Tariffs Are Back PART 1 — Here’s What They Actually Do to Your Stocks

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PART 1 — THE RETURN OF TARIFFS

For about thirty years, the global economy ran on a simple bet that trade barriers would keep falling, that factories would move to wherever labor was cheapest, and that companies would build their supply chains around cost and not safety. It was the operating system of the world economy from roughly 1990 to 2018. Stock markets, central banks, multinational corporations they all built their strategies around the assumption that this system would continue.

That system is now ending. Not crashing but ending gradually, by deliberate policy choice. Tariffs are the most visible piece of this shift, but they aren’t the cause. They’re the symptom. The cause is that major countries have decided that being economically efficient and being strategically safe are not the same thing, and they’re no longer willing to sacrifice safety for efficiency.

To understand why this matters for markets, one has to understand what the old system actually delivered. For thirty years, when American or European companies needed something manufactured, they could source it from China, Vietnam, Mexico, or wherever else offered the lowest cost. This kept the prices of physical goods like clothes, electronics, furniture, car parts extraordinarily low. Ordering from Alibaba was extremely common due to the cheap prices. It also kept inflation extraordinarily low because the cost of goods is a major component of overall inflation. (Inflation, in plain terms is just the rate at which prices rise across the economy)

Here’s where it gets interesting. Because inflation stayed low for thirty years, central banks like the Federal Reserve could keep interest rates extraordinarily low. The Fed’s main job is controlling inflation. When inflation is naturally suppressed by cheap imports, the Fed doesn’t need to fight it with high interest rates. Low interest rates in turn, make borrowing cheap, which makes companies more valuable, which pushes stock prices up (through higher PV valuations as well). Low interest rates also make bonds pay less which pushes investors into stocks looking for higher returns, pushing stock prices up even more.

So the cheap-imports system wasn’t just a feature of the economy. It was a hidden engine underneath the entire bull market in stocks. When you unwind cheap imports, you are also unwinding part of what made stocks expensive in the first place. This is the first thing to internalize. Tariffs aren’t an isolated event. They’re a partial reversal of one of the biggest forces that drove asset prices higher for a generation.

Why is this reversal happening now? Three reasons –

First, the hollowing-out problem. When factories move abroad, they don’t just take jobs. They take the entire ecosystem – the engineers, the suppliers, the institutional know-how, the smaller companies that feed the big ones. Once that’s gone, getting it back is enormously expensive and slow. Economists call this hysteresis, which is just a fancy word meaning “history matters and you can’t easily reverse it.” The 2018 tariffs alone which covered only a fraction of US imports cost the US economy $1.4 billion per month in lost real income, according to Amiti, Redding and Weinstein. That was a partial tariff regime. The current one is broader. Scale accordingly. By the mid-2010s, it became clear that strategically critical industries, semiconductors, pharmaceuticals, rare-earth metals, batteries had concentrated almost entirely in a few foreign countries, including geopolitical rivals.

Second, the security wake-up call. COVID exposed how fragile global supply chains had become. When ports closed and factories shut, the West discovered it couldn’t make basic medical supplies. The war in Ukraine showed that if you depend on a country for critical goods, that dependence is a weapon they hold over you. Each of these events alone might have been absorbed. Together, they produced a consensus in the US and increasingly in Europe that the previous system needed to change.

Third, the political revolt. The communities that lost their factories never recovered. The economic gains from globalization were real but concentrated in cities and among highly educated workers. The losses were concentrated in manufacturing towns and among workers without college degrees. After decades, that imbalance produced political movements demanding the system change. Tariffs are partly the policy expression of that demand.

Once you understand these three forces, tariffs stop looking like a strange political decision and start looking like a logical consequence of an updated set of priorities. The previous system optimized for low prices. The new system optimizes for low prices plus strategic security plus domestic employment and you can’t get all three simultaneously, so something has to give. What’s giving is the cheap-imports pillar that supported a generation of low inflation, low rates, and high stock valuations.

This is the framing institutional investors need to start with. Tariffs are not a temporary tax that distorts a few prices and then goes away. They are one instrument in a multi-year structural shift in how the world economy works. That shift changes the long-run path of inflation, interest rates, corporate margins, and asset prices. The market does not have a clean historical playbook for this transition because the last transition of similar magnitude moved in the opposite direction over a similar timeframe.

