Tariffs: The Goods, The Bad and The Ugly

We wrote at the beginning of this year that 2025 was likely to be a wild ride given the uncertainty around which policies the new US administration would pursue, how successful it would be in enacting them and how markets would react to them once implemented. The first 100 days of Trump 2.0 have not disappointed on this front. He has signed more executive orders than any other modern-day President, overseen the steepest decline in the Dollar in the past 50 years and presided over a stock market fall rivalled only by those under Nixon and Ford, in a period stretching from today all the way back to JFK’s Presidency in 1961.

He has of course broken another 100-day record: the amount of revenue the federal government has collected from custom duties, otherwise known as tariffs. The more than $40bn raised since his inauguration is only set to rise further once the 90-day pause, announced amidst last month’s market turmoil, comes to an end.

The question of tariffs presents a considerable quandary to investors. From a macro perspective, the range of possible outcomes is wide — and it is far from clear which is most likely. On a micro level, the impact will vary markedly depending on a company’s business model and exposure. In our view, Quality Growth companies are generally well equipped to weather the worst effects of tariffs. In this month’s newsletter, we’ll explore both the macro and micro perspectives, before concluding with a review of the Seilern Funds’ exposure to tariffs.

Inflation, Recession, or Both?

Today’s economic environment presents a complex puzzle, with the core focus revolving around the impact of significant new US tariffs imposed last month. The consensus view, and certainly the fear that is prevailing in the markets, leans toward a challenging stagflationary scenario developing in the United States.

The rationale for this is straight forward. Tariffs are essentially a tax on imported goods, inflating the cost of goods sold. While some companies may bear these costs themselves, thereby lowering margins, there is a strong likelihood that the majority of them will be passed on to customers. This would lead to a classic case of supply-side, cost-push inflation.

Higher prices have the added disadvantage of reducing customer purchasing power in real terms, which could have the effect of slowing growth. Weaker consumption, in turn, may have the second-order effect of causing businesses to rein in their own investments, hiring and expansion. In this scenario, the economy would be squeezed from persistent inflation on one side and from slowing growth on the other, resulting in stagflation.

However, we should remember that the consensus macro view has a remarkable record of being wrong. Just ask any of the 85 per cent of economists who forecast a US recession in 2023,¹ or indeed the officials at the Federal Reserve who forecast continued growth in the US economy in 2008.² So any assessment of the impact of tariffs needs to take into account the several credible counterarguments which challenge the key assumptions behind both inflationary and recessionary fears.

Looking just at the arguments against sustained inflation, companies may choose to absorb the increased tariff costs halting the transmission mechanism in its tracks. In addition, the focus on a narrow set of goods may overstate the broader inflationary impact in a country where services represent approximately 75 per cent of the economy. Should consumption contract meaningfully, the resulting slowdown could even trigger deflationary forces, offsetting tariff-driven inflation. To cap it all off, we don’t know how long these tariffs will be implemented for, nor indeed whether some may end up being reversed in the event of empty shelves or a sharp downturn.

Predicting which of these forces will dominate in the short term is incredibly challenging. Looking further out is harder still. Even if companies are forced to restructure supply chains, this is a process that is more likely measured in years and decades than it is in weeks and months. Businesses and entire business clusters would have to move, and many sole-sourcing issues would have to be solved (for example, TSMC’s facilities in Taiwan have an outright monopoly on leading-edge chips. Such is the complexity of the chips and the manufacturing process, they cannot be produced anywhere else in the world).

This is before we even get onto the impact of potential deflationary forces in Europe and China, the effects of heightened geopolitical tensions in Ukraine, Taiwan, the Middle East and the Arctic and how moves in the dollar and the Treasury market may influence decision makers. Each of these cranks up the uncertainty dial. For the CFO working through the internal rates of return of different global projects, there has rarely been a time where there were more variables to consider.

Keeping One’s Head

For the Quality Growth investor, the question becomes how best to adapt to this backdrop of heightened uncertainty. At the heart of our philosophy is a fundamental commitment to Quality Growth companies, one that has been consistent over the last 35 years.

