Written March 6, 2025
In this research note, we address four essential questions on tariffs for investors, representing our latest insights into the situation. We run through the stated goals of tariff policy, possible economic effects and the investment impact for various asset classes.
The U.S. tariff landscape is rapidly evolving. President Trump has implemented (with some postponements) significant tariffs on China, Mexico and Canada—the nation’s three largest trading partners. Potential levies on the European Union and specific product categories are likely forthcoming. The policy environment remains highly fluid, introducing substantial market uncertainty.
A tariff is a tax levied by a government on goods imported from other countries, usually with the goal of protecting domestic industry. On the surface, the domestic importer pays the tariff, but the true economic payer could be the importer (accepting thinner margins), the foreign exporter (lowering their prices), the end consumer (if the importer passes on higher costs), or some combination of the three.
1. What are the goals of U.S. tariff policy?
Multiple rationales have been offered for increased utilization of tariff policy by administration officials. They can broadly be summarized into four categories.
Leverage to achieve foreign policy objectives: The U.S. has immense wealth and economic influence. Tariffs can be used as leverage to exact concessions (e.g., Mexico’s help on the border, European defense spending) because the U.S. is usually more important to its trading partners than vice versa. Tariffs used in this way are more likely to be short-lived.
Re-industrialization: The U.S. manufacturing sector has atrophied as the economy has gotten richer and more service-oriented, and as globalization has driven these activities to emerging markets with cheaper labor. Trump trade advisor Peter Navarro has been a leading voice in talking about tariffs as a tool to bring back manufacturing capacity, especially in strategically important sectors like steel, autos and semiconductors. Tariffs used in this way would need to be longer term in nature to convince firms their best course of action is to bring production back to the U.S.
Rebalance trade relations: The president sees the large U.S. trade deficit as a sign of unfair treatment from our trading partners and a principal cause of our economic issues. He and his advisors often point out that the average U.S. tariff rate is less than the rate other countries charge on U.S. imports. The president’s plan to introduce reciprocal tariffs in early April is designed to address this concern.
Raising revenue: President Trump has floated the idea of replacing federal income taxes with revenues from tariffs and/or using tariffs to help reduce the deficit. Currently, tariffs represent only 1.6% of federal receipts. Estimates show that the most aggressive tariff policy being proposed could raise around $500 billion in a year, or about 25% of the projected 2025 budget deficit of $2 trillion. Again, these tariffs would need to be broad-based and long-lasting to raise real revenue; Congress would also likely need to be involved.
2. What are the potential economic impacts?
The economic impact of tariffs will depend significantly on the measures’ scope, scale, duration, and predictability. The more broadly applied, the harder it will be for U.S. firms to navigate supply chains around them. The higher the tariff rate, the larger the impact. The longer they are applied, the more significant the possible disruption. And the more retaliation from trading partners, the larger the impact. We are already seeing the impacts of increased policy uncertainty on businesses and consumers, which we can expect to impact both parties’ willingness to spend and invest.
Broadly, we can expect the following impacts from tariffs.
Slower growth: Tariffs act as a tax that reduces real income. Depending on the aforementioned true payer of the tax, that reduction will be felt by end consumers, U.S. firms, foreign exporters, or a combination of all three. Generally, forecasts show a 0.5%–1.0% hit to U.S. gross domestic product (GDP) growth over the next 12 months if proposed tariffs are applied and left in place. Given base case forecasts for 2025 U.S. GDP growth were around 2.5%, this would likely lead to slower growth but not necessarily a recession. The impact to growth is likely to be more substantial outside the U.S., especially in countries like Mexico and Canada where trade with the U.S. represents a substantial portion of their economy. Uncertainty around levels of retaliation and the impacts of broad uncertainty make the magnitude of the impact to growth challenging to ascertain.
Higher prices, not necessarily higher inflation: Historically, tariffs have led to a one-time spike in the price of affected goods. Inflation is the ongoing increase in the level of prices, and it is not clear whether tariffs would cause inflation to rise over the long term. We should, at the very least, expect an upward move in inflation data in the near term. Disentangling one-time shocks from more insidious inflation in the data will be incredibly challenging for the Fed as they look to set interest rate policy.
