Impact of trade wars on markets for mom & pop investors

The following is a "deep research" project using ChatGPT conducted in early March 2025. The requirement was to research whether global portfolio diversification mitigated risk for the "average investor" in highly volatile environments, specially tariff-induced trade wars. I requested a predictive market analysis based on historical global financial market behavior in such environments over the past ≈100 years.

Introduction

Periods of escalating tariffs and trade barriers between major economies have recurred over the past century. Notable episodes include the Smoot-Hawley Tariff Act of the 1930s, various post-World War II trade disputes in the late 20th century, and the recent U.S.–China trade war of 2018–2019 (amid broader U.S. tariff actions on allies).

This report examines the medium-term (1–3 year) impacts of these tariff conflicts on key asset classes including equities (U.S. and international), bonds (U.S. Treasuries, corporate debt, global bond ETFs), and on macroeconomic indicators like inflation, consumer confidence, and manufacturing output.

We compare historical patterns to the current late-2010s tariff environment and assess whether global diversification remains a sound investment strategy under such conditions, given valuation differences and past market reactions.

The analysis is structured into case studies with data and then a synthesis of forward-looking implications.

Historical trade war case studies

1. The Smoot-Hawley Tariff Act (1930s)

Enacted in June 1930, the Smoot-Hawley Tariff Act sharply raised U.S. import duties (by about 20% on top of already high tariffs).¹ It was intended to protect American farmers and industries during the early Depression, but it backfired disastrously. Global trade plummeted as over 25 countries retaliated with their own tariffs, causing international trade volumes to collapse – a roughly 65–66% decline in world trade between 1929 and 1934.²

U.S. Equities

The U.S. stock market had crashed in late 1929, and Smoot-Hawley’s passage coincided with the accelerating downturn. Investors reacted very negatively, fearing collapsing prices and corporate profits; share prices were sold off “in record-breaking numbers.”

The Dow Jones Industrial Average, which had already fallen sharply from 1929 highs, continued to plunge – ultimately losing almost 90% of its value from 1929 to 1932 in the depths of the Depression.³

This multi-year bear market reflected not only the tariff’s impact but also bank failures, deflation, and collapsing demand. In the 1–3 years after Smoot-Hawley, U.S. equities were deeply depressed, with no recovery until 1933–1935 when policies changed (e.g. tariff reductions in 1934).

International Equities

Foreign markets suffered in tandem. European economies, already weakened by post-WWI issues, were badly hurt by the collapse in trade. Many European stock markets fell significantly as exports tumbled and global economic activity seized up.

In essence, there was no safe region for equities – the tariff spiral helped turn a U.S. downturn into a global depression, so international equities moved in the same downward direction as U.S. stocks.

Bonds

In this deflationary environment, high-quality bonds (e.g. U.S. Treasuries) held up better than stocks. With prices falling and interest rates cut, bond yields declined and government bonds preserved capital. However, corporate and foreign bonds faced rising default risk due to economic stress. The flight to safety favored U.S. government debt.

Overall, the severe deflation (U.S. prices fell ~6% in 1930 alone) meant real yields were high; investors in Treasuries earned modest positive returns as nominal yields trended downward.

Macroeconomic Impact

The tariffs exacerbated the Depression’s severity. Consumer prices fell (deflation) as demand evaporated, and unemployment soared (reaching 25% in the U.S. by 1933). Industrial output collapsed – U.S. manufacturing production halved by the early 1930s. Smoot-Hawley itself did not single-handedly cause the Great Depression, but it “added considerable strain” to an already fragile global economy. Economists widely agree it worsened the downturn, though trade was a smaller share of GDP then than today.

In summary, the medium-term aftermath saw plummeting equities worldwide, severe economic contraction, and deflation, with only bonds offering relative stability as a safe haven.

2. Post-WWII Trade Disputes (1960s–1980s)

In the decades after World War II, global trade policy shifted toward liberalization (GATT and other agreements). Broad multi-country tariff wars like the 1930s did not recur, but there were episodic trade disputes and protectionist measures.

These were often narrower in scope – targeting specific industries or countries – and their medium-term market impacts were more contained. Key examples include:

The “Chicken War” (1962–64)

A minor trade spat in which Europe slapped tariffs on U.S. chicken imports, and the U.S. retaliated with tariffs on items like light trucks (the origin of the enduring 25% U.S. light truck tariff).⁴

This was industry-specific. The macro effect was negligible – U.S. and European equity markets in the mid-1960s saw little impact, and broad economic growth continued. However, it showed tit-for-tat retaliation in trade disputes even in a booming global economy.

Nixon’s 1971 Import Surcharge

In August 1971, President Nixon abruptly imposed a 10% tariff (import surcharge) on virtually all imports, as part of the “Nixon Shock” to force currency realignment and protect the U.S. dollar. This was short-lived (removed after new exchange rates were set in 1972), but it occurred amid an inflationary backdrop.

Medium-term impacts: The early 1970s saw rising inflation and the 1973–74 recession/crash, though the tariff was only one factor (the oil embargo and end of Bretton Woods played larger roles).

U.S. equities initially continued a late-60s bull into 1972, then fell sharply in 1973–74; it’s hard to isolate the tariff’s effect since broader monetary issues dominated. Bonds in the 1970s suffered as inflation surged (U.S. CPI hit double digits by 1974), sending yields up and bond prices down.