We select these companies exactly because they can stand the test of time and because of their resilience through past economic cycles. This minimises the number of investment decisions that we must make which hinge on macroeconomic forecasts. Instead, we focus on identifying and investing in businesses whose inherent strengths position them to weather most storms such as the ability to pass on costs to customers during inflationary periods without eroding demand, high gross margins which cushion profitability amid rising input costs, and low debt levels which reduce vulnerability to rising interest rates or deflationary shocks. These characteristics create resilience in companies that protect them exactly when it is most needed.

While this theory is reassuring, in practice we need to assess how our portfolio companies will be affected in the various possible scenarios, because they are not all entirely insulated. The first thing to note is that the portfolios are predominantly invested in service-based, and by definition, asset light businesses. In Seilern World Growth, roughly 60 per cent is invested in industries like software, data analytics and payment processing, while in Seilern America the services exposure rises to approximately 70 per cent. Non-tariff retaliatory measures cannot of course be ruled out and risks such as digital services taxes, increased regulatory scrutiny or market access restrictions are all measures that have seen real-world applications.³ However these companies should at least be less exposed to headline tariffs.

Measuring Tariffs

The extent of the remaining 40 per cent of Seilern World Growth’s goods-based exposure depends on a variety of factors. Due to the nuanced picture, we broadly categorised them into three groups at the time of the announced tariffs in early April: those with low exposure to tariffs, those with moderate exposure and those with high exposure.

Approximately 21 per cent of Seilern World Growth had low exposure. These companies have significant sales in the United States but also have a significant manufacturing base in the country. Idexx Laboratories, who sell diagnostic machines and tests to veterinarians, fit into this category. Although 65 per cent of their sales are in the US, most of their manufacturing base is also there and less than 1 per cent of sales are to China. Therefore, the effect of tariffs on Idexx is relatively limited.

A further 12 per cent of the portfolio had moderate exposure. These companies have a larger mismatch between where their revenues are and where the production takes place, but this is then offset by their position within the industry, pricing power and margins. Hermès, the luxury leather goods manufacturer, has nearly all of its production in Europe yet has significant sales in China and the United States. They have already commented that they will be passing on all the effects of tariffs onto consumers, such is the strength of their pricing power.

Finally, we had two companies, or 7 per cent of the fund with high exposure. These companies have a large mismatch between where they source their revenues and their manufacturing base. It is harder for these companies to offset this mismatch, with a less flexible manufacturing base. Intuitive Surgical, the leading robotic surgery company, will not be able to offset the tariffs on imports from their overseas manufacturing base and have already flagged a 1.7 per cent headwind to its gross margin. Fortunately, this is just shy of 70 per cent, so the hit is manageable. Nike faces an even greater challenge, with 36 per cent of revenues in the US, while the vast majority of its footwear and apparel is manufactured in Southeast Asia (especially Vietnam) and China, regions directly impacted by tariffs. Offsetting these tariffs will be more of a challenge for Nike. This challenge is compounded by a lower gross margin (45 per cent) and a recent strategy that has prioritised cleaning up marketplace inventory, which limits its ability to pass pricing on to the consumer. The combination of these factors ultimately led us to divest this position, the only company where we have had to take this measure.

Staying the Course

The current environment undeniably presents challenges. Macroeconomic forces, policy uncertainty, and geopolitical risks cloud the outlook. However, this is precisely the environment where our long-standing investment philosophy demonstrates its value. The more uncertain the world becomes, the more critical it is to focus on resilient companies that can withstand the volatility and who in some cases, have the resources to take advantage of it. Through it all, our priority remains clear, to identify and own exceptional businesses capable of not just surviving, but strengthening their market positions through turbulent times. By doing this, we hope to ensure that our product remains true to our goal of delivering the most consistent Quality Growth funds in the market, no matter what the next 1361 days have in store.

¹FT and University of Chicago Booth School of Business survey, December 2022

²FOMC Meeting Transcript June 2007

³The US Government, for example, has banned the selling of advanced semiconductor and chip-making equipment to Chinese companies, which is a high-technology embargo in all but name.