Bonds, Equities, and Indexes Under the Tariff Lens: What Holds Up Best?

With multiple developments after Liberation Day, investors remain divided with regard to the optimal investment strategy given the potential outlook on tariffs. In this article, I delve deeper into the outlook of various investment instruments in light of the current economic landscape.

Index Funds

To keep it simple, there's honestly no need to deviate from status quo if you're dollar-cost-averaging into well-diversified index funds, especially if you have a long-term horizon. Some notable examples are Vanguard FTSE All-World UCITS ETF USD Accumulation (LON:VWRA) and iShares MSCI World ETF (NYSE:URTH). While some investors seek to pull out from the equity market in hopes of coming back in during the market's total capitulation, history has shown that timing the stock market is, more often than not, fruitless.

With regard to the tariff situation, there is significant uncertainty under President Trump's governance — it's impossible to tell how things play out in the short term. From the catastrophic reciprocal tariffs announced on Liberation Day, we now have a 90-day break, multiple negotiations on the table, tariff exemptions on specific imports, and now, a hope to come to a consensus with China. Microsoft (NASDAQ:MSFT) and Meta (NASDAQ:META)'s recently reported earnings in Q1 also demonstrate resilience in big tech, even in light of the tariff situation.

The 'tariff doomsday' narrative is slowly dissolving, and it's not surprising considering the ludicrous magnitude of the initially announced tariffs, coupled with the highly dubious method used to calculate them. 

In addition, even in the unlikely case of a full-blown trade war, history has shown that the economy eventually recovers through new fruitful trade agreements, or increased productive efficiency in various economies. As such, given a long investment horizon, there is simply no reason to deviate from a sound dollar-cost-averaging strategy for a well-diversified portfolio of index funds. 

If anything, it may be advisable to achieve some level of portfolio diversification on a regional or sector basis. That would mean, for example, not putting all your eggs into the tech basket (e.g. having 100% allocation in IXN ETF), and also not being fully concentrated in a single region (e.g. having only US-based index funds like Vanguard S&P 500 ETF (NYSE:VOO) or Invesco QQQ Trust (NASDAQ:QQQ)). Regional or sector-based diversification reduces the risk of violent portfolio swings and ensure sustained portfolio growth as long as the broader market recovers and becomes stronger in future years.

Bonds

Investors who are more risk-averse or have shorter investment horizons may flock to bonds or bond funds. While these instruments provide shelter from the volatility, there are a couple of things to consider. 

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Firstly, the US bond market isn't exactly behaving the way it's expected to. Bond yields are rising — which shouldn't be the case during periods of uncertainty in the stock market. Nonetheless, we are seeing a sell-off in treasuries — potentially due to retaliative measures from other countries, investors offloading treasury-based derivative trades, or heightened inflation expectations in the US which have eroded bond valuations. As such, investors seeking shelter from volatility may not achieve this objective given the current peculiar bond yield situation. 

Secondly, there is generally large opportunity cost when deciding to dedicate a significant portion of your portfolio to fixed income instruments like bonds. Historical returns for bond funds pale in comparison when compared with equity funds. It is crucial to note that fixed income instruments like bonds provide value in being a hedge against market risk, as well as providing regular income in certain cases, like bond coupons — capital appreciation is not the focus here. Being clear with your investment objective and horizon before committing to a bond position is of paramount importance. 

In light of the above, one may consider investing directly into a diversified portfolio of investment-grade bonds or buying into diversified bond index funds like BND ETF.

As for equities, the impact of tariffs varies greatly across different sectors. In this article, I will cover autos, pharmaceuticals and semiconductor stocks — three of the most talked-about industries in the investor space as of late.

Auto Stocks: Easing Impact on Auto Parts

While many investors offloaded American auto shares upon initial tariff announcements, Trump’s latest executive order on tariffs on auto parts has sparked optimism for the sector. 