The 1971 import tariff likely had a mild short-term boost to U.S. price levels (costlier imports) but was too brief to create sustained inflation by itself. Consumer confidence in the 1970s was more shaken by stagflation and oil shocks than by the import surcharge.

In sum, the 1971 episode demonstrated that tariffs can be inflationary (by raising import costs), but the medium-term outcome was intertwined with the larger cycle of 1970s stagflation.

U.S.–Japan Trade Frictions (1980s)

During the 1980s, the U.S. faced large trade deficits with a rising Japan, prompting various protectionist responses. In 1981, the Reagan administration negotiated voluntary export restraints (VERs) with Japan, effectively capping Japanese auto exports to the U.S.⁵

This protected U.S. automakers but at a cost: auto prices in the U.S. jumped (Japanese cars became scarcer and more expensive, and domestic automakers faced less competition). Indeed, the quota led to a decade of higher car prices (est. +8% on average) for American consumers. The immediate beneficiaries were U.S. auto industry jobs, which saw a respite, and Japanese firms who responded by shifting production to the U.S. to bypass the export limits.

In terms of broad markets, however, these measures did not derail the 1980s economic expansion. U.S. equities in the early 1980s were more influenced by the Federal Reserve’s interest rate policy (the 1981–82 recession from Fed tightening, followed by the robust bull market from 1982 onward) than by the auto tariffs.

After an initial recession (largely monetary), the mid-1980s equity market boomed. Japanese equities famously surged into a late-1980s bubble despite trade tensions, partly fueled by yen revaluation and easy money after the 1985 Plaza Accord. Thus, global equities continued to rise in the medium term, trade war notwithstanding.

Bonds. By the mid-80s, inflation was falling and bonds entered a long bull market (yields down, prices up) – again largely driven by macro-policy, not modest trade barriers. One caveat: trade tensions contributed to currency volatility. For instance, U.S. threats to devalue the dollar to fix trade imbalances were factors rattling markets in 1987.⁶

The 1987 stock crash was precipitated in part by worries about trade deficits and potential currency/trade conflict between the U.S. and its trading partners. Overall, the 1980s taught that targeted protectionism (autos, steel, electronics) could inflate prices in specific sectors and strain international relations, but as long as disputes stayed limited, the broader market impact was contained. The global economy kept growing, and diversified equity investors still saw strong medium-term gains through the decade.

Other Episodes

The U.S. imposed temporary steel tariffs in 2002 (Bush administration), prompting EU threats of retaliation. This was short-lived (repealed by end of 2003) and had minimal market impact – at the time, equities were focused on the tech-bubble bust and early 2000s recession. Analyses later found the steel tariffs caused more job losses in steel-using industries than jobs saved in steel-making.^7,8

Similarly, tire tariffs in 2009 (Obama administration on Chinese tires) had limited macro effect, raising tire prices for consumers but not budging overall inflation much. These episodes underscore that post-WWII trade actions, until recently, were usually small-scale or temporary, with localized economic effects (higher costs for certain goods, modest job shifts) but little lasting impact on broad indices or growth. Markets mostly viewed them as corporate sector issues rather than economy-wide threats.

Summary of Post-War Patterns

In the medium term, U.S. equities generally digested these trade disputes without prolonged downturns (any dips were recovered once policy uncertainty cleared).

International equities could be hit if they were the target (e.g. Japanese auto exporters saw U.S. import caps, but many Japanese companies thrived by adapting – building U.S. plants – and Japan’s stock market soared).

Bonds reacted mainly to inflation trends: protectionism in the 1970s contributed to inflation and hurt bonds, whereas in the 1980s and 2000s, trade measures were too limited to outweigh disinflationary forces benefiting bonds.

Inflation tended to rise in affected product categories (autos, steel, etc.), but unless the tariffs were broad or sustained, overall CPI impact was minor.

Consumer confidence in post-war cases was only dented if the trade issue threatened a wider economic slowdown (e.g. 1980s fear of U.S. industrial decline did weigh on sentiment in rust-belt regions, but nationally the recovery of the 1980s dominated).

Manufacturing output sometimes got a short-term boost in protected industries (steel, autos) but often at the expense of higher input costs and retaliation hurting other exporters, muting net gains.⁹

In sum, unlike the 1930s, these later disputes were skirmishes rather than full-scale wars, so medium-term market and macro effects were moderate.

3. U.S.–China Trade War (2018–2019)

In 2018 the U.S. launched a series of aggressive tariff actions, marking the most significant trade war in decades.

Tariffs were levied on approximately $370–$380 billion of Chinese imports (by 2019) along with duties on steel and aluminum globally (hitting allies like Canada, Mexico, EU). China retaliated with its own tariffs on U.S. goods.

