One sentence from President Trump has the gravity to reshape the hype surrounding AI.
Since the end of 2022, it’s been all systems go for Wall Street. Over the last two years and nearly two months, the iconic Dow Jones Industrial Average (^DJI -1.69%), benchmark S&P 500 (^GSPC -1.71%), and growth-fueled Nasdaq Composite (^IXIC -2.20%) have respectively rallied by 33%, 59%, and 91%, with all three indexes notching multiple record-closing highs.
Investors have plenty of reasons to be optimistic, including the rise of artificial intelligence (AI) and President Donald Trump’s return to the White House. The former is an estimated $15.7 trillion addressable market, per the analysts at PwC, while President Trump oversaw scorching-hot respective returns of 57%, 70%, and 142% in the Dow Jones, S&P 500, and Nasdaq Composite during his first term.
However, 20 simple words from President Trump regarding tariffs have the gravity to completely derail what’s been a jaw-dropping rally in AI stocks and the broader market.
President Trump taking questions from reporters at his Mar-a-Lago resort. Image source: Official White House Photo by Daniel Torok.
Statistically, tariffs are troublesome for the stock market
In the weeks leading up to Trump’s inauguration, concerns mounted on Wall Street over the incoming president’s proposed use of tariffs. A tariff is a tax on imported goods that’s designed to make domestically manufactured goods more price competitive.
On paper, the idea behind implementing tariffs is to protect American manufacturing jobs and encourage multinational businesses catering to U.S. consumers to produce their goods in America rather than abroad. But plotting things out on paper doesn’t always translate to the real world.
If Country X places a tariff on a group of goods being imported from Country Y, it’s not uncommon for Country Y to retaliate by implementing tariffs of its own on imports from Country X. These escalatory tactics can also expand beyond these two countries and hurt trade relations and/or trust with other nations.
In early December, Liberty Street Economics, which is comprised of economists who publish research and analysis on behalf of the Federal Reserve Bank of New York, unveiled a report that looked at how tariffs impact domestic companies. What researchers found in their study (Do Import Tariffs Protect U.S. Firms?) is that publicly traded companies with direct ties to tariffs performed poorly on the days they were implemented.
Liberty Street Economics referenced tariffs Trump implemented on China in 2018 and 2019 and noted a clear share-based underperformance for companies with direct exposure to these tariffs. Further, the analysis showed that profits, employment, sales, and labor productivity, on average, declined for these exposed businesses from 2019 to 2021.
Perhaps the most telling finding is that tariffs sometimes make it tougher for domestic manufacturers to compete with overseas producers on price. Whereas some tariffs are focused on finished goods (known as output tariffs), others are geared at inputs, such as steel, which are used to manufacture finished goods domestically. Tariffs on inputs can create all sorts of issues for U.S. companies.
While President Trump has targeted specific countries (China, Mexico, and Canada) with tariffs through the first month of his second term, the AI revolution could now be in his sights.
AI has helped to fuel a virtually unstoppable two-plus-year rally in Wall Street’s major stock indexes. ^DJI data by YCharts.
One sentence from President Trump could bring the AI rally to a screeching halt
Prior to his inauguration, Donald Trump had stated that he would revoke President Joe Biden’s AI executive order and effectively foster an America-first mentality. Trump’s approach to AI focuses on national security, domestic AI innovation, and deregulation. The latter allows for an uptick in merger and acquisition activity and potentially gives game-changing AI innovations an easier path to mainstream adoption.
However, one recent comment from President Trump could throw a monkey wrench into what’s been a well-oiled hype machine for the AI movement. When speaking about semiconductor companies receiving funding from the CHIPS and Science Act, which was signed into law by President Biden in 2022, Trump noted that cash infusions from the federal government weren’t needed and that:
The incentive is going to be they’re not going to want to pay at 25%, 50%, or even 100% tax.
These 20 words make it clear that Trump has no faith in doling out incentives to chipmakers to manufacture domestically and firmly believes that the threat of tariffs will coerce foreign semiconductor companies, such as Taiwan Semiconductor Manufacturing (TSM -0.93%), to manufacture goods in the U.S.
According to Trump’s timeline, a 25% tariff on automobiles, pharmaceuticals, and semiconductors would tentatively go into effect on April 2, with the expectation that these tariffs would be raised “substantially higher over a course of a year,” in the president’s words.
Aside from the prospect of dramatically increasing the cost of various goods and services for tech companies and enterprise/retail consumers, tariffs on chipmakers may strain trade relations between the U.S. and select Asian countries.
For instance, Nvidia (NVDA -4.05%), which has become the face of the AI revolution, doesn’t import goods from China, which has been a target of the Trump administration’s tariffs. It does, however, have a key working relationship with world-leading chip fabricator Taiwan Semiconductor, whose chip-on-wafer-on-substrate packaging is necessary to incorporate the high-bandwidth memory needed to make AI-accelerated data centers tick. Possible tariffs on Taiwan Semi, coupled with strained trade relations with China — Nvidia sells billions of dollars in goods to China each quarter — could cause Nvidia’s otherworldly rally to come to a grinding halt.
Image source: Getty Images.
History is not on the side of AI stocks either
If investors were to take a step back and widen their lens, there’s a good chance they would see the value artificial intelligence can bring to the table. Empowering software and systems with the capacity to reason, act, and evolve on their own is a long-term game-changer for multiple sectors and industries.
But history is also quite clear that next-big-thing innovations and technologies have a consistent track record over the last three decades. Since (and including) the advent of the internet in the mid-1990s, every next-big-thing technology has, without exception, endured a bubble-bursting event.
It’s easy for investors to become enamored with eye-popping addressable markets. Unfortunately, investors consistently overestimate how quickly a new innovation will be adopted and/or go mainstream. With most businesses lacking clarity on how they’ll optimize AI or generate a positive return on their AI investments, the writing is on the wall that we’re amid yet another early-stage bubble.
In other words, AI giants, like Nvidia, and Wall Street’s major indexes, which have been propelled higher by AI stocks, such as the Dow Jones, S&P 500, and Nasdaq Composite, have more to be concerned with than just President Trump potentially implementing 25% to 100% tariffs on chip imports.
All technologies take time to mature, and we’re nowhere close to this maturation phase with AI.
