The impact of Trump's tariffs on the US stock market: This utility ETF may become a safe haven

Trump's imposition of high tariffs on imported goods has intensified global trade tensions, causing investors to worry about market volatility, leading to declines in both the S&P 500 and Nasdaq indices. However, compared to other sectors, the U.S. utility sector has been less affected and may even benefit. With its revenue primarily coming from the U.S., rising domestic demand and the foreign exchange advantages brought by a stronger dollar have allowed it to avoid the impacts of tariffs. Additionally, the development of AI technology is driving an increase in electricity demand, providing long-term benefits for the utility industry. The Vanguard Utilities ETF (VPU.US), with its low expense ratio and stable growth potential, has become an investment choice worth considering.

Trump has imposed a 20% tariff on goods imported from China and a 25% tariff on goods imported from Canada and Mexico. He also mentioned a 25% tariff on goods imported from Europe. All countries affected by the tariffs have already taken or plan to take retaliatory actions, and Trump has threatened to retaliate in kind.

The nonpartisan Tax Foundation in the U.S. estimates that the tariffs proposed by President Trump will raise the average tariff rate on U.S. imported goods to 13.8%, the highest level since 1939. Investors are concerned about the consequences of a trade war. The S&P 500 index has fallen 6% from its peak, while the Nasdaq Composite index has dropped 9%.

Compared to other sectors of the stock market, the utility sector may benefit (or at least suffer less) as the trade war weighs down the broader market. This makes the Vanguard Utilities ETF (VPU.US) an attractive investment idea at present.

Why might tariffs be beneficial (or at least not harmful) to the U.S. utility sector?

In January of this year, JPMorgan strategists led by Thomas Kennedy wrote, "The net impact of tariffs and the effects of government policy goals may benefit the industrial and utility sectors, as these sectors will require infrastructure development."

Additionally, in theory, tariffs should strengthen the dollar by reducing demand for foreign imports, which would suppress demand for foreign currencies. The Federal Reserve may also raise interest rates to combat inflation triggered by tariffs, stimulating foreign investors to purchase U.S. bonds and creating demand for the dollar.

How will tariffs affect exchange rates? This will become more unpredictable as foreign countries impose retaliatory taxes. However, the tariffs in 2018 and 2019 did strengthen the dollar, and a stronger dollar posed foreign exchange headwinds for companies earning revenue in international markets. Utility companies derive less than 1% of their total revenue from international markets, so they are hardly affected by adverse foreign exchange factors. For context, the international revenue exposure of other stock market sectors ranges from 18% in real estate to 56% in technology.

Utility stocks may not be impacted by tariffs because most of their revenue comes from the U.S. They may even benefit from tariffs, as the reduction in imported goods could lead to increased domestic manufacturing activity, thereby creating demand for electricity, gas, and water.

The Vanguard Utilities ETF tracks 69 U.S. utility companies. This index fund has the largest weight in electric utilities (61%) and multi-utility companies (25%). However, it also provides exposure to independent power producers (6%), gas utilities (5%), and water utilities (3%) In addition to tariffs, utility companies benefit from the growing demand for artificial intelligence (AI), which is another favorable factor. On average, ChatGPT requires ten times the electricity per query compared to traditional internet search engines. Therefore, Goldman Sachs strategists expect electricity demand to "accelerate growth by the end of this decade, reaching levels not seen in over 20 years."

The Vanguard Utilities ETF has returned only 21% over the past three years, below the S&P 500 index's 40% return. However, due to data centers consuming more electricity and the impact of tariffs on other industries, the utility sector is expected to outperform the broader market in the next three years.

Overall, utility companies saw a 16% increase in earnings in the fourth quarter of last year. This makes the industry's 20 times price-to-earnings ratio appear reasonable. The Vanguard Utilities ETF has a very low expense ratio of only 0.09%, meaning shareholders only need to pay $9 annually for every $10,000 invested