By late 2018, the U.S. was also threatening tariffs on autos from Europe and additional duties on Canada/Mexico (though the latter were resolved through USMCA talks). This “trade war” unfolded in waves through 2018 and 2019, creating a highly fluid policy environment.¹⁰

We now focus on its medium-term impact through the end of 2019:

U.S. Equities

The trade war coincided with increased volatility for American stocks. Markets swung in response to each twist in negotiations. In general, tariff escalation news prompted sell-offs, while talk of deals or pauses sparked rallies.¹¹

In 2018, the S&P 500 index ended the year modestly down (–4.4% total return) amid rising trade tensions and other factors. Notably, late 2018 saw a sharp correction (the S&P fell ~20% from its peak) as tariffs on China escalated and global growth showed signs of slowing.

However, by 2019, markets had adapted to some tariffs and were bolstered by other positives (e.g. central bank easing).

When a preliminary “Phase One” trade deal was eventually announced (October 2019), U.S. equities surged to new highs. The S&P 500 jumped +31.5% in 2019, more than erasing the prior year’s dip. Tech-heavy stocks (NASDAQ) and the Dow Jones followed a similar pattern – a volatile 2018 with flat-to-negative returns, then a robust rally in 2019.

Sector differentiation was evident: companies exposed to global trade (industrials, semiconductors, farm equipment, etc.) underperformed during tariff escalation, whereas more domestically insulated or service-oriented sectors fared better.

But by the end of the 2018–19 period, broad U.S. indices had achieved solid net gains, illustrating that the medium-term impact was a “roller coaster” but ultimately not a lasting drag once partial trade resolutions and policy adjustments occurred.

International equities

Global markets bore a significant brunt of the trade war, especially export-oriented economies.

Chinese equities were hit hard in 2018 – for example, the MSCI China A-share index plunged about –30% in 2018 amid tariffs and domestic growth concerns. Other emerging markets also fell (MSCI Emerging Markets index around –15% in 2018), partly due to weaker Chinese demand and a rising U.S. dollar.

European equities declined as well (MSCI EAFE developed market index was down roughly –13% in 2018) as industrial giants in Germany, Japan, and Korea saw order reductions and sentiment soured. However, like the U.S., 2019 brought a rebound. Once investors perceived that worst-case trade outcomes (e.g. a complete U.S.-China decoupling or auto tariffs on Europe) might be averted, international stocks bounced back.

Chinese stocks, despite ongoing tariffs, soared ~+36% in 2019 (MSCI China A index) as stimulus in China and hopes of a deal lifted sentiment. Other emerging market equities gained roughly +15–20% in 2019, and European/Japanese markets also rose around +20%.¹²

The net result for the 2018–2019 period was that a globally diversified equity portfolio saw modest growth, but with a lot of pain in year one and recovery in year two.

Notably, U.S. stocks slightly outperformed international peers over the full period (having smaller drawdowns). This aligns with historical patterns: the tariff-instigating country (U.S.) can sometimes outperform in a trade war as it shifts policy, whereas export-dependent markets (China, Germany) feel immediate pressure but can snap back if policy eases.

Still, correlations were high – trade tensions were a global risk-off event, at least temporarily, causing flight from risk assets worldwide in 2018.

Bonds

The trade conflict period saw significant moves in bond markets, chiefly driven by shifting growth and inflation expectations. Initially, in early 2018, the prospect of tariffs raised some inflation fears – investors pondered if import taxes would push consumer prices higher.

This contributed to a rise in U.S. bond yields in 2018 (the 10-year Treasury yield climbed above 3% by Q4 2018).¹³

However, as the trade war began to slow global growth and inject uncertainty, the narrative flipped to one of “safe-haven” demand and central bank easing.

Throughout 2019, investors seeking safety poured money into bonds whenever trade talks faltered. The U.S. 10-year Treasury yield duly plunged, from about 3.2% in late 2018 down to ~1.5% at its 2019 lows, reflecting expectations of slower growth and Federal Reserve rate cuts.

In statistical terms, on major tariff news days U.S. Treasury yields fell significantly (e.g. 10-year yield drops of ~5 basis points on average on tariff announcement days)¹⁴, confirming the risk-off, bond-positive reaction.

Bond returns

The Bloomberg U.S. Aggregate bond index was flat in 2018 (0.0%) and then jumped to +8.7% in 2019 as bond prices rallied with falling yields.¹⁵

Government bonds led the way, outperforming corporate credit in 2019. Corporate bonds saw some spread widening during the 2018 turmoil (investors demanded more yield to hold corporate debt amid recession fears), but recovered in 2019 with the easier monetary policy.

In Europe and other regions, yields likewise fell – for instance, German Bund yields turned deeply negative in 2019 as the ECB signaled easing.

International bond ETFs hedged to USD delivered solid returns thanks to declining global yields, whereas unhedged holders saw mixed results due to a stronger dollar in 2018 (the U.S. dollar tended to firm up during trade uncertainty, which can erode unhedged foreign bond returns).

Overall, bonds fulfilled their typical defensive role during the trade war, protecting portfolios when equities sank and benefiting from the policy shift to lower rates.

Macroeconomic factors

Inflation

Tariffs by design raise the import cost of goods, so they exert upward pressure on prices of affected items.

Indeed, various studies showed U.S. tariff costs were largely passed to importers and consumers – for example, prices of imported washing machines jumped roughly $86 per unit after tariffs¹⁶, and overall U.S. import prices from China rose nearly one-for-one with the tariff rates.

