The tariff crisis: How scared should investors be?

Legendary investor and mutual fund pioneer Sir John Templeton apparently once said: “The four most dangerous words in investing are 'This time it’s different.'" 

It’s true that investors often get into trouble when they convince themselves that the usual rules of investing no longer apply, particularly after a crash or correction. Sir John, on the other hand, famously liked to take advantage of market downturns and saw them as a chance to buy stocks more cheaply.

But what about the market turmoil caused by President Trump’s tariff strategy? Some commentators are saying that this time really is different. Are they right?

It was billed by Donald Trump as “liberation day” for the United States. But, within hours of the President’s announcement of huge tariff hikes on US imports on 2nd April, liberated was the last thing investors around the world were feeling. 

Over the next few days, global financial markets suffered their steepest falls since the spread of the Covid-19 pandemic five years ago. The decision to pause the tariffs for 90 days led to a partial recovery, but, at the time of writing, there is little sign of an end to the crisis, and fears are growing of a worldwide recession. 

How market falls affect our brains

Even for experienced investors, episodes such as these can be very discomfiting. The intense uncertainty caused by market falls activates fear and stress in the brain, setting off the ancient fight-or-flight response that helped humans survive. This fear sharpens our focus on threats, heightens sensitivity to what others are doing, disrupts our short-term memory, and makes it harder to think clearly or adapt to new information.

Although most investors know that the best thing to do in these situations is nothing at all, the compulsion to act can feel overwhelming. But whatever form it takes, whether it’s trying to time the market, reducing your equity exposure or bailing out of stocks altogether, any such action tends to lead to worse outcomes. 

Think about something else

My standard advice after a market fall is to tune out the noise. Ignore the financial news as much as possible, and resist the temptation to check the markets or the latest value of your portfolio. Try to distract yourself and focus on something entirely different; going for a walk in nature is an excellent way to clear your mind and calm your nerves.

It sounds simple, but it’s hard to do in practice. Sometimes we just can't stop ourselves thinking about it. So, if you feel compelled to apply some mental effort to the problem, try some reading. No, don’t read opinion pieces from market commentators, which are only likely to make things worse. Instead, read some history, and financial market history in particular. 

Markets have consistently recovered

While each market crisis feels catastrophic, history shows that financial markets consistently recover from even severe downturns.

In The Panic of 1907, for example, the the Dow Jones lost half its value but recovered most of its losses within two years. Then came the Great Depression, two world wars, the inflation crisis of the 1970s, Black Monday in 1987. More recently we’ve had the bursting of the dotcom bubble and the Global Financial Crisis of 2008-09. In every case, it all looked grim, and yet markets eventually recovered and reached new heights.

Sometimes, in fact, markets rebound very quickly. In 2020, for instance, the U.S. stock market fell 34 per cent in just 23 days as the scale of the Covid-19 pandemic became clear. Within a year, the market had not only recovered, but also risen 78% from its lowest point.

Is this particular crisis an exception?

Of course, there is no guarantee that, just because markets have always recovered in the past, they will continue to do so in the future. Several highly intelligent people have argued in recent days that President Trump’s trade war somehow threatens to rewrite the rules of investing, because of its almost unprecedented nature and the scale of its potential impact on the global economy.

However, history offers reassurance: commentators have claimed ‘this time is different’ during nearly every market downturn. In the Great Depression, for example, people genuinely questioned whether capitalism would survive; in 2008, it was feared the entire financial system would collapse; and, in 2020, as the pandemic took hold, the global economy virtually shut down overnight. In each case, the reasons for despair felt entirely rational. But, over time, investors who held their nerve were rewarded for their patience and discipline.

Again, it’s not a given that markets are bound to recover from the economic shock that President Trump’s trade policy has caused. They may have further to fall; indeed, this could be just the start of a painful and protracted bear market. 

Conversely, it’s also possible that the crisis resolves much faster than anticipated. Remember, things can change very fast. On 9th April, for instance, when the 90-day pause was announced, the S&P 500 surged by 9.5%, marking one of its biggest single-day gains in history.

The truth is, no one knows what will happen — perhaps not even senior White House advisers. And, even if we did know how the tariff crisis will unfold, it’s even harder to predict how the financial markets might react to all of the possible eventualities.

The rational strategy

For most investors, the logical response is to sit tight. Selling after markets fall turns paper losses into real ones. Taking risk off the table after markets have fallen only means you’re turning paper losses into actual ones. If you’re feeling brave, you might want to invest more in stocks than you were doing; after all, they’re rather cheaper now than they were before 2nd April. Otherwise, just carry on as before, automatically investing every month and periodically rebalancing to restore your original asset allocation. 

Remember: for equity investors, occasional crashes and corrections go with the territory. But if you believe, by and large, that human enterprise works and that in the long term, there will continue to be a demand for goods and services, and so companies will carry on making profits, then it makes sense to stay invested so you can benefit from this process yourself.

What if the direst predictions are correct?

One final thing. Let’s say the most pessimistic market pundits are correct and we’re in for a decade or more of stagnant or declining stock prices. What’s the best way for equity investors to limit their losses in this worst-case scenario?

Professor Meir Statman, a finance professor at Santa Clara University, tackled this question in an article for the Wall Street Journal, shortly before the tariff crisis began. “Stocks don’t cease to be risky investments once they are held for decades,” Statman warned. “But investors can mitigate their losses by investing in the most broadly diversified low-fee index funds and refraining from trading.” 

Automatically putting money away in low-cost, passive funds — and doing nothing else — is a thoroughly sensible way to invest. Whether markets end up higher or lower in 2035 than they are today, the odds are you’ll be better off doing that than taking a chance on more expensive active funds and jumping in and out of markets when investor sentiment changes.

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