The single most important idea to grasp not for the purpose of this article but in general. Markets are not pricing the current economy. They are pricing expectations about the future economy. When the rules governing those expectations change, every asset has to be re-priced not because anything has happened yet, but because the range of possible futures has shifted. That re-pricing is what tariff-driven market moves actually are. Understanding this saves you from the most common mistake in financial commentary, which is asking “did the tariff cause inflation yet?” The market doesn’t wait for the data. It moves the moment the regime changes.

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PART 2 — WHAT A TARIFF ACTUALLY IS

The textbook definition is easy- a tariff is a tax on imported goods. This definition is technically correct and almost completely useless, because it doesn’t tell you the one thing that actually matters which is who ends up paying the tax.

That question, “who actually pays,” is what economists call tariff incidence. And the answer is almost never “the country being tariffed,” which is what political rhetoric usually claims. The real answer is messy and depends on the specific market.

Let me walk you through what physically happens. Suppose the US puts a 25% tariff on industrial machinery imported from Germany. A US company orders a machine. The machine arrives at the port. US Customs charges 25% of the machine’s value as duty. The US company writes the check. That’s it — that’s the legal payment. The German exporter never sends a dollar to the US government.

So legally, the US importer pays the tariff. But economically, who really pays depends on what the importer does next.

Scenario A: The importer needs the machine and has no good alternatives. They pay the tariff and raise the price they charge their own customers by 25%. Their customers say, a US factory using the machine end up paying more. The factory either absorbs the higher cost (squeezing its profits) or raises its prices to its customers. Eventually, the cost works its way down to the consumer at the end of the chain. In this scenario, the German exporter is unaffected. The American buyer pays the tariff.

Scenario B: The importer can easily switch to a Japanese supplier instead. They stop buying from Germany. The German exporter loses the sale entirely. Now the German company has a choice — either accept losing the US market, or cut its pre-tariff price by 25% so the final US price stays competitive. If the German company cuts its price, it pays the tariff (in the form of reduced revenue). The US buyer pays the same as before.

Scenario C: The importer has some alternatives but switching is expensive and slow. The German exporter has some pricing flexibility but not unlimited. The two negotiate. The German company cuts its price by 10%. The importer absorbs another 8% in reduced margin. The remaining 7% gets passed to the US customer. The tariff is split across three parties.

Every real-world tariff produces some version of Scenario C. The 25% tariff is one number, but the actual economic cost gets distributed across foreign producer, US importer, US business customer, and US consumer in proportions nobody can predict precisely in advance.

What determines those proportions? A concept called elasticity. Elasticity sounds technical but the idea is simple- it measures how much people change their behavior when prices change.

• Inelastic demand means buyers keep buying even when prices rise. Think insulin for diabetics, or gasoline for daily commuters. Price goes up; people pay it because they have no real choice.
• Elastic demand means buyers cut back sharply when prices rise. Think restaurant meals, or a particular brand of sneakers. Price goes up; people switch to something else or do without.

Same logic on the supply side. Inelastic supply means producers can’t easily redirect their goods elsewhere or make more if conditions change. Elastic supply means they can.

The crucial rule of tariff incidence: whichever side of the transaction has fewer options ends up paying more of the tariff. If American buyers desperately need the German machine and there are no substitutes, German exporters can keep their prices high and American buyers eat the tariff. If American buyers can easily switch suppliers, German exporters have to cut prices to keep the business, and they eat the tariff. The party trapped without options pays the bill.

There’s clean data on this. Cavallo, Gopinath, Neiman and Tang tracked the actual price data at the border and at the store during the 2018-19 tariffs. At the border, a 20% tariff produced an 18.9% cost increase for US importers and only a 1.1% price reduction by Chinese exporters. The cost fell almost entirely on the US side. At retail, prices barely moved as retailers absorbed the hit in their own margins. Which sounds like a win for consumers until you realize that margin compression is how companies go bankrupt slowly

Amiti, Redding and Weinstein reached the same conclusion through completely different data and methodology. Complete pass-through. The full cost on US consumers and importers. $1.4 billion per month in lost real income by the end of 2018. Two independent research teams, two different approaches, same answer. The ‘they pay, not us’ claim has been empirically dead since 2019.