However, in aggregate, inflation remained moderate. Core U.S. inflation hovered around the Fed’s 2% target in 2018–2019. Any direct price increases from tariffs (estimated at a few tenths of a percent on CPI) were offset by slower demand and a strong dollar.

In fact, the broader fear by late 2019 was tilted toward disinflation as growth slowed. Economists noted that while tariffs are inflationary in theory, “tariffs do not necessarily raise [overall] inflation” if they simultaneously dampen economic activity and are limited in scope.¹⁷

The medium-term outcome: slight uptick in specific goods’ prices (and higher inflation expectations in mid-2018), but no runaway inflation – by 2019 U.S. 12-month inflation was actually a bit lower than a year prior, as the tariff shock was small relative to the whole economy and the Fed eased policy.^18,19

Consumer confidence

U.S. consumer confidence was robust through most of 2018, buoyed by tax cuts and a strong job market, but it showed vulnerability as the trade war wore on.

Surveys in 2019 indicated that tariff headlines began to dent consumer sentiment, especially when trade tensions flared. For instance, mid-2019 saw the Conference Board consumer confidence index dip to its lowest level of that year, with a notable share of respondents citing tariffs/trade as a concern.²⁰

Still, the declines were from very high levels down to merely average confidence readings. Households were watching prices (e.g. potential cost increases on consumer goods) and job security (farmers and manufacturing workers grew anxious).

Notably, by late 2019, business confidence and investment took a bigger hit than consumer spending. The Fed’s Beige Book reports in 2018–19 consistently noted that firms were delaying capital expenditures and hiring due to trade policy uncertainty.

In sum, consumer confidence in the medium term dipped somewhat (particularly during tariff escalation episodes) but did not collapse; it remained sufficient to keep consumer spending growing, aided by a strong labor market. The real damage was more on business confidence and capex, which stalled in 2019 under the cloud of trade uncertainty.

Manufacturing output

Manufacturing was on the front lines of the trade war. By 2019, U.S. and global manufacturing activity had weakened notably. The U.S. manufacturing PMI (Purchasing Managers’ Index) slipped into contraction territory (below 50) by late 2019, indicating output was shrinking modestly.

Several Federal Reserve studies found the tariffs led to net job losses in manufacturing, as higher input costs and foreign retaliation outweighed the benefits of import protection.

Industries like steel and aluminum saw upticks in production and employment due to tariffs, but downstream industries (autos, machinery, farmers facing retaliation) saw declines – on net, manufacturing output and employment were a bit lower than they would have been without the trade war.

Globally, export-driven sectors struggled: Germany fell into an industrial recession in 2019, and Asian supply-chain countries saw factory output slow. However, the damage was moderate in a macro sense – manufacturing is a smaller share of GDP today than in decades past, and services continued to expand.

By end-2019, there were signs that the manufacturing downturn was bottoming out as the Phase One deal stabilized expectations. Essentially, tariffs squeezed manufacturing margins and caused a minor industrial slump in the 1–3 year horizon, but not a freefall.

To summarize the 2018–2019 trade war’s medium-term impact: equity markets experienced a sharp but temporary setback, followed by a strong recovery, bonds thrived as safe havens amid policy easing, and the economy saw higher uncertainty, specific price increases, and a hit to manufacturing, but avoided a recession.

This episode demonstrated that while modern trade wars can create significant short-term volatility, their medium-term effects can be mitigated by monetary policy and adaptability, resulting in only a modest net impact on broad asset class performance after a couple of years.

Comparing historical patterns to the current (Late-2010s) tariff environment

Drawing lessons from these episodes, we observe both parallels and contrasts:

Equities reaction

A common pattern is an initial equity sell-off when a trade war begins or escalates, reflecting fears of higher costs and lower growth. In 1930, that sell-off turned into a prolonged crash amid a collapsing economy.

In more recent cases (1980s, 2018), the sell-offs were real but temporary. For example, U.S. stocks dropped on most tariff announcement days in 2018²¹, and global indexes slumped in the latter half of 2018, similar to how stocks fell after Smoot-Hawley’s passage.

However, the magnitude and duration differed: the Great Depression bear market lasted years, whereas the 2018 downturn lasted months. By the 1–3 year mark, earlier trade conflicts saw recoveries – the 2018–19 U.S.-China war ultimately did not derail the bull market.

Similarly, the 1980s “Japan trade war” did not prevent equities from rising in the medium term. The key is that, unlike 1930, later trade wars occurred in otherwise supportive economic conditions or were met with offsetting policies.

Bottom line

Historically, broad equities often rebound within 1–3 years of a trade-war shock, provided that monetary/fiscal policy turns accommodative or a partial truce is reached.

The current trade war (late-2010s) seems to fit this pattern – after the initial volatility, the S&P 500 and global indices went on to new highs once the panic subsided.

International vs U.S. equity performance:

In global trade disputes, the relative performance can vary. In the 1930s, virtually all markets were dragged down together. In the 1980s, interestingly, the targeted country (Japan) had a stock boom despite U.S. pressure, partly due to internal dynamics.

In 2018–19, the U.S. stock market held up better than China’s or Europe’s during the worst of the conflict (U.S. indices fell less in 2018), reflecting America’s stronger domestic economy and policy flexibility.

