Tariffs Are One Thing, Investment Is Another

The market has been shrugging off the escalation of the trade war until June 25, 2018, when the S&P 500 ended the day down 1.37% and the Nasdaq ended down 2.09%. Over the past several months, speculation of tariffs and the minor imposition of them has resulted in only small impacts to the market. Tariffs have far reaching and complex effects that can be both negative and positive for the country imposing them and the countries affected by them, which could explain why the impact to the market has been so minimal. We dive deep into the effects of tariffs on trade and inflation in Trade Wars and Tariffs | Here’s What to Know. So with all the speculation about trade wars going on for months now, why did the market sell off today?

Until now, technology companies had been relatively insulated from the talks of tariffs because they generally don’t have a tangible product that they are shipping and selling overseas. Their exemption from trade war speculation has contributed to their remarkable price appreciation; before the pullback today, the Nasdaq outperformed the S&P 500 by 9% year to date. The selloff today can be traced back to words from the president directly tying technology companies into the trade war speculation by suggesting limiting foreign investment in U.S. tech firms.

The policy is meant as a punishment to China-based investors who are looking to profit off of the U.S. companies without truly equal opportunities for U.S.-based investors in China. Whether or not this action would be justified is another matter entirely, but the results of such an action can be seen directly. There are no complicated models needed to understand the basic principles behind what happens when you inorganically decrease the demand for something; the price drops.

Not only was it the potential limitation of capital flows that drove the market lower, but also the possible repercussions that could be taken by the Chinese on U.S. tech companies. China has largely been frontier territory for U.S.-based tech companies, representing a huge opportunity if they are able to break into the Chinese market effectively. The size of the market has been a crucial selling point for investors looking to profit from the opportunity through U.S. tech companies. The limitations on investment inflows mentioned by the president could engender a response from China that directly hampers tech’s ability to exploit the market potential of China.

While no new policies based on these threats have yet been implemented, they have a direct effect on the demand for tech shares and the profit potential of the tech companies themselves. Either one of these factors would work to reduce a company’s valuation. Working in tandem, the two factors have led to the minor selloff we saw on June 25. The reaction to the speculation is probably just a harbinger of what is to come if these policy ideas move closer to becoming a reality.

Read more market insights from Twelve Points here.