Do tariffs even matter?

The market doesn’t care about tariffs anymore. That’s the message being sent from stock markets that are now trading at record highs. Tariffs have not gone away; they are higher today than they were entering the year. Furthermore, there has hardly been a breakthrough as far as trade deals are concerned. The US has announced just three revised trade deals—with the UK, Vietnam, and China. Recently, President Trump announced that his paused tariffs will go back in effect on August 1st. Stocks couldn’t even fall 1% on the day of that announcement. This begs the question…

Tariffs do matter, but the market’s reaction to tariffs matter even more. Admittedly, it is strange to see the market yawn at new tariff announcements after they caused a 20% sell-off just three months ago. In our view, this change in market behavior is a by product of a few things:

1. When Trump paused tariffs the first time, it immediately took away the negative connotation associated with subsequent tariff announcements.

This first point can be best explained with a classic childrens story: The Boy Who Cried Wolf. In the market’s version, President Trump is the boy and tariffs are the wolf. In the story, the villagers stop paying attention to the boy’s constant shouting that a wolf is attacking his sheep. Investors have done the same when it comes to Trump’s tariffs—they don’t think the proposed tariffs will actually be (a) real or (b) nearly as damaging as initially feared.

2. As the market pays less attention to the boy who cried wolf, it pays more attention to the company screaming about AI.

As we’ve written about for years now, the AI boom is real. No company exemplifies this boom better than Nvidia, which just became the first company in history to pass a market value of $4 trillion. Nvidia’s size means it has an outsized impact on the market’s performance. Nvidia’s 15% rise in the last one month (and 65% rally since the tariff pause) continues to be a rising tide that is lifting many boats (other areas of the market).

When will the market next run into major trouble? Probably when Nvidia’s management sounds an alarm on AI spending. Today, AI spending is still super strong.

3. Tax certainty

The passage of Trump’s tax bill provides tax clarity for at least the next four years. Markets no longer have to grapple with the potential ramifications of Trump’s 2017 tax cuts expiring. The extension of these tax cuts, and increase in the SALT cap, is a deficit-spending stimulant for the economy in the coming quarters. The market views the tax bill as helping to offset some of the expected negatives from Trump’s trade policy.

4. Less geopolitical uncertainty

Trump’s decision to support Israel in their war with Iran seems to have led to a deescalation of tensions in the Middle East. There’s also been a tenuous cease-fire agreement reached between Israel and Hamas. Lastly, the US and NATO have reaffirmed their support for Ukraine in their war with Russia. These factors all combine to equal less geopolitical tensions today compared to yesterday, at least in the market’s eyes.

Visualizing less uncertainty

The market can tell you more about the economy than the economy can you tell you about the market. And the market’s message today is that the economy is on solid footing with an improving outlook. This contrasts to a few months ago when the market was worried the outlook was deteriorating. If you visualize the market as a weighing mechanism, it is currently assigning more weight to positive factors as opposed to negative ones.

Now, none of this is to say that the market’s view won’t change and a downturn won’t follow suit. The following three truths are surely reflected in the market to some extent:

The market is calling Trump’s bluff on stiffer tariffs and restrictive trade policy
And/or the market assumes the economy can handle a higher effective tariff rate than originally thought
The market has fully bought into Trump’s approach as a negotiating tactic and expects positive trade deals as a result

It’s obvious to see what could go wrong with this line of thinking. Let’s recall the fable of The Boy Who Cried Wolf once more—in the end, a wolf does indeed show up and eat the sheep. If Trump were to follow through on extremely restrictive tariffs, the market would surely recalibrate its outlook. The tricky part is Trump could follow through only to back off again (creating another yo-yo sell off and recovery like scenario that’s unfolded in the last few months). Lastly, the market could lose patience with the lack of deals if there aren’t more official agreements in place in due time.

If by now you are thinking, “Why the hell are we even trying to figure this stuff out anyway?” We couldn’t agree more. We write about this topic because clients ask about this topic, not because we believe there’s merit in guessing what a President will do. In the end, while uncomfortable at times, staying the course has been a winning strategy for long-term investors.