Up, up and away. That was the story for the stock market this year. The bull market shifted into even higher gear after the election of Donald Trump as the new president last week.
When everything goes right in a movie, you know something is going to happen that puts an end to the smooth sailing. Real life isn’t always like the movies, but Wall Street could be in for a big dose of Hollywood.
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I predict Trump’s stock market rally is doomed. Why? There is one simple reason.
Image source: Getty Images.
I think Trump’s stock market rally will end because of Trump. Stocks in particular will (eventually) suffer from Trump’s tariffs. The president-elect has pledged to impose 10% to 20% tariffs on all U.S. imports and wants tariffs between 60% and 100% on all Chinese imports.
The stock market is unlikely to slam on the brakes immediately after the tariffs are implemented. However, what will happen almost immediately after blanket tariffs are imposed is that the prices of many goods purchased by Americans will increase significantly.
The countries that export goods to the US do not pay tariffs; so do the American companies that import the products. These companies could cover some or all of the additional costs. However, many will choose to pass the costs on to their customers.
As an alternative, can’t customers purchase American-made products? In some cases yes. But not every product will have an American-made alternative. It is also possible (if not likely) that US companies will raise prices as well.
Suppose you run a US company that sells widgets for $100. If your main rival’s products, a foreign company, now cost customers $120, it would be very tempting for you to raise the price of your widgets to, say, $115. You still get a lower price than your competition, but you can significantly increase your sales.
Tariffs will almost certainly lead to higher inflation. The Federal Reserve is unlikely to continue cutting rates as inflation threatens again, and could even be forced to raise rates again. Consumers may also limit their spending due to the sudden price increases. The situation would become even worse if other countries were to impose retaliatory tariffs and ignite a full-blown trade war that hurts U.S. exporters.
Imagine a row of dominoes. The first one labeled “rates” falls and topples the next domino labeled “inflation.” This domino topples the next, in line with the ‘interest rates’ printed on it. The last domino to fall represents the stock market.
The domino analogy also highlights the Achilles heel of my prediction. Not all dominoes will fall if the first domino does not knock over the second domino. I’m assuming the current stock market rally is doomed because President-elect Trump will follow through with the tariffs he has promised to impose — but it’s possible he won’t.
Look for companies lobbying aggressively to convince Trump not to implement his tariffs. Countries that trade with the US will likely make efforts to avoid tariffs that could potentially hurt their economies.
Another possible scenario is that Trump’s tariffs are implemented, but with many loopholes. If there are sufficient exemptions for specific countries and/or products, the net impact of the tariffs could be much lower than expected. Alternatively, Trump could implement full tariffs but lift them quickly enough to avoid significant damage.
However, let’s assume that Trump does what he said he will do and implements high tariffs across the board. What should investors do? The best answer is the simplest: Invest for the long term.
Warren Buffett once said, “If you’re not willing to own a stock for ten years, don’t even think about owning it for ten minutes.” Buy stocks that pass this Buffett test. And if you need your money in less than ten years, stocks aren’t the safest choice anyway.
The reality is that all stock market rallies are doomed to end at some point. However, if you are a long-term investor, you know there are more rallies to come.
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Prediction: The Trump Stock Market Rally Is Doomed for This Simple Reason was originally published by The Motley Fool
