Free trade, protectionism, and the investor who looks past policy

The US and China reached an agreement last week on a substantial reduction of their mutual trade tariffs. US tariffs on Chinese goods drop from 145 to 30 percent, and China lowers its retaliatory tariffs from 125 to 10 percent. Markets responded with one of the strongest weeks of the year. The S&P 500 rose more than 5 percent, and industrial stocks and commodity names were the big winners. The news is being widely viewed as a turning point — or at least a breather — in a trade conflict that has weighed heavily on the global economy over the past year. But for the long-term investor, the real question is not what was announced last week. The real question is what trade policy means, over the long term, for the value of the companies in a portfolio.

What is trade policy and why do markets react so strongly to it?

Trade policy concerns the rules governments set on the import and export of goods and services. Tariffs are the most visible form: a tax levied on imported products, paid by the importer in the receiving country. A tariff of 30 percent on a product worth 100 dollars means that the importer pays an additional 30 dollars before the product is allowed into the country. Those costs are typically passed on partly to the consumer, partly absorbed by the business, and partly avoided by switching to alternative suppliers. In every case, the result is friction, inefficiency and uncertainty.

Markets react so strongly to trade policy because they look ahead. When tariffs rise, company costs rise, margins fall, and investment decisions slow. When tariffs fall, the opposite improves. But the market reaction often overstates the immediate economic impact, in both directions. Last week's tariff reduction is a positive signal, but the underlying structural tensions between the US and China — over technology, state subsidies and geopolitical rivalry — have not been resolved. It is a de-escalation, not a normalisation.

Free trade versus protectionism: an old debate without a simple answer

The debate between free trade and protectionism is as old as modern economics itself. The theoretical argument for free trade — that countries benefit from specialising in what they are relatively best at and importing the rest — is economically robust and widely accepted. Free trade increases total welfare, lowers consumer prices, and stimulates innovation through international competition.

The argument for protection, however, is not unreasonable. Strategic industries, national security, and the protection of employment in vulnerable sectors are legitimate policy considerations. The problem is that protective measures rarely serve only those goals: they also raise costs for consumers and businesses, reduce the pressure to improve efficiency, and provoke trading partners into retaliation. The US-China tariff war of the past two years is a textbook example: higher tariffs hurt both American consumers and Chinese exporters, without fundamentally changing the structural pattern of trade.

What the investor learns from this

For the long-term investor, the trade policy of recent years offers a series of useful lessons. The first is that policy is cyclical. Countries swing back and forth between greater openness and greater protection, depending on political conditions, economic circumstances and geopolitical relations. The investor who adjusts the portfolio to every policy change will be running behind the facts and consistently missing returns.

The second lesson is that quality companies compound through policy cycles. A company with a unique product, deeply entrenched customer relationships, and a competitive position that cannot easily be replicated will be able to pass on higher tariffs, adapt its supply chain, or diversify its customer base. Companies that operate purely on cheap input prices and have no other competitive advantages are the vulnerable cases. Selecting the first category is no guarantee of protection against policy uncertainty, but it is the best protection available.

The third lesson is that the industrial world is being structurally transformed, regardless of the trade-policy climate. The automation of production processes, the energy transition, the reshoring of strategic production to Western jurisdictions, and the digitalisation of industry create structural demand for machinery, components, drive systems and engineering — demand that no tariff agreement creates or destroys. Companies positioned within those structural demand flows benefit from a tailwind that stands apart from the geopolitical noise of the week.

Last week's agreement in perspective

Last week's agreement is good news, and the market reaction was understandable and warranted. But the investor who builds the portfolio on the expectation of a permanently freer trading system is taking a risk that is not proportionally rewarded. The investor who builds the portfolio on the quality of individual companies, on their ability to create value in both good and difficult trading times, on their positioning in markets with structural growth, stands stronger regardless of what the next round of negotiations delivers.

Patience, quality selection, and a long horizon remain the three pillars of a durable investment strategy. That conclusion does not change when tariffs rise, and it does not change when they fall.

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Disclaimer. This article is published by Lunar Asset Management N.V. for general informational and educational purposes only. It reflects the personal views of the author at the time of writing and does not constitute investment advice, a recommendation, an offer, or a solicitation to buy or sell any security or financial instrument. References to specific companies are illustrative and should not be interpreted as buy or sell recommendations. Investing involves risk, including the possible loss of principal. Past performance is not a reliable indicator of future results. Readers should consult a qualified financial advisor before making any investment decision based on their personal circumstances. Lunar Asset Management N.V. is supervised by the Centrale Bank van Curaçao en Sint Maarten (CBCS).