The washing machine tariffs are the cleanest real world example of this. Flaaen, Hortaçsu and Tintelnot tracked the whole thing. Prices jumped roughly 12% within months. But here’s the part the textbooks don’t tell us. Dryer prices rose too, even though dryers weren’t tariffed. Manufacturers used the washer price increase as cover to raise prices on the untariffed companion product. Tariffs don’t just raise prices on the goods they target. They give firms license to raise prices on everything nearby.

Fajgelbaum and Khandelwal ran the full general-equilibrium math on the 2018 tariffs. The direct cost to US consumers and businesses- $51 billion a year. Net of tariff revenue and domestic producer gains, still a $7.2 billion annual loss. And that’s before you count the retaliatory damage, which landed hardest on agricultural counties that had voted for the tariffs in the first place

This is why headline rhetoric like “China pays the tariffs” or “American consumers pay the tariffs” is almost always misleading. Both can be partially true at the same time, in different proportions, depending on the specific product, the specific industry, and how easily either side can find alternatives.

This brings us to a closely related idea called pricing power. Pricing power is just business speak for “the ability to raise your prices without losing customers.” A company with strong pricing power can pass tariff costs through to its customers without much sales decline. A company with weak pricing power can’t — it either absorbs the cost (which crushes its profits) or raises prices and watches customers leave.

What gives a company pricing power? A few things:

• Brand strength. Apple can raise iPhone prices because customers are emotionally and operationally attached to the ecosystem. A generic phone maker cannot.
• Switching costs. If switching products is painful (software your employees know, equipment that integrates with everything else you own), customers will tolerate price increases.
• Limited competition. If there are only two or three companies that make a product, they can collectively hold prices higher than if there were twenty.
• Differentiated product. If your product is genuinely unique with proprietary technology, special formulation, specific regulatory approval the customers can’t easily substitute.

Companies that have these things weather tariffs much better than companies that don’t. This is one of the most important variables for stock picking during tariff regimes, and we’ll come back to it in much more depth when we discuss winners and losers.

There’s one more wrinkle that even professional analysis often glosses over which is timing. Even companies with strong pricing power usually can’t pass costs through immediately. They’re often locked into existing contracts that fixed prices before the tariff hit. They have warehouses full of inventory they bought at pre-tariff prices, which they’re now selling at post tariff market prices (so for a while, their reported margins actually look good cause they’re selling cheap inventory at new higher prices). They also face competitive pressure to not be the first to raise prices, because whoever moves first risks losing market share.

The practical result is that the financial impact of a tariff usually doesn’t show up in company earnings for one to three quarters. The tariff is announced. Stock prices react immediately. But the actual hit to reported profits takes time to appear, because of contracts, inventory cycles, and competitive dynamics. This delay is one of the most important reasons that tariff stories play out in the market in waves- initial reaction, then “see, it wasn’t that bad,” then later “actually, it was that bad,” then revised expectations. Investors who don’t understand the timing get whipsawed repeatedly.

So when you hear “25% tariff on imports from Country X,” the right professional response is not “what does this cost?” The right response is a chain of questions: Who buys these goods? Do they have alternatives? Do the foreign producers have alternatives? Who has pricing power in this chain? How much existing inventory exists at pre-tariff prices? How are contracts structured? What’s the elasticity on both sides?

The answers to those questions, not the headline rate, determine what actually happens.

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PART 3 — WHY MARKETS CARE ABOUT TARIFFS

To understand why stocks move on tariff news, you have to understand what a stock price actually is. This sounds obvious but most people skip over it and miss why tariffs hit valuations so hard.

A stock is a claim on a company’s future profits. When you own a share, you own a tiny piece of every dollar the company will earn from now until forever. The price of the stock should equal the value of all those future profits but with a critical adjustment: future dollars are worth less than today’s dollars. A dollar you’ll receive in ten years is worth less than a dollar in your hand right now, because you could invest the dollar you have now and earn returns on it. So those future profits have to be “discounted” back to today’s value.

