Guest Post: Positioning Investment Portfolios for Potential Tariffs and Trade Wars

In most respects, tariffs are straightforward and easy to understand. They are a simple tax on imported goods from another country. While the basics of tariffs are simple, the impact of imposing tariffs on one's trading partners is uncertain and ripe for unintended consequences.

The Tariffs Cannon

In his first month in office, President Trump confirmed his oft-stated love of tariffs, at least as a negotiating tool. With some exceptions, including Canadian energy products at 10% tariffs, the administration has imposed 25% tariffs on imports from Mexico and Canada and a cumulative 20% tariff on Chinese imports. Ongoing negotiations have resulted in some reprieves and exemptions for a few weeks. President Trump has also unveiled a sweeping plan to impose “reciprocal" tariffs on America's trading partners on a "country-by-country" basis, including 25% tariffs on all EU imports. Reciprocal tariffs would charge U.S. trading partner countries the same percentage of tariffs that these countries are currently imposing on U.S. goods.

While trade policy is a moving target on any given day in Washington, the uncertainty has impacted U.S. equity markets. After gaining 4.6% for the year on a total return basis and reaching an all-time high on February 19th, the S&P 500 is down over 2.2% year-to-date, and the NASDAQ composite has lost almost 6.3%. While tariff announcements can be bluster and a negotiating tactic to force other countries to treat the U.S. more fairly, real problems can arise should the country on the receiving end of U.S. tariffs not back down or even respond by imposing additional tariffs on the U.S., potentially setting off a tit-for-tat trade war. Trade wars can begin with minor trade skirmishes that quickly escalate into an all-out trade war. (Data as of 3/6/2025. Source: Bloomberg)

Tariff Wars Can Lead to Currency Wars

Tariffs can lead not only to trade wars but also currency wars. When a country imposes tariffs, its currency typically increases in value. In contrast, the country on the receiving end of the tariffs may attempt to devalue its currency to mitigate the impact of the tariffs, thereby offsetting the attempt to make another country's exports less competitive.

In response to this devaluation attempt, the country imposing fresh tariffs may seek to devalue its own currency to remain competitive, often called competitive currency devaluation. And this is how tariffs can ultimately lead to currency wars. Currency wars can have serious negative consequences, such as increased volatility in currency markets, inflation, and uncertainty in the global economy. 

Potential Scenarios 

Two potential scenarios could play out from the Trump administration’s numerous tariff announcements and threats on trading partners. The optimistic result, which most investors are currently counting on, is that the threats are a negotiating tactic designed to get U.S. trading partners to reduce the tariffs they impose on U.S. goods coming into their country. If this is effective, then the threats of tariffs alone will be enough to lead to negotiations and settlements, and they will be rescinded quickly without much damage.

However, there is also a non-zero probability that another country may call the President’s bluff and institute its own set of additional tariffs on U.S. goods in retaliation. Canada has responded swiftly with 25% tariffs against $155 billion of U.S. goods. China plans to impose tariffs up to 15% on some U.S. goods and has said, “If war is what the U.S. wants, be it a tariff war, a trade war, or any other type of war, we're ready to fight till the end.” A full-on trade war could lead to an increase in inflation and even the potential for stagflation. During stagflation, inflation increases and the global economy slows and can even decline into recession.

We believe that the 3EDGE multi-asset strategies could offer better protection from potential trade wars since they can invest in hard assets such as gold, commodities, and TIPS (U.S. Treasury Inflation-Protected Securities).

Investors may be too complacent about the potential risks of tariffs and trade wars.  We look at this situation and accept that the chances of something bad happening, at the very least, are greater than zero. For example, an increase in inflation expectations simply due to the threat of U.S. tariffs, could impact the global capital markets.

We believe protecting investment portfolios in the current environment requires going beyond a traditional mix of stocks and bonds. That is why at 3EDGE, our core multi-asset strategies, 3EDGE Conservative and 3EDGE Total Return, employ full-time broad asset diversification. We hedge the equity exposure in our core strategies not only with bonds, but we can also hold investments in gold, commodities, and TIPS (U.S. Treasury Inflation-Protected Securities), which could offer better protection and benefit from the potential impact of tariffs and trade wars.

So far this year (as of 3/6/2025), gold is up almost 11% and the Bloomberg Commodity Index BCOMTR is up over 6.5%. In comparison, the S&P 500, after being up over 4.6% earlier in February, is now down over 2.2% for the year, given inflation concerns and a slide in consumer sentiment and confidence. University of Michigan’s Consumer Sentiment report released on February 21 showed a 10% decline from January and a 15.9% drop year-over-year, the steepest annual decline since late 2022.¹ February data also showed that The Conference Board’s Consumer Confidence Index declined by 7 points and registered its largest monthly decline since August 2021.²

We are hopeful that the administration's tough talk on tariffs will lead to a series of negotiated settlements with U.S. trading partner countries and that trade wars will be avoided. However, we also believe that it is prudent to construct portfolios that seek to protect investors from the potential for negative consequences, including unintended consequences of trade disputes that could cause a resurgence of inflation and even a period of stagflation, which would not be a positive environment for investors and their portfolios.