This suggests that the initiator of tariffs (often a larger, diversified economy like the U.S.) may outperform in the short run, while export-dependent markets underperform when trade tensions flare.

However, the flip side is that once a resolution or stabilization occurs, those beaten-down international markets can rally strongly (as seen in 2019 with Chinese equities outperforming U.S. on the upside).

Thus, diversification across regions gives an investor exposure to such rebounds. The current U.S.-centric tariffs have indeed caused more pain abroad in the short term, but historical patterns imply that international equities can catch up once uncertainty ebbs, potentially offering higher medium-term returns especially if they started at lower valuations.

Bonds and interest rates

Virtually all episodes show inversely correlated moves between trade tensions and bond yields.

Heightened trade war risk tends to drive yields down (bond prices up) as investors seek safety and central banks lean dovish – evident in 1930s (deflation and Fed easing), in 2019 (Fed rate cuts and yield-curve inversion), and even during sporadic 1980s scares (brief rallies in Treasuries on safe-haven flows).

One exception was when tariffs stoked inflation fears without immediate growth fears (e.g. early 2018, or the 1970s environment) – then yields can spike on expected inflation. But such spikes were short-lived in the modern context; soon after, growth concerns took over and yields fell.

The current trade war environment has reaffirmed that bonds provide effective ballast – U.S. Treasuries rallied when equities fell in 2018, cushioning portfolios. International bonds mirrored this, though currency moves must be considered. Thus, a diversified bond allocation (across geographies or including Treasuries and global sovereigns) remains a prudent hedge in a trade conflict scenario.

Macroeconomics

Historically, tariff wars tend to reduce economic growth in the near term – by cutting export demand, raising costs for businesses, and hurting confidence. The Smoot-Hawley episode coincided with catastrophic output losses.

More recent tariffs (2018–19) had a milder effect: estimates suggest the Trump-era tariffs would trim long-run U.S. GDP by only ~0.2% and cost ~140,000 jobs. But importantly, even if the aggregate hit is small relative to a large economy, certain sectors and regions feel disproportionate pain (e.g. Midwest farmers, manufacturing hubs).

Tariffs also risk stoking inflation at the wrong time – e.g. if applied when the economy is at full capacity, they can create a stagflationary tilt (higher prices and slower growth).

In the late 2010s, the inflation effect was modest, but had the trade war broadened (e.g. 25% tariffs on all auto imports, etc.), we might have seen more sustained inflation increases.

Another pattern: trade wars often provoke policy responses – for instance, central banks may ease in response to trade-induced slowdown, as the Fed and ECB did in 2019. This policy cushion is a big difference from the 1930s, when policy initially tightened and then was slow to react.

So the medium-term macro outcome nowadays tends to be slower growth but not collapse, as policymakers intervene. In the current U.S. tariff conflict, global GDP growth in 2019 was dented (estimated ~0.5–0.8 percentage points lower than it would have been without the trade war)²², and manufacturing recessions occurred in some countries – but a combination of stimulus in China, Fed rate cuts, and fiscal spending helped avert a broader recession.

Consumer confidence and business investment did weaken in the tariff uncertainty, which aligns with historical precedent that prolonged uncertainty can be as damaging as the tariffs themselves.

The lesson is that while trade wars are clearly a negative for the macro outlook, the scale of impact in the medium term depends on the policy offset and initial conditions. The late-2010s trade war, occurring in a relatively strong economy with proactive central banks, ended up causing a slowdown but not a crisis – a far cry from the unmitigated downward spiral of the 1930s.

In summary, the current trade war environment (U.S. tariffs on China, Canada, Mexico, threats on EU) shares the hallmark features seen before: an initial shock to markets and growth, sector-specific winners and losers, and a global ripple effect.

However, global financial markets have thus far followed the more optimistic historical pattern – after an adjustment period, they have stabilized and even rallied, pricing that the worst outcomes will be avoided.

Historical comparisons suggest that if the conflicts remain contained (no full collapse of trade), the medium-term damage is likely to remain limited and reversible.

That said, risks remain – a broader or more protracted trade war (or one without monetary easing) could yet tap into the more dangerous dynamics of past eras (e.g. persistent stagflation or a crisis of confidence).

Global diversification under trade war conditions

A key question for investors is whether global diversification (holding a mix of U.S. and international assets) remains a sound strategy amid widespread tariffs and trade disputes.

Historically and in the current scenario, evidence suggests that diversification still offers benefits, though its short-term efficacy can vary:

Correlation and opportunity

In a severe global trade war (like the 1930s), all equity markets became highly correlated – diversification didn’t prevent losses because the downturn was worldwide.

In moderate disputes, however, different markets respond differently and at different times, creating opportunities for diversification to add value. The U.S.-China trade war showed alternating leadership: U.S. equities outperformed during the worst of the conflict (2018) while emerging Asia underperformed, but when tensions eased, some foreign markets outpaced U.S. in the rebound (e.g. China’s +36% vs S&P’s +31% in 2019).

An investor diversified globally would have been hurt by the larger drop abroad in year 1, but helped by the robust recovery abroad in year 2. Over the full 2-year medium term, the diversified portfolio ends up in a similar place as a U.S.-only portfolio, but with different drivers – potentially reducing risk if rebalanced.