This produces what’s basically the master equation of stock valuation. The value of a stock equals:

(Expected future profits) ÷ (a discount rate that reflects how much you discount future dollars)

Higher future profits → higher stock price. Higher discount rate → lower stock price. That’s it. Every fancier model in finance is some elaboration of this basic structure.

Tariffs affect both sides of this equation simultaneously. That’s why they hit stocks so hard.

The profits side. Tariffs raise costs for companies that import inputs. Those companies either pass the cost on (losing some customers and reducing volume) or absorb it (preserving sales but losing profit margin). Either way, future profits are now expected to be lower than they were before the tariff. The numerator of the master equation shrinks.

But there’s a subtler effect that matters more than most people realize. Tariffs don’t just reduce expected profits but they also make profits more uncertain. A company that used to confidently project $10 of earnings per share might now project somewhere between $7 and $13, depending on how trade policy develops, how exchange rates move, how competitors respond, and a dozen other factors. The central estimate might still be $10. But the range of possibilities has widened dramatically.

Markets care a lot about this widening, and here’s why. Predictable earnings are easier to value, easier to lend against, easier to base business decisions on. A company with stable, predictable $10 earnings will trade at a higher price than a company with volatile $10 earnings even though the average number is the same. The market pays a premium for predictability. When tariffs inject uncertainty into corporate earnings across a wide range of the economy, the market’s willingness to pay for those earnings falls even before any actual earnings number has been revised.

The discount rate side. This is where the analysis usually gets too technical. Let me make it concrete.

The discount rate has two main pieces. The first is the “risk-free rate” basically what you could earn just by lending money to the US government, which is considered the safest possible borrower. This is what the yield on a 10-year Treasury bond pays. The second piece is an “equity risk premium” which is an extra compensation investors demand for taking on the risk of owning a stock instead of a safe government bond.

Tariffs push both pieces higher.

They push the risk-free rate higher because tariffs are inflationary in the short run (we’ll explain exactly why in the next post). When investors expect higher inflation, they demand higher interest rates on bonds to compensate for the fact that the dollars they get back will be worth less. So Treasury yields rise. The risk-free rate goes up. The discount rate goes up. The stock price goes down mechanically, even if expected profits haven’t changed at all.

They push the equity risk premium higher because tariffs increase uncertainty about future business conditions. Investors demand more compensation to bear that uncertainty. So even the spread of equity returns over bonds widens. Again, the discount rate goes up. Again, stock prices go down.

This is what professionals mean by multiple compression and it’s a phrase you’ll hear constantly in tariff discussions, so it’s worth understanding precisely. The “multiple” is the ratio of a stock’s price to its earnings (the P/E ratio). Multiple compression means the market is paying less for each dollar of earnings than it was before. A company earning $10 per share that used to trade at a P/E of 20 (a $200 stock) might now trade at a P/E of 15 (a $150 stock) — even though earnings haven’t moved. The 25% drop in the stock price is entirely due to the discount rate going up.

Tariff regimes commonly cause multiple compression even when underlying business performance is fine. The stock market falls not because companies are suddenly less valuable but because the price of future profits has gone up. This is one of the most counterintuitive features of tariff-driven market moves, and it’s why “companies are still making money, why is the market falling?” is a question that misses the point.

There are a few more channels worth understanding briefly before we go deeper:

The capital spending channel. Companies make decisions about building factories, buying equipment, hiring people based on multi-year forecasts of business conditions. When trade policy becomes unpredictable, those forecasts become unreliable. The rational response is to delay big investment decisions until the uncertainty resolves. Across thousands of companies, the cumulative effect is a slowdown in corporate investment, which feeds back into slower economic growth and weaker future profits. This channel takes longer to show up than the others, but it’s structurally important — it affects not just this year’s earnings but the trend rate of growth for years afterward.

The confidence channel. Surveys of business executives — like the manufacturing PMI you’ll see in news headlines — measure how optimistic or pessimistic decision-makers are about the next six to twelve months. These surveys are real economic data; they predict actual investment, hiring, and inventory decisions. Tariff regimes typically cause sharp drops in business confidence indices, which the market reads as advance warning of weaker corporate performance ahead. This is one of the things professionals watch most closely.

