Trump tariff time bomb: Shield your portfolio from the brewing chaos

He also wanted tit-for-tat written all over his tariff document. The more a country levied tariffs on goods imported from the US, the higher the tariffs the US would impose on goods imported from that country.

This has eventually come to be known as ‘reciprocal tariffs’.

Well, the numbers are finally out, and they are not looking good to be honest.

The tariff hammer has really come down hard on Asian countries, with Vietnam leading the pack at 46%, followed by Thailand (36%), China (34%), Taiwan and Indonesia (32%).

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This means that goods coming into the US from, say, Vietnam will now be 46% costlier than before, from China 34%, and so on. Needless to say, they will lose a lot of the 'price competitive' edge that they had earlier.

Coming to India, although Trump has not been as punitive on India as on other Asian nations like Vietnam and China, Indian goods will still attract a steep tariff of 27%.

Yes, that's true. Consumers and companies in the US may have to shell out 27% to purchase goods that come with the 'Made in India' label.

Well, this is certainly not good news from a stock market perspective, given the significant contribution that exports to the US make to the profitability of Indian companies.

And sure enough, the US market has crashed overnight.

But why didn't the Indian market have a much bigger negative reaction to what seems like a strong blow to the growth prospects of Indian corporates?

First, the markets have known for quite some time now that tariffs were coming. It's not as if this was an announcement that caught the market off guard.

As markets knew that tariffs are on their way, a lot of the damage from them was already priced in. In fact, a good part of the recent correction in the stock market, particularly in the mid- and small-cap space, had to do with the tariffs as well.

Second, IT services exports and pharma are two of our biggest contributors to US exports and fortunately, both have been spared tariff pain.

Yes, that's true. Trump has imposed tariffs only on goods for now and since our IT exports are predominantly in the form of services, they won't face the tariff hurdle. Another sector that escaped rather narrowly from the tariff clutches is the pharma sector.

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You see, Indian pharma companies play a critical role in delivering cost-effective, life-saving generic medicines and are crucial to the political and economic stability of the US.

Hence, the US government would not want to risk bringing the sector under the tariff ambit and invite a lot of flak. Having said that, while the pharma sector can breathe easy for now, tariff imposition in the future cannot be fully ruled out.

It's also possible that once a more refined analysis is made, markets may correct further from here on. But nothing can be said for certain, and we could be in for a volatile ride.

Now, the all-important question...

What is an investor supposed to do amid all this chaos? Should she sell all her holdings and run for the hills or be like the proverbial Ostrich that sticks its head in the sand and pretends that all is well?

Well, choosing either of these options would mean giving in to fear and panic. And you won't go too far in investing if you keep succumbing to these two emotions.

The right thing to do would be to hand over the reins to the logical, thinking part of your brain and allow it to come up with a plan of action.

This plan of action should be simple, logical, and have a proven track record when it comes to dealing with such situations.

Here's our suggestion for a robust plan of action. Build a portfolio of 25-30 companies that are fundamentally sound and are available at a discount of at least 30-35% to their intrinsic values.

So, say the intrinsic value of a stock is ₹100 per share. Do not buy it until the price falls below ₹70 per share. And do this for all the 30 stocks in your portfolio.

You see, the impact of Trump's tariffs will either be positive, negative or neutral for every single company listed on the Indian stock exchange.

If the impact is negative for all the stocks in your portfolio, their intrinsic value could fall from, say, ₹100 per share to ₹70 per share.

In such a scenario, your loss would be zero or close to zero since you had bought them at a discount to their intrinsic value anyway, i.e., you ensured a sufficient margin of safety.

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So, even in a worst-case scenario, you are not losing a lot of your capital.

Now, if the impact is neutral and the intrinsic value stays at ₹100 per share, your ₹70 or lower purchase price will eventually climb to ₹100 per share in the next 1-2 years. In this case, you will walk away with a decent 40-50% profit.

And finally, if the impact is positive and the intrinsic value climbs to say ₹150 per share, then you will double your money in 1-2 years flat.

You see, there are investors who believe they have the analytical ability to predict which sectors and stocks will be impacted positively as well as negatively by Trump's tariffs and where the impact will be neutral.

And they make their buy and sell decisions based entirely on this prediction.

Well, we boast of no such ability.

We think that this topic is too complex to wrap one's head around and there are unknown second-order and third-order effects that are beyond the ability of any human to grasp.

An ideal approach would be to try and minimize the downside and allow the upside to take care of itself.

A portfolio of fundamentally sound 25-30 stocks purchased after ensuring a sufficient margin of safety would be a great way of putting this approach into practice.

As highlighted, while it minimizes the downside in the face of an adverse event like Trump tariffs, it maximizes the upside should things go your way.

We've always believed that when it comes to the future, being prepared is far better than predicting the market's next move.

At Equitymaster, we are preparing for Trump tariffs and its aftermath by recommending only the fundamentally strongest companies that also have a sufficient margin of safety in their valuations.

These principles are time-tested and should not change. What can change is how they are applied and to which stocks or sectors.

So, tweak your portfolio if you want to in view of the tariff announcements.

But ensure that you are buying fundamentally strong stocks and are applying the concept of margin of safety in the spirit in which it's meant to be applied.

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Doing this would mean you not only minimize the wealth destruction from the tariff time bomb but also any such event in the future.

Happy Investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com