Moreover, trade disputes can create valuation dislocations: in 2018–2019, U.S. equities became relatively expensive while international equities were cheaper (after their selloff). This valuation gap can be a setup for future outperformance of the lagging markets once uncertainties clear.

Indeed, Vanguard noted in late 2010s that there was a “tug-of-war” between U.S. stocks with strong earnings momentum and more attractively valued international stocks (Considering the potential impact of tariffs | Vanguard). Maintaining exposure to both sets allows investors to benefit whichever side “wins” over time.

Global diversification ensures you’re invested in regions that might recover faster or be less affected by a specific bilateral spat.

Risk mitigation

Diversification is fundamentally about risk mitigation. Even though a trade war emanating from the U.S. affected global markets, not all economies are affected equally.

For example, a U.S.–China conflict might push Chinese policy makers to stimulate their domestic economy or seek new trade partnerships, which could help Chinese and other Asian markets weather the storm better than expected.

Europe might temporarily benefit from trade diversion (e.g. China importing more from Europe instead of the U.S., or U.S. buyers sourcing from Vietnam instead of China). Such second-order effects mean a globally diversified portfolio could find pockets of resilience.

Additionally, currency movements during trade wars can cushion or amplify returns – often the U.S. dollar strengthens as a safe haven. For a U.S.-based investor, that can actually boost the relative value of U.S. assets versus foreign holdings in the short run (as happened in 2018). But if and when the dollar eases (as it did somewhat in 2019), foreign assets get a currency kick. Thus, having both USD and non-USD exposure balances these currency swings over the medium term.

Bonds and other Assets

Global diversification isn’t only about equities. Holding international bonds or foreign credit can provide exposure to different interest rate cycles and policy regimes.

During the 2018–19 period, for instance, European bond yields were even lower than U.S. yields, and Japanese bonds yielded near zero – adding hedged international bonds mostly provided stability and income similar to U.S. bonds, but with some diversification of central bank risk.

When the Fed was hiking in 2018, other central banks were still very dovish, so a diversified bond portfolio had parts that did well (non-U.S. bonds) even as U.S. rates rose.

Conversely, when the Fed pivoted to cuts in 2019, U.S. bonds outperformed – but by then the global investor would benefit from that portion. Diversification across fixed income markets ensures that no single yield spike (from inflation scares or a local selling frenzy) wrecks the entire bond portfolio.

It’s also worth considering diversifying into assets like gold or commodities in a trade-war scenario – those often rise on uncertainty or inflation hedging. However, within the scope of stocks and bonds, global diversification remains a core, time-tested approach to reduce portfolio volatility.

Valuation differences

At the time the U.S. activated broad tariffs (late 2010s), U.S. equities were generally priced at a premium (higher P/E ratios) to European, Japanese, and emerging market equities.

Those non-U.S. markets had lagged for years, and the trade war initially made them even cheaper. From a long-term investor’s perspective, lower valuations imply higher expected future returns, assuming the geopolitical risk eventually passes. Thus, diversifying into these markets could be rewarded when normalcy returns.

History provides examples: After the 1980s trade friction, the 1990s saw U.S. stocks dominate while Japan stagnated (in that case, the cheaper market – U.S. – won out). But in the 2000s, international and emerging markets vastly outperformed U.S. stocks, rewarding diversification for those who didn’t abandon them after a rough period. The lesson is that today’s underperformer can be tomorrow’s outperformer.

If global tariffs keep pressure on non-U.S. economies, their markets may price in a worst-case scenario. Should outcomes prove better (e.g. negotiated agreements or adaptation), those markets could rally strongly.

Global diversification ensures an investor participates in that upside and not just in one country’s trajectory.

Historical market reactions

Historically, once trade tensions resolve or stabilize, markets refocus on fundamentals.

The transient nature of many trade disputes means that globally diversified portfolios eventually revert to being driven by earnings growth and interest rates rather than tariff headlines.

For example, by early 2020 (pre-pandemic), markets worldwide were more concerned with growth prospects and monetary policy than with the remaining tariffs. Those who stayed diversified through the 2018–19 storm not only saw a recovery but also kept their portfolio aligned with long-run strategy rather than making a wrong guess on short-term politics.

Vanguard’s guidance during the tariff volatility was to “maintain both a long-term perspective and disciplined adherence to your strategic asset allocation”, emphasizing that broad diversification “across and within asset classes” is crucial to weathering such policy-driven volatility. This view echoes the experience that diversifying is one of the best defenses against unpredictable events – including trade wars.

In evaluating the current situation: The U.S. tariffs on China, Canada, Mexico, and potentially the EU create a more synchronized global risk factor (since multiple regions are involved).

This means in the short run, correlations might increase (a broad sell-off like late 2018 where most markets fell together). Purely in that short window, diversification didn’t prevent losses – a globally diversified equity investor saw losses across the board.

However, as we move to the medium-term (1–3 years), divergences emerge in performance and recovery speed, which is where diversification proves its worth. Some economies will adjust and bounce back faster. Some markets might benefit from being less directly in the crosshairs (for instance, if U.S.-China tensions stay high, countries like India or Brazil might gain export market share, supporting their equities).