The inflation expectations channel. This deserves its own section (next post) but the basic point is that tariffs raise market-measured inflation expectations almost immediately. Those expectations feed into Treasury yields, into Fed policy decisions, into bond prices, and back into stock discount rates. The whole system updates in real time, before any actual inflation data has been released. This is why bond yields can spike on tariff announcements even when actual price increases won’t show up in official data for months.

Here’s the punchline of this section, and it’s the most important takeaway in this whole document- markets react before any data changes. The market doesn’t wait to see how earnings actually get hit, how inflation actually moves, how companies actually adjust their capital plans. It runs all of that analysis instantly, in parallel, across millions of participants, and prices the resulting expected outcome into asset prices immediately. By the time the actual economic data starts coming in, the market has already moved.

This is why stocks can fall 5% on a tariff announcement before a single dollar of new tariff has been collected at any port. The market is not pricing the goods crossing the border. It is pricing the entire chain of expected consequences for profits, for margins, for inflation, for interest rates, for risk premiums, for capital spending, for confidence weighted by their probabilities and translated back into present-day stock prices.

It’s also why tariff effects can sometimes appear to “fade” even when the tariffs themselves remain in place. The market digested the regime, updated its expectations, and re-priced everything. If subsequent data confirms the initial fear, the market stays at the new lower level. If the data turns out better than feared, the market drifts back up — not because tariffs disappeared, but because their effects were less severe than the initial pricing assumed. The tariff didn’t cause the second move. The gap between expectation and reality did.

This framing is what allows you to think analytically about tariffs instead of reactively. The question is never “are tariffs good or bad for stocks?” — that’s a non-answer to a non-question. The right questions are:

1. What does the current stock price already reflect about tariff impact?
2. What is the actual transmission likely to be?
3. Where is the gap between price and reality?

Everything else is noise that gets traded on Twitter.

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PART 4 — CORPORATE MARGIN DESTRUCTION

To see exactly why tariff regimes hurt stocks so much, you need to look at what happens inside an actual company’s profit-and-loss statement when tariffs hit. Most commentary stays at the abstract level like “tariffs raise costs” and misses the actual mechanics. We’re going to look at the real line items.

Every company’s income statement follows the same basic structure:

1. Revenue — total money coming in from sales
2. Minus Cost of Goods Sold (COGS) — direct costs of making the products: raw materials, factory labor, components
3. Equals Gross Profit — money left after covering direct production costs
4. Minus Operating Expenses — rent, salaries for office workers, marketing, R&D, depreciation
5. Equals Operating Income — money left after covering all costs of running the business
6. Minus Interest and Taxes
7. Equals Net Income — the bottom line

Tariffs hit the COGS line directly. If you import steel and a tariff raises the cost of steel, your COGS goes up. Revenue stays the same (assuming you didn’t raise prices yet). So gross profit shrinks.

Here’s where it gets interesting and most people miss the real damage. The shrinkage doesn’t stop at gross profit — it amplifies as it works down the income statement, because of something called operating leverage.

Operating leverage is about the mix of fixed and variable costs in a business. Some costs scale with how much you produce (variable): more steel for more cars, more electricity for more production hours, more hourly labor for more shifts. Other costs don’t scale (fixed): the rent on the factory, the salaries of the management team, the depreciation on the equipment you already bought. Whether you make 10,000 cars or 100,000 cars, the rent on the factory is the same.

When a company has lots of fixed costs (high operating leverage), small changes in revenue or gross margin produce big swings in net profit. Here’s a concrete example.

Company A has:

• Revenue: $100
• COGS: $60 → Gross profit: $40 (40% gross margin)
• Fixed operating costs: $30
• Operating income: $10 (10% operating margin)

Now tariffs raise COGS by 5%. New numbers:

• Revenue: $100 (unchanged — the company absorbed the cost rather than raising prices)
• COGS: $63 → Gross profit: $37
• Fixed operating costs: $30 (unchanged — these don’t move)
• Operating income: $7

The 5% cost shock just produced a 30% decline in operating profit ($10 to $7). The fixed costs ate disproportionately into the shrinking gross profit pool because they couldn’t adjust.

