What Trump’s Tariffs Mean For ETFs

March 16, 2018

This article is part of a regular series on thought leadership from some of the more influential ETF strategists in the money management industry. Today's article is by Wes Flanigan, a senior research analyst at ClearRock, a registered investment advisor with offices in San Francisco and Sun Valley, Idaho.

Earlier this month, President Trump officially raised tariffs on steel and aluminum imports, imposing 25% on steel and 10% on aluminum. His reasoning: Foreign countries’ current trade practices with the U.S. are a threat to national security.

Despite GOP dissent from the likes of Rep. Kevin Brady and Speaker of the House Paul Ryan, as well as the subsequent resignation of Trump’s top economic advisor, Gary Cohn, this marks an unprecedented turning point in U.S. trade policy, away from bluster and brinksmanship, and toward actual protectionist measures.

In our most recent weekly investment committee meeting, we discussed how this may affect the global economy and whether it would have a negative impact for investors.

Won’t Spark Global Recession

There is talk that Trump’s efforts to level the international-trade playing field could spark a trade war, potentially resulting in a global recession. We do not believe there will be an immediate effect on the world economy.

Together, steel and aluminum imports account for only about 2% of world trade, according to Capital Economics research.

The effect on emerging markets is also unlikely to have a major impact. For investors, in the case of emerging markets, a broad emerging market ETFs such as, the iShares MSCI Emerging Markets ETF (EEM) is a position where impact is likely to be small.

Why? The first country that comes to mind as far as being in President Trump’s tariffs crosshair is China. 

After all, Trump has criticized China for flooding the market with cheap metals in the past. China, however, does not even make the top 10 list of steel exporters to the U.S.

In fact, two of the top four exporters were recently carved out of the proposed tariffs: Canada and Mexico. Therefore, it is unlikely these tariffs would have a meaningful effect from the perspective of the larger trade players and steel exporters (see chart below).

 

 

Risks Still Exist

One risk these tariffs do pose is that it could prompt a broader shift toward protectionism, which may be a reason for the recent volatility in emerging markets. The most affected emerging markets would be a few Middle Eastern countries, particularly Bahrain, which exports large amounts of aluminum.

Even then, the negative consequences of the tariffs could be delayed or avoided via legal challenges or exemptions (the latter seems likely for Gulf States, which are important strategic partners of the U.S.).

Another risk is that these tariffs could prompt retaliatory action. Before Canada was carved out, it announced it would take measures to protect its domestic trade interests. Brazil has echoed the same sentiment, and the EU has reportedly discussed possible targets for retaliation as well. Other governments may also move to protect their own steel industries, a legal move under World Trade Organization terms.

 

Why MLPs Could Be Pressured

There has also been some chatter in the markets that master limited partnerships (MLPs) could come under pressure on the heels of these tariffs because of their industry reliance on steel imports.

ETPs such as the Alerian MLP ETF (AMLP) or the J.P. Morgan Alerian MLP Index ETN (AMJ) are investment products that could be impacted. For example, almost two-thirds of the constituents within the Alerian MLP Index (AMZ) (which AMJ tracks) comprises pipeline companies.

However, we do not believe this will result in a material adverse effect for that sector. A February 2018 MLP market update by Goldman Sachs Asset Management highlights that, while approximately half of the steel used in pipelines is imported, a significant portion of this steel comes from Canada and Mexico.

While both countries remain exempt from the proposed tariffs, this could change as the NAFTA negotiations continue. Moreover, only 56% of U.S. pipelines primarily comprise steel.

Goldman argues that the modest cost inflation could be offset by charging higher rates to pipeline customers, and that the expectation the sector’s CAPEX will decline by over 50% through 2020, according to Wells Fargo, further refutes the idea that tariffs will adversely affect these markets. 

 

 

It is safe to assume market volatility will persist, especially since the 15-day window for U.S. firms to win exemptions from this mandate is quickly closing. Either way, we believe the best course is to continue to monitor the situation closely and avoid making kneejerk investment decisions based on headlines alone.

At the time of writing, ClearRock clients currently owned EEM, AMLP and AMJ. Wes Flanigan is a senior research analyst at ClearRock, an SEC-registered investment advisor with offices in San Francisco and Sun Valley, Idaho. Contact: [email protected]. For a full list of disclosures, please click here.

Find your next ETF

Reset All