Additionally, if the U.S. extends tariffs to Europe, one could see periods where U.S. stocks take a bigger hit (due to higher input costs for U.S. firms or European retaliation on U.S. exporters), and at that point non-U.S. stocks might relatively outperform. Having both means the investor is hedged either way.

Overall, global diversification remains a sound and prudent strategy under trade war conditions. While it cannot fully shield one from global shocks (nothing can in a deeply integrated world), it avoids concentrated bets on any single country’s outcome.

Given the valuation gap favoring international stocks and the historical tendency for leadership to rotate, diversifying globally positions a portfolio to capture returns wherever they materialize, and to mitigate regional risks.

As Vanguard’s 2025 outlook noted, U.S. vs. international equity performance is partly a “tug-of-war” – and since one cannot be sure which will lead in the next phase, holding both is wise.

Diversification also extends to holding bonds alongside stocks; the 2018–2019 period reinforced that a mix of assets buffers volatility (a global 60/40 portfolio had a much smoother ride than an all-equity one during the trade war). In a world of trade disputes, “don’t put all your eggs in one basket” applies at the country level as well as the asset class level.

Forward-looking market implications

Looking ahead, investors should consider several implications based on historical and current patterns:

Volatility is likely to persist

Trade negotiations tend to be protracted and politically driven, which means headline risk will continue. Markets can swing on news of tariff increases, delays, or deals.

We have seen that “further bouts of volatility are likely to continue” as tariff headlines emerge. Investors should brace for intermittent spikes in volatility (VIX) around key negotiation deadlines or tariff implementation dates.

However, each episode of volatility has thus far been followed by relief rallies when worst-case outcomes are avoided. A prudent approach is to expect “episodic volatility” rather than a permanent impairment of market trajectory.

Flight to quality in risk-off moves

In any renewed tariff escalation, expect the classic flight-to-safety pattern: U.S. Treasuries, high-quality bonds, the U.S. dollar, and possibly gold are likely to catch a bid, while equities and credit spreads come under pressure. We saw this clearly in the last trade war skirmish – e.g., tariff threats led to notable intraday drops in stocks and a bid for Treasuries.

Investors might consider maintaining or even increasing allocations to quality bonds or cash as a buffer if trade tensions intensify. This also implies that yield curves could flatten further or invert if growth fears jump (as happened in 2019).

Impact on sectors and styles

Tariffs will affect sectors unevenly. Manufacturing, materials, technology hardware, and agriculture-related stocks are in the line of fire for tariffs and retaliation.

For instance, automakers and suppliers were among the hardest hit on tariff news regarding Canada/Mexico, given the integrated supply chains and potential cost increases. Conversely, sectors like utilities or software (more domestic or less goods-oriented) might be relatively insulated.

Value stocks (which include many industrials and exporters) could be pressured during trade conflicts, while some growth stocks or defensive yield-oriented stocks might hold up.

But once a resolution nears, the cyclical and trade-sensitive names could rebound sharply. Thus, rotation strategies around trade news are tricky but relevant – active investors will need “good judgment in discerning signals from noise.” A diversified portfolio should include both sectors to avoid being caught on the wrong side of a rotation.

Economic growth and policy response

If tariffs broaden (e.g., the U.S. following through on auto tariffs on the EU or expanding China tariffs further), global growth forecasts would likely be revised down.

We could see downgrades to manufacturing output and business investment plans worldwide. Central banks have signaled they would respond – the Fed in 2019 cited trade uncertainty as a reason for preemptive rate cuts. We might therefore anticipate more accommodative monetary policy (or extended low rates) if the trade war resurges.

This could be supportive for bonds and equity valuations (lower discount rates), though it would be coming alongside weaker earnings growth – a mixed bag for stocks.

Inflation bears watching: a broader tariff regime (covering most imports) would push inflation slightly higher (the Fed estimated the late-2010s tariffs might add roughly 0.3–0.4% to core inflation).

If combined with a slowing economy, that could resemble stagflation in the short term, a challenging environment for both stocks and bonds. So far, that hasn’t materialized beyond a mild degree, but forward-looking, investors should monitor inflation expectations.

Breakeven inflation rates in bond markets may rise with each new tariff round, as seen when 2-year inflation expectations jumped above 3% in anticipation of tariffs on Mexico/Canada. If inflation were to pick up while growth falls, it could limit central banks’ ability to ease – a risk scenario for risk assets.

Global supply chain reconfiguration

One medium-term consequence of the U.S.-China trade war has been a reorientation of supply chains. Companies have started to diversify their sourcing away from China (often to Southeast Asia, Mexico, etc.) to mitigate tariff impacts.

Over 1–3 years, this could create new investment opportunities in countries that pick up manufacturing market share (e.g. Vietnam, India) and in industries like automation or logistics. It could also marginally raise costs for businesses as they shift production.

Investors with a global mindset might look at emerging markets that could benefit from these shifts, or at multinational companies that successfully navigate the change (versus those with inflexible supply chains).

In the long run, if supply chains become less China-centric, the vulnerability to a single bilateral trade war may lessen – but in the interim, there are winners and losers among countries.

Global investors can capitalize by being diversified across emerging Asia and other regions poised to gain. Additionally, sectors such as industrial real estate (warehouses) or robotics may see tailwinds as firms restructure operations due to tariffs.