This is the magnification effect that makes seemingly modest tariffs catastrophic for certain businesses. Capital-intensive industries like automakers, steel companies, semiconductor manufacturers, airlines all have heavy fixed costs. When their input costs rise, the earnings damage is far worse than the input-cost increase would suggest in percentage terms. Light-asset businesses like software companies, consulting firms, financial services have mostly variable costs and aren’t as exposed to this amplification.

Now layer on the next complication: inventory timing.

Manufacturers carry weeks or months of inventory. When tariffs hit, they’re still selling products made from pre-tariff materials they bought before the tariff. Their reported margins in the first quarter after the tariff often look better than expected, because they’re selling cheap inventory at new higher market prices. Analysts who don’t understand this trap conclude “the tariffs aren’t hurting margins.” Then two quarters later, the pre-tariff inventory is gone, the company is selling products made from expensive post-tariff materials, and margins collapse. The headlines say “tariffs finally hit the bottom line.” But the impact was always there — it was just hidden by the inventory cycle.

This timing dynamic is why tariff stories play out in waves of market reaction. Initial fear. “It wasn’t that bad” relief rally. “Actually it is that bad” decline. By the time the data clearly shows the impact, the smart money has already repositioned.

Then there’s foreign exchange (FX) complications, which can partly offset or amplify tariff impact in ways that are easy to miss.

When the US puts tariffs on goods from Germany, the typical short-run reaction is that the dollar strengthens against the euro. (We’ll explain exactly why in next post- for now just take it as observed pattern.) A stronger dollar means euros are cheaper to buy. If you’re a US importer buying from Germany, you’re now paying more in dollars because of the tariff, but you’re paying fewer euros because the dollar is stronger. The two effects partially cancel out.

This is why tariff impact estimates often turn out smaller than back-of-envelope math suggests. The currency adjustment absorbs some of the blow. But the offset is partial, lagged, and uneven and it works better for goods from countries with freely floating currencies, worse for goods from countries that manage their exchange rates. Companies that source from many countries naturally get more of this hedge than companies concentrated on a single supplier country.

Within any given industry, the distribution of pain from tariffs is wildly uneven. The companies that get crushed share three characteristics:

1. Heavy reliance on imported inputs from tariffed countries
2. Weak pricing power which means they can’t pass costs through to customers
3. High operating leverage — they have lots of fixed costs that amplify the margin damage

The classic profile is a mid-sized manufacturer that imports specialized components from a single foreign supplier and sells to a handful of big customers who have all the negotiating power. This company has nowhere to hide. It absorbs the tariff, the operating leverage magnifies it, the stock falls 40%.

The companies that survive — and sometimes even thrive — have the opposite profile:

1. Diversified sourcing across multiple countries
2. Strong pricing power from brand, technology, or market structure
3. Asset-light cost structure with mostly variable costs

The classic winner profile is a consumer brand with strong customer loyalty, multiple sourcing options, and a cost structure dominated by marketing rather than fixed manufacturing assets. This company passes most of the tariff through to customers (margins preserved), shifts sourcing where economical, and isn’t punished by operating leverage even when partial absorption is needed.

The investment implication is critical: tariff regimes create huge differences in performance even within the same industry. Two companies that look similar on paper — same sector, similar revenue, similar product mix can have completely different outcomes from the same tariff if their supply chain structures and pricing positions differ. The market eventually figures this out, which is why during tariff episodes you see big gaps in stock performance even between direct competitors.

This is also why broad index analysis is nearly useless during tariff regimes. “How will the S&P 500 do?” is the wrong question. The S&P 500 will be the weighted average of thousands of company-specific outcomes that depend on idiosyncratic supply chain details that have nothing to do with index-level macro factors. The right question is “which specific companies are well-positioned and which aren’t?” and that requires actually reading 10-K filings to understand sourcing footprints, customer concentration, and pricing flexibility.

The deeper insight is that tariffs don’t destroy economic value uniformly. They redistribute it. The total profit pool of the corporate sector shrinks somewhat. But within that smaller pool, well-positioned companies gain market share and pricing power from poorly positioned competitors. There are winners alongside the losers. The job of professional equity analysis during a tariff regime is identifying which is which because the headline tariff rate tells you almost nothing about the actual company-level outcome.

This is Part 1 of our 3-part tariff series. Start here, then head to our homepage to stay updated when Part 2 drops.

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