Inflation Myths, Market Realities, and the Tariff Scapegoat

Dear Mr. Market:

Ah, tariffs. The misunderstood villain of the economic world, blamed for everything from rising grocery bills to why Uncle Bob’s imported car parts now cost a fortune. But let’s set the record straight—tariffs are not always a pure cause of inflation. At least, not in the way most people think.

Read more: Inflation Myths, Market Realities, and the Tariff Scapegoat

Trump Tariffs 1.0

During President Trump’s first term, multiple rounds of tariffs were introduced, including significant levies on solar panels, washing machines, steel, and aluminum in 2018. These tariffs were targeted at Canada, Mexico, and the European Union. Throughout his term, the trade tension with China also escalated, culminating in what was widely dubbed the “trade war.” This played out with a series of tariff increases on Chinese imports, making headlines throughout his presidency.

So, how did the U.S. stock market respond to these tariff announcements? The reaction was, unsurprisingly, negative—similar to what we’re seeing today. Each new tariff announcement sparked sharp sell-offs in the stock market. Here are the annual returns for the S&P 500 Index during Trump’s first term:

• 2017: +21.9%
• 2018: -4.41%
• 2019: +31.74%
• 2020: +18.38%

Looking at these numbers, history shows that the first wave of tariffs introduced by Trump created notable market volatility, hurt certain U.S. industries, and led to increased prices for goods and services across the economy. Despite the widespread negative press surrounding the tariffs and trade war, the U.S. stock market posted solid gains in 3 out of the 4 years during his first term.

Trump Tariffs 2.0 Are Larger

It’s important to recognize the key differences between the tariffs imposed during Trump’s first term and the latest round of tariffs announced on February 2, 2025. The new tariffs are significantly larger than those from his previous administration, which may have a much larger impact on the U.S. economy and further drive up prices. While Trump was strategic in his tariff choices during his first term, the new round is far more sweeping—introducing a 25% tariff on all goods from Canada and Mexico (except oil) and a 10% tariff on goods from China.

The Supply & Demand Reality Check

Before we start pointing fingers, let’s remember the basics: inflation is an increase in the average price of a basket of goods. What causes prices to rise? Simple: supply and demand. If supply shrinks while demand stays constant (or rises), prices go up. If supply surges but demand drops, prices fall.

For example, during COVID, oil prices literally went negative (we wrote about that here). Why? Nobody was driving, so demand collapsed while supply remained. Meanwhile, toilet paper prices skyrocketed because demand spiked while supply chains were a mess. And fast forward to today, and we’re talking about eggs. None of this had anything to do with tariffs.

Also, for a brief snippet of history, in the 1800’s about 97.5% of our entire country’s revenue came from tariffs. Ironically enough, inflation was basically zero that entire time…

The Real Inflation Culprit: M2 Money Supply

If you really want to know what caused the inflationary chaos of the past few years, look no further than M2 money supply—essentially all the cash, checking deposits, and easily accessible savings in circulation. If you stuffed your face beyond belief (let’s say like on Thanksgiving) how do you typically feel a few hours later? That lethargic and downright comatose feeling the body goes through trying to digest too much food is akin to what our economy is dealing with right now.

From 2020 to 2022, the U.S. government printed and pumped a staggering $7 trillion into the system—roughly 40% of all U.S. dollars ever created! Just digest that number for a minute. We’d also make the case that most people could not write out how many actual zeros there are in a trillion dollars. Anyway, that’s like dumping jet fuel onto an open flame. The result? Too much money chasing too few goods, sending prices soaring across the board. Tariffs didn’t do that—excess liquidity did.

Without question in this political environment it is almost impossible to disconnect one’s ideology from economic facts. Love him or hate him, it’s essential to recognize that President Trump often employs tariffs not merely as economic measures but as strategic tools for negotiation. By imposing or threatening tariffs, the administration aims to bring trading partners to the negotiating table to address trade imbalances, intellectual property concerns, or other disputes. This tactic is less about the tariffs themselves and more about leveraging them to achieve broader economic or political objectives.

Global Tariff Landscape

To understand the current tariff dynamics, let’s look at how other countries impose tariffs on U.S. goods compared to recent U.S. proposals:

• European Union (EU): The EU imposes a 10% tariff on U.S. automobiles, while the U.S. currently has a 2.5% tariff on European cars. This disparity has been a point of contention, with discussions about aligning these rates to ensure fair trade practices. statista.com
• China: The U.S. has recently increased tariffs on Chinese imports to 20%, aiming to address issues like trade imbalances and the influx of illicit substances. In retaliation, China has imposed a 15% tariff on American agricultural products, highlighting the tit-for-tat nature of trade disputes.

The Market’s Reality Check

Lately, Mr. Market has been throwing a bit of a tantrum. The past few weeks have seen a selloff across U.S. equities, with the S&P 500 and Nasdaq pulling back after their meteoric rise the past couple years. Why? A combination of factors:

• The Fed’s persistent “higher for longer” interest rate stance.
• A slowing economy, with cracks starting to show in consumer spending and corporate earnings.
• Geopolitical uncertainty.

But here’s where it gets interesting: European and Emerging Markets have been outperforming the U.S. lately. Why? Valuations. The U.S. stock market, especially tech, has been priced for perfection. Meanwhile, Europe and EM equities have been trading at a relative discount, and as global investors hunt for better risk-reward scenarios, they’re rotating into those markets. In some recent My Portfolio Guide, LLC newsletters we briefly discussed what we thought could be a potential “value trap” in overseas markets but here we are “eating our own cooking” and possibly changing our tune a bit… as to remain solvent in this game, you have to be able to adjust to what the environment is currently telling us.

How Often Does the Market Correct?

Market corrections are a normal and actually healthy part of investing. On average:

• The market declines 5% three times per year.
• A 10% correction happens about once per year.
• The average peak-to-trough drawdown per year is -14.3%. (below is our favorite chart depicting this for anyone who has a short memory!)

For context, the last time the market declined 10% or more was in the second quarter of 2022. During that period, the index fell approximately -16.1%, reflecting investor concerns over rising inflation and tightening monetary policy (sound familiar?) These pullbacks may feel painful, but they are necessary for resetting valuations and providing new buying opportunities.

What Happens Next?

Historically, election years tend to see volatility early in the year, followed by a rally in the back half. With a Fed that might cut rates later in 2025, we could see some tailwinds for equities later in the year. But for now, expect more chop before the market finds its next trend.

So, before you blame tariffs for everything, remember: the market moves on liquidity, expectations, and capital flows. Tariffs? Sure, they will rattle nerves for the near-term but ultimately they’re just a subplot in the grand drama of Mr. Market.

Lastly, remember who our character Mr. Market is… he is emotional, reactive, and constantly looking for a villain. But as always, the truth is usually right there in the data—not just the headlines.