Opinion: Market underreaction to tariffs threat ‘naïve’

It seems few people today know about the Smoot-Hawley Tariff Act of 1930. At that time, one year into the Great Depression, the economies of Canada and the United States were in the dumps and political isolationism ushered in a protectionist trade policy that was prescribed as an antidote to job losses. This Act was passed on June 17, 1930 in the U.S. and it raised import duties in order to protect American businesses and farmers. It was the last legislation under which the U.S. Congress set tariff rates.

What was the result of the tariffs, which raised import duties on a wide range of agricultural and industrial goods by 20%? Economists everywhere had warned against them and the stock market did not react well. Nevertheless, the prices of most things imported to America rose and only the wealthy could afford them. What’s more, the amount of exported goods decreased significantly and it led to bank failures, among other things.

Because of the tariffs, duties rose so that countries could no longer sell goods to the U.S. and that led to retaliatory tariffs; two dozen countries implemented them. We then saw more bank failures. The upshot of all this was that the Smoot-Hawley Tariff Act was a significant factor in international trade declining by 65% between 1929 and 1934.

Here we go again. The only real difference is the reversal of the chicken-and-egg causation in the story. In 1930, the economy was in the dumps while today, the U. S. economy is performing well. Looking back, most agree that the 1930 tariffs did more to exacerbate the economic problems than to solve them.

In 2025, a wave of nativism and related protectionist policy are once again giving rise to the imposition of tariffs. As in 1930, most economic experts believe none are needed. But it now looks as though tariffs may well cause a major market downturn. Almost a century ago, tariffs were a policy prescription that abetted the isolationist stance and worsened a downturn that had already started. Could history be repeating?

Last month, The Globe and Mail reported a survey that showed Canadian CEOs are optimistic about economic growth prospects despite the fact they are facing Trump tariffs in the immediate future. That strikes me as a case of groupthink and self-serving denialism. It also looks like a severe case of optimism bias. Optimism bias is when you acknowledge that bad things can happen but think those bad things will never happen to you (or your company/industry). The truth is no one is immune.

Simply put, we can’t have it both ways. Either the Trump tariffs will have modest impact, or they will prove to be chaotic. From a macro perspective, political commentators and economists are nearly unanimous that a significant trade war will be massively disruptive. Despite this, our heads of industry are proceeding as though the likely impact will be negligible — and capital markets are yawning at the prospect. This dichotomy calls into question the notion of stock market efficiency, since markets are widely believed to synthesize all available information quickly and accurately.

More than a few people think Trump’s ever-changing policy announcements amount to a large-scale example of market manipulation. It should also be noted that the economy and capital markets are different things. Still, they are related and the consensus view regarding employment opportunities and inflationary impacts is that they will be harmful and substantial. It seems highly unlikely that stock markets will emerge unharmed.

Most people have never experienced a meaningful tariff war, which is what Washington is threatening. It’s difficult for people to imagine something they haven’t experienced personally.

Three years ago, Ukrainians watched in bewilderment as Russian soldiers amassed on their border. Even though the military threat was clear, Ukrainians were nonetheless shocked when the attack began; they simply couldn’t fathom what Russian President Vladimir Putin was prepared to do. Similarly, many Canadians today cannot fathom their U.S. neighbours starting an unprovoked and mutually harmful trade war.

Severe pain on the way

In Canada, there is a naïve market viewpoint that impact of the threatened tariffs on capital markets will be modest, even if the impact on the economy is severe. This seems highly improbable. If (when?) implemented, it seems likely that Trump will maintain the tariffs at least until the midterm elections in November 2026. That would mean there is severe pain on the way for both the economy and stock markets , yet judging by how people are reacting, no one is prepared to acknowledge the second half.

How should advisors, investors and industry leaders react?  What can specifically be done to prepare in case tariffs do materialize?  Some in the industry suggest that the best reaction is no reaction and that one’s asset allocation and risk profile should not be adjusted based on something as gauche as unpredictable public policy moves.

I disagree. Concerned people can add to their emergency reserves (more in regard to the overall economy than to capital markets), they can lower exposure to both Canadian and U.S. securities based on the anticipated impact on corporate profits and they can increase exposure to things like tangibles, hard assets and commodities that typically do well when inflationary pressure (which is what tariffs produce) comes to the fore.