Varying sectoral impacts: The impacts of tariffs will vary greatly depending on sector and industry. For example, autos, electronics and agriculture stand to be acutely affected. At the same time, part of the goal of tariff policy is to bring production capacity back to the U.S. for strategic sectors such as steel, semiconductors, pharmaceuticals and other manufacturing. While this is a longer-term goal, we have already seen large domestic investments announced by Apple, Taiwan Semiconductor Manufacturing Company Limited (TSMC) and Eli Lilly.
3. What are the mitigating factors, if any?
The U.S. is a fairly closed economy: Gross trade (imports and exports) is only about 25% of U.S. GDP— a remarkably small number. Compare that to our major trading partners, such as China (37%), Canada (67%), Mexico (73%) and the European Union (EU) (96%). This is a crucial point as it insulates the U.S. economy from the effects of trade disruptions relative to other major global economies. It also gives the U.S. material leverage in negotiations.
Ingenuity of American businesses: U.S. businesses have historically been very good at adjusting to disruptions. Research shows they were able to ameliorate a decent portion of the impacts of the Trump 1.0 tariffs by moving supply chains, finding new input sources and raising prices on non-tariffed goods. Again, the more broadly applied the tariffs are, the more challenging this will be, but we should not underestimate the ability of U.S. businesses to adapt.
Don’t forget about the other policy priorities: While tariffs have taken center stage, we should not forget many other policy priorities of the new administration are decidedly more pro-growth. This includes extending the Tax Cuts and Jobs Act (and possibly further tax cuts) as well as reducing regulations across the economy. While the outcomes and impact of these policies remain uncertain, they could work to counteract part of the impact on GDP growth.
4. What are the investment implications?
Things can change quickly, but broadly speaking:
Public equities are at risk: We have already seen significant volatility in traded stocks, and for good reason—the public U.S. equity market is much more exposed to trade than the overall economy and currently very expensive.
- While exports are only about 11% of our economy’s GDP, the S&P 500 gets 34% of its revenue from abroad and the Nasdaq 100 gets about half from overseas. As we have discussed, the stock market is very much not the economy, and while that has been great for stocks over the past 15 years, it is not good now.
- The equity market’s current price-to-earnings (P/E) of 21x–22x is historically high and inherently prices a positive/nearly perfect economic outcome. What we are getting may not be a disaster, but it is far from a Goldilocks outcome. There is little room for error priced into U.S. stocks right now, and that is a major risk.
Rate volatility will increase: Tariff policy and its uncertain impact on the economy and inflation is driving interest rate volatility higher. The Fed will need to sift through incoming inflation data and decide what is signal (and thus should impact its policy) and what is simply noise that will filter out. Markets are now pricing three rate cuts in 2025 (up from one a few weeks ago), but that can easily change if tariffs are added/removed and as economic data starts to tell us a story about the impacts. We retain our higher-for-longer rate call but should be clear that the uncertainty band has widened. Volatility is the one factor we can count on, a risk for fixed-rate bonds, despite their recent rally.
The private U.S. middle market could offer a refuge: The U.S. middle market comprises approximately 200,000 predominantly private companies, accounting for about one-third of the nation’s private sector GDP. These firms typically: 1) closely reflect the broader U.S. economy, in contrast to global large-cap stocks, 2) trade at more attractive valuation multiples and 3) are poised to benefit from significant domestic investments spurred by recent tariff policies. A few points.
- Unlike the S&P 500 and Nasdaq 100, which derive 66% and 52% of their revenues domestically, private U.S. middle market firms generate about 84% of their revenues within the United States. This substantial domestic focus aligns these firms more closely with the U.S. economy, which is the most insulated from trade and likely the most resilient in the face of increased tariffs.
- Middle market firms’ supply chains are broadly less global and less complex than larger multinational firms, again making them less exposed to tariff disruptions.
- Entry valuations are about 35% lower in middle market private equity than the S&P 500 and 20% lower than large-cap PE. Given the prevailing uncertainty, identifying assets not priced for perfect outcomes is crucial.
- Among the primary goals of tariff policy is to bring production in critical industries back to the U.S. Investments like those from Apple, TSMC and Eli Lilly (with more likely to come) will spider out into the economy and unlock demand for downstream goods and services from U.S.-centric firms— many of them in the middle market.
- Selection will be critical: Tariffs will drive a wedge between the performance of different industries, companies and investment managers. Competence, ingenuity, investment selection and relationships will be key. While tariffs present challenges, dispersion also presents opportunities for talented managers to produce alpha.