Firstly, measures like ‘tariff de-stacking’ have been implemented to keep tariff rates under control. To be specific, the de-stacking of tariffs implies that tariffs on auto parts are not to be stacked upon by other prevailing tariffs. For example, automakers who import steel parts such as body panels won't have to pay the 25% tariff on foreign parts and the 25% duty on the value of the steel sourced abroad. Only the highest relevant tariff will be applied — in most cases, this would be the tariff on foreign parts.

Automakers can also seek reimbursements for additional tariffs that have already been paid. Another significant exemption is that United States-Mexico-Canada Agreement (USMCA)-compliant parts made in Mexico or Canada will not be hit by the 25% tariff. 

Secondly, tariff reimbursements would be in place for certain parts like wiring harnesses, which are challenging to restore to the US in a short period of time, contingent on the assembly of the cars being in the US. Based on the new terms, automakers can be reimbursed for tariffs on foreign-made auto parts up to an amount equal to 3.75% of the value of a US-made car for one year, then 2.5% the year after, before this provision expires.

This helps to buy time for automakers to expand existing domestic production, while also considering new domestic substitutes for foreign parts.

All in all, the new executive order on auto parts certainly eases the impact of tariffs on automakers. While costs are still likely to increase overall, the new terms help to mitigate a good amount of damage to auto companies’ bottom lines. As such, big names like Ford and General Motors (NYSE:GM), both of which have slashed guidance on earnings due to cost increases, may see a silver lining in these new terms.

Pharmaceutical Stocks: Under Fire

It was announced by Trump earlier in the week that tariffs on pharmaceutical imports will come within the next two weeks, after signing an executive order with the intention to boost domestic manufacturing for American pharmaceutical companies. In his words, he intends to “bring medical supply chains back home” — and to achieve this objective, the incoming tariff rates on pharmaceuticals could be astronomical.

While encouraging domestic manufacturing of pharmaceuticals is a worthy cause, the potential impact of a huge tariff on pharmaceutical imports could be disastrous. 

Pharmaceutical companies already face huge competition and are operating on tight margins given the current economic landscape. In addition, it’s difficult to understate America’s reliance on pharmaceutical imports, with $200b of pharmaceutical products imported into the US in 2023 alone.

Ireland, Germany, and Switzerland were formerly the top three jurisdictions for American pharmaceutical imports, and China and India have assisted the US significantly in providing core ingredients for medicinal products. To find replacements for pharmaceutical manufacturing hubs abroad, as well as for the various ingredients required for medicine, will be a tall order. 

Semiconductor Stocks: Mixed Sentiments

While it seemed that semiconductor stocks would catch a break, it now appears that a new set of tariffs on semiconductor imports is looming over the industry. This could prove to be drastic, especially when considering how much the sector has to adapt to a tariff-dominated landscape. At present, most GPUs aren’t sold as stand-alone semiconductors. Instead, many of them comprise of multiple non-chip components due to their complexity — and much of the assembly is done abroad.

In addition, when we consider analog and consumer semiconductors — which are exposed to PCs, handsets, autos and more — we can expect an even rockier path ahead, especially considering how sensitive these products are to supply chain disruptions.

That being said, big players in the space have announced that they would be ramping up domestic manufacturing. In particular, Nvidia (NASDAQ:NVDA) itself plans to build up to $500b in AI servers in the US. The company’s CEO, Jensen Huang, states that he is “enthusiastic about building in America” and that “in the near term, the impact of tariffs won’t be meaningful. Fellow player AMD (NASDAQ:AMD) has also announced that it would be following suit.

For the first time in history, AMD's flagship chips will be produced at TSMC’s Arizona facility, marking a significant shift toward domestic production and also an indicator of diminishing reliance on overseas manufacturing. With industry leaders already making plans to adapt to tariffs, the rest may follow suit, and the overall impact of a new tariff-dominated economic landscape on the semiconductor industry may not be as severe.

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Disclaimer: All in all, it’s important for investors to be clear about their risk tolerance and investment objectives before making any investment decisions. This article serves as my personal opinion on the current outlook of various investment instruments, and is not specific to any portfolio — as such, it is still necessary for you to do your own due diligence.

Written By: Alaric Pow