Here Are the Sectors and Industries That Are Vulnerable if Reciprocal Tariffs Come Back

Susan Dziubinski: Hi. I’m Susan Dziubinski with Morningstar. With President Trump’s tariff deadline fast approaching, there are plenty of questions about what higher reciprocal tariffs may mean for the economy, stocks, and investors. I sat down with Morningstar’s director of equity research in the US, Damien Conover, to discuss what sectors and industries would be most vulnerable to a worst-case tariff scenario and what the impact could be on stock valuations. Here’s what he had to say.

Now, Damien, Morningstar’s equity research team recently published some new research examining the impact of tariffs on Morningstar’s valuation for stocks across sectors and across industry levels. And then you examined both the direct impact of tariffs and then that indirect impact of tariffs on economic growth. So first, outline the three scenarios that your team considered during this research.

Damien Conover: Susan, one of the things we’re finding is a lot of interest in potential pathways that we might go down because of the tariffs. And so we had our chief US economist look at three different scenarios that potentially could happen because of the tariffs. We took a look at a bear case, which we think is sort of the 25th percentile of likeliness to happen. The base case, which we think is most likely, that’s the 50th percentile of likeliness to happen. Then a bull case, an optimistic scenario, which will be about the 75th percentile of likelihood. And take a look at different tariff rates and different sorts of economic growth rates behind each one of those scenarios.

Dziubinski: And let’s focus, not to be negative, but let’s focus on sort of that bear case, the worst-case scenario that we would imagine from the tariff rates of, I think you said, 18% and the growth rate being the lowest.

You said that the two sectors in that scenario that would be affected most by tariffs would be consumer cyclical and basic materials. So give us an idea of what the bear case is for those two sectors and whether that’s largely due to the tariffs themselves or it’s due to, indirectly to, the tariffs and that impact on economic growth.

Conover: Yes, great question. When we think about that bear case, with tariffs going about 18% for the long term for the next five years, these are the two sectors we think are most at risk. So cyclicals, we think the valuation damage there, if we go down that bear case, it’s going to be over a 20% hit to valuation of that sector. It’s a big hit. This is a space where a lot of things are manufactured internationally. It’s really in the direct bull’s-eye of those tariffs. You think about all those tariffs, all that goods coming back, you’re getting hit with those tariffs. That’s going to be a pretty heavy hit.

Now, if we think about basic materials, it’s a little bit more of an indirect hit. This is an area where it’s very exposed to the overall economy growth, and in that bear case, we do have the GDP growth slipping quite a bit. And basic materials are going to have that amplified exposure there and sort of the secondary impact, not the direct impact of tariffs, but the slowing of the economy.

Dziubinski: Got it. So then what industries across different sectors would be most negatively impacted by tariffs in that bear-case scenario?

Conover: Yeah, so first to maybe unpack a couple of the sectors a little bit more by industry—so we think about cyclicals, this is an area, like I said, close to over a 20% hit to valuation. Retail, apparel, this is a very sweet spot for the damage of the tariffs. All, not all, but a very high percentage of that material is being manufactured internationally, and hit with the tariffs—that’s going to bring down the valuations for these companies.

When we think about basic materials, mining is an area where it has amplified exposure to a slowdown in the economy. So this is an area where we think over 20% hit the valuation for that specific industry.

If we get outside of those two main sectors of damage, one other area that is also very exposed to a bear case is the asset management group and this is one where you see the economy slowing, you see the market pulling back, and this is a basis-points business, where these asset managers typically charge money on a basis point how much assets they have, and when the market comes down that hurts them, and it’s sort of amplified in their margin structure. So three industries that I’d say are probably some of the most exposed in a bear case.

Dziubinski: So let’s talk a little bit about what’s the change then if it’s not the bear case, but it’s more of our base-case assumption? Are we still talking about, I’m assuming it’s still similar sectors and similar industries, but how bad could it get from a valuation standpoint?

Conover: Yes, so when we think about shifting from the bear case to the base case, the damage is typically reduced by about 10%. So, we talked about some of the worst-hit sectors in the bear case, cyclicals, basic materials, you add over a 20% hit to valuation. If we go close to a base case, which is still worse than where we were pre-April, the damage is closer to, close to negative eight to, call it, high-teens damage. So maybe call it a 10% delta of difference. So still a headwind for those particular sectors, but much more manageable in the base case.

Dziubinski: So let’s look at the other side of the coin and talk about sectors that actually look most tariff-resilient in our base case and our bear case, I guess. Let’s look at both. It’s not surprising. I did take a peek at the research, so I know that the sectors are traditionally what investors would think of as those defensive sectors, right?

Conover: Absolutely. So it’s going to be sort of your traditionally thought of as defensive spaces. We’re talking about utilities, we’re talking about consumer defensive, and healthcare. These are sectors that, regardless of the economy, people are still going to be purchasing those assets. The other thing that’s sort of unique about them is they are less exposed to tariffs. Think about healthcare, that’s typically more service-driven and even the pharmaceutical firms have a lot of manufacturing here in the US. When you think about utilities, that’s very localized, and then defensive as well. These are products that folks are going to have to buy regardless of the price, so these are sectors that we don’t expect a lot of valuation impact regardless of our scenarios but have very minimal exposure even under the base case.

Dziubinski: So what industries then that maybe within those sectors or outside of those sectors also look somewhat resilient?

Conover: Yeah, so a couple that I’d pull out from those sectors within healthcare—drugs is a space, again, where I talked about just briefly before, but this is an area where there’s incredibly strong pricing power there, and these firms can pass along any impact that they may have. And then on top of that, drugs are something that folks are going to have to buy regardless. And a lot of times they’re protected by the payment itself. Yes, there are copays, but insurance is picking up a lot of that.

Additionally, we get into utilities, regulated utilities, I think is a great area to be. This is an area where utilities are a little bit constrained in what they can charge, but they are allowed to have that spread and that spread should enable some pretty stable returns going forward.

If we think about the consumer defensive area, the beverage area is an area where there’s a lot of continual buying. The price elasticity for all those areas is pretty favorable for firms that, if they need to pass along pricing, they can, and a lot of times consumers are going to need to buy these things regardless of the market environment.

Dziubinski: So, Damien, as you noted, there remains so much uncertainty around tariffs today, where we’re going to end up and by when. So, what advice would you give investors today who are looking for new investment opportunities amidst all of this uncertainty?

Conover: Yes, great question. I’d highlight three key points. One, keep thinking about investing for the long term. There’s a lot of volatilities. The tariff news definitely caused increased volatility. But when you think about investing, think about the very long term, and that should set you up to work through these different volatilities.

Second point, I say take advantage of valuation opportunities. The volatility provides different entry points, and be aware of when things pull back for too much for too wrong of the reason, and it can be great opportunities to get into great stocks at discounted prices.

Then the third point I’d say is keep in mind the moat ratings on stocks. There are stocks, if you want to be more immune to the tariff news, you think about some of the wide-moat firms that have strong pricing power. These are firms that can pass along tariff increases by pricing to consumers. And because of their wide moats, they’re protected from some of the competition, and that can enable a little bit more safety when thinking about investing in this tariff volatility.

Dziubinski: So sounds like people should build wide-moat watchlists.

Conover: Absolutely.

Dziubinski: Good to see you, Damien. Thank you for your time.

Conover: Thanks for having me, Susan.