike, which has 500,000 people working in Vietnam across 155 factories, even as high-value design is done here in the US. Does Nike reshore all their manufacturing facilities, and what do they do with the ones abroad? Moreover, who builds these factories here in the US (we likely don’t have enough construction workers), and where do we find half a million workers to manufacture sneakers, assuming that low value-add activity is something desirable to be reshored? Companies will be asking a lot of questions, to which there aren’t any clear answers.
A Shock That Could Leave the Fed on the Sidelines
The Budget Lab at Yale calculates that the US average tariff rate will rise to 22.5% if these tariffs are implemented, the highest since 1909, even higher than the Smoot-Hawley tariffs signed into law by President Hoover in 1930.
To be clear, this is a massive shock to the economy—akin to a big tax increase on consumers and/or businesses (if they don’t pass the increased tariff cost to consumers). We just don’t know how large and for how long.
My colleague, Associate Portfolio Manager, Blake Anderson, who manages equity portfolios and focuses especially on the technology sector, says that Apple runs about 97% gross margins on its products, and 85-90% of production costs are Asia based. A 50% tariff on those products and the gross margins collapses to 5%, which likely explains why Apple shares fell more than 8% on the day after Liberation Day. Of course, Apple could as charge consumers more for iPhones, iPads, etc., but that runs the risk that they stop buying altogether.
In fact, a lot of companies in the traditional industrial heartland of America and even the Great Plains may be disproportionately impacted by the tariffs, and retaliatory tariffs. These areas still have a lot of manufacturing that rely on capital goods and intermediate inputs (including being a key part of the auto supply chain). And they also rely a lot on exports, including agricultural products, commodities, and even aerospace.
Over the last two years, we’ve repeatedly talked about the fact that manufacturing construction in the US has soared since the end of 2020 (by over 130% in inflation-adjusted terms). Ordinarily, we would now be expecting companies to purchase (and import) industrial equipment to for these factories, but they’re going to get big tariffs slapped on them. In other words, it just got more expensive to build in the United States.
The massive tariffs may also paralyze the Fed. Investors expect three to four interest rate cuts this year, but I’m not so sure. You would expect rate cuts in the face of a rising unemployment rate, which will occur if the tariff shock pushes hiring even lower and layoffs really surge as companies retrench. This could happen but the Fed may be paralyzed between a rise in inflation (albeit “transitory”) and reacting to a rising unemployment rate. Right now, investors are estimating a near zero chance of no rate cuts this year, but I think it’s a lot higher than that—perhaps not as high as to be the base case, but not insignificant either. Even if the Fed cuts rates, they would be reacting to a rise in unemployment rate as opposed to taking preemptive action. In other words, they’re going to fall even further behind the curve on easing policy (and elevated rates are already hurting housing and manufacturing).
Now, long-term Treasury interest rates have been falling for a couple of months now. Normally that would be a tailwind for areas like housing, via lower mortgage rates. But housing is also going to be buffeted by higher tariffs on inputs into the construction process, including lumber. And rates are falling for the wrong reasons, i.e. because investors expect slower economic growth in the future.
Economists in the administration have also said that the inflationary impact of the tariffs can be muted by a rising dollar. But that assumes that the US economy will continue to outperform the rest of the world and interest rates in the US will stay much higher than elsewhere (attracting flows into USD based assets). But markets are betting the opposite will happen—that growth will collapse, pushing the Fed to cut rates—and so the USD has actually fallen, including after the latest tariffs announcement. That’s going to make imports even more expensive.
What About Markets, and Portfolios?
With respect to markets in general, everything we’ve seen policy-wise over the last two decades has been to lower volatility—whether it’s the Fed stepping in with QE or rate cuts, or Congress and the White House sending out stimulus checks. (That doesn’t mean they were successful every time, but the goal was to smooth over cracks that were forming in markets or the economy.) But policy right now is actively volatility-inducing. Administration officials have openly talked about “short-term pain” for “long-term gain,” with President Trump himself admitting that a transition period for the economy is likely, and that “you can’t really watch the stock market.” Treasury Secretary Scott Bessent said that the selloff in stocks was due to a pullback in technology stocks rather than protectionist policies, calling it “a Mag7 problem, not a MAGA problem.”
Of course, given the seemingly incompatible goals of these policies, as I described earlier, it’s hard to see a clear long-term gain right now. The risk of a recession over the next 12 months has increased quite significantly, but things are still very fluid.
All this has implications for portfolio construction and how different parts of the portfolio complement each other. For example, if inflation surprises to the upside over the next few months, the Fed may not cut, and we could see bonds failing to act as a diversifier to stocks. But you don’t want to throw out long-term bonds from a portfolio in case a recession materializes, and interest rates plunge. Low volatility stocks are another way to diversify portfolios—these are stocks that tend to outperform when markets are volatile.
Another thing to keep in mind is that the current account deficit for the US (which is mostly the trade deficit) is the other side of the capital account surplus, i.e. net inflows of capital into the US. It exactly balances out. Over the last two decades, those inflows of capital have mostly gone into portfolio investment rather than fixed direct investment (FDI), for example US debt (especially Treasuries) and stocks, mostly thanks to outperformance of these assets over everything else. If the trade deficit disappears, the capital surplus has to also disappear as these things have to balance. The ramifications of the tariff announcement go beyond mere trade. It also has implications for flows of capital into various global assets, which could impact differential returns between all these assets.
Diversification has had a tough decade and half, thanks to the US stock market, led by technology-oriented stocks, outperforming by as much as they have. But now may be the time when a really diversified portfolio is crucial. That includes both within equities and actual diversifiers (the stuff you expect to zig when stocks zag). You likely don’t want to be concentrated in any single side of the equity market, including just US equities, instead diversifying globally to take advantage of lower correlations between US and international stocks. If the dollar continues to pull back, as other countries reduce trade with the US, that will be a potential tailwind for international stocks. On the diversifiers side, as we’ve consistently been saying, you want to diversify your diversifiers, across cash, bonds, commodities, managed futures (a trend following strategy that can provide exposure to different types of assets), and even low volatility stocks (as I mentioned above). Given all the uncertainty, it’s hard to say which one zigs when stocks zag. The good news is that there are myriad ways to create well-diversified portfolio cheaply right now, much more so than 20 years ago, or even 10 years ago.
Sonu Varghese is a non-registered affiliate of Cetera Advisor Networks, LLC.
The views stated in this blog are not necessarily the opinion of Cetera Advisor Networks, LLC, or CWM, LLC. and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. A diversified portfolio does not ensure a profit or protect against loss in a declining market.