Valuations and allocation tilts

Given current valuations, many analysts (as of 2019) argued for increasing exposure to international equities, which were trading at lower earnings multiples than U.S. equities, partly due to trade-war discounts.

The expectation is that over a 5-10 year horizon, those cheaper markets could deliver superior returns especially if trade tensions ease or at least don’t escalate dramatically. Thus, forward-looking investors might use periods of trade-war-induced weakness in non-U.S. markets to rebalance into those markets at favorable valuations.

On the bond side, with yields low globally, one cannot count on huge further capital gains, but non-U.S. bonds might still offer diversification if, say, the U.S. inflation rises relative to Europe/Japan.

Currency positioning will also matter – if the trade war subsides and global growth improves, the U.S. dollar could weaken, boosting unhedged foreign asset returns.

Scenario planning

It’s wise to contemplate both the bear case (tariffs broaden into a full-fledged global trade war) and the bull case (negotiated settlements and tariff rollbacks).

In the bear case, we’d likely see a more pronounced equity correction globally (perhaps a mild global recession), in which case all equities fall but high-quality bonds and maybe certain safe currencies rise. Diversification would still help (as some economies might fare a bit better and your bonds would buffer), but it’d be a challenging period requiring patience.

In the bull case, a comprehensive trade deal could unleash a surge of business confidence and a rebound in manufacturing activity. Cyclical and international stocks would likely lead a strong rally.

An investor positioned across U.S., European, and emerging equities would capture that broad upswing, whereas someone who fled to purely U.S. assets or to cash might lag in the recovery.

Thus, maintaining a baseline diversified stance allows you to participate in the upside if tensions resolve, while your bond allocation and perhaps gold/defensive stocks protect you if things worsen.

In conclusion, the historical record of trade wars shows they are disruptive but usually not permanently devastating to markets, especially when met with policy responses. The current wide-ranging U.S. tariffs echo some of the alarm of the past, but also the eventual resilience.

A well-diversified global portfolio, balanced across regions and asset classes, remains a robust strategy to navigate the uncertainty. It lets investors stay invested through the turmoil, knowing that they have spread their bets and reduced reliance on any single economy’s fate.

As always, careful attention to valuation and risk management is key – but abandoning global diversification in response to tariffs would be counterproductive given that history often “rhymes” and markets tend to normalize after these shocks.

The medium-term outlook therefore favors those who keep a cool head, stay globally diversified, and perhaps tactically tilt toward undervalued areas, positioning for eventual global recovery once trade tensions abate.

Asset class performance during the 2018–2019 trade war

To illustrate the medium-term market impact of the recent trade war, the table below shows the calendar-year returns for major asset indices during 2018 (when tariffs began and escalated) and 2019 (when partial resolutions and policy easing occurred). This highlights the dip-and-rebound pattern discussed:

Sources: Invesco, MSCI, Bloomberg, UpMyInterest, as cited. (Note: † Approximate range; MSCI EM index returned about –14.6% in 2018 and +18.4% in 2019 in USD terms.)

As shown, 2018 saw broad equity declines (especially abroad) and flat bonds, whereas 2019 showed robust equity gains (especially abroad) and strong bond performance as yields fell. A diversified global portfolio blending these would have smoothed out some volatility and delivered a positive cumulative return over the 2-year period. This real-world outcome supports the case for staying invested globally despite trade war jitters.

Conclusion

Trade wars have repeatedly tested investors over the last century. From the cataclysm of Smoot-Hawley to the jolts of modern tariff fights, markets have reacted with short-term turbulence but often adapt in the medium term.

The 1–3 year impacts of tariffs have included equity market volatility (initial losses then recoveries), rotations into bonds, and mixed macro effects (pockets of inflation, dips in confidence, lower industrial output).

By comparing history to the current environment, we see that while the scale of today’s disputes is significant, the global economy’s resilience and policy tools available are also far greater than in the past.

For investors, the key takeaway is to remain disciplined and diversified. History shows that succumbing to panic – for example, retreating from international markets or exiting equities entirely during a trade war – often results in missing the subsequent rebound once tensions ease.

Conversely, concentrating bets (whether all-in on U.S. markets or on a hoped-for trade resolution) can backfire if the conflict takes a different turn.

A balanced approach that spans geographies and asset classes positions one to ride out the storm and benefit from eventual calm.

In practical terms, that means continuing to hold broad indices like the S&P 500 and international indices, holding quality bonds as ballast, and rebalancing thoughtfully.

Valuation signals currently favor adding to non-U.S. equities – an example of turning short-term trade war fallout (lower prices abroad) into long-term opportunity.

Meanwhile, monitoring policy developments is important: investors should be nimble to adjust if a trade skirmish threatens to become a much larger economic threat. But absent such worst-case scenarios, sticking with a globally diversified portfolio remains a sound strategy, validated by both past and recent market behavior.

In conclusion, global diversification still makes sense in a tariff-troubled world. It provides exposure to recovery wherever it occurs, and buffers against any one nation’s policy errors. Trade wars, as unpleasant as they are, eventually tend to get resolved or absorbed by the market.

By maintaining a well-diversified, valuation-conscious portfolio through these episodes, investors can protect themselves in the medium term and stand ready to capture the upside when the tides of trade turn for the better.