Tariffs and Inflation: A Looming Stagflation Risk for U.S. Equities

The U.S. economy is teetering on the edge of a stagflationary scenario, driven by a confluence of aggressive tariff policies and persistent inflation. As of July 2025, the annual inflation rate stood at 2.7%, with core inflation hitting 3.1%—the highest in five months [1]. This trend is inextricably linked to the Trump administration’s sweeping tariff measures, which have pushed the average effective tariff rate to 22.5%, the highest since 1909 [3]. These policies, while framed as a tool to protect domestic industries, are increasingly distorting supply chains, inflating consumer prices, and dragging down GDP growth. For investors, the implications are clear: strategic sector rotation and defensive positioning are now critical to navigating the dual threats of inflation and economic stagnation.

The Stagflationary Tightrope

Stagflation—a combination of stagnant growth and rising inflation—has reemerged as a credible risk. J.P. Morgan Global Research estimates that U.S. real GDP growth will be reduced by 0.5 percentage points in both 2025 and 2026 due to tariffs [1]. The Yale Budget Lab projects an even steeper drag, forecasting a 0.9 percentage point reduction in 2025 GDP growth and a persistently smaller economy by 0.6% in the long run [3]. Meanwhile, consumer prices have risen by 1.8% in the short run, with households facing an average income loss of $2,400 in 2024 dollars [6]. These dynamics mirror the “Stagflation Lite” scenario described by AInvest, where inflation and growth constraints coexist without the full-scale crisis of the 1970s [5].

The regressive nature of tariffs exacerbates the problem. Lower-income households, which spend a larger share of their income on imported goods, bear the brunt of price hikes. For instance, the April 2025 tariffs alone are estimated to cause a 2.3% annual income loss for households in the second income decile [4]. Sectors like apparel and footwear—where prices have risen by 37% and 1.4% respectively in July 2025—highlight the uneven impact of protectionist policies [1].

Sector-Specific Vulnerabilities and Opportunities

The economic fallout from tariffs is not uniform. Certain sectors are disproportionately affected, while others offer resilience in a stagflationary environment.

1. Tariff-Sensitive Sectors:
2. Apparel and Textiles: Clothing and textile prices have surged by 17% due to tariffs on China and other key suppliers [4]. Footwear prices alone rose 1.4% in July 2025, reflecting the sector’s vulnerability [1].
3. Household Goods: Tariffs on imported household furnishings have driven year-to-date price increases, compounding the burden on consumers [6].

4. Durable Goods: While machinery and technology-related durables showed growth in July 2025, the broader durable goods sector faces headwinds from high mortgage rates (6.6–7%) and weak housing demand [1].

5. Defensive Sectors:

6. Healthcare and Utilities: These sectors have demonstrated resilience, with stable demand and inelastic pricing power. Healthcare, in particular, benefits from long-term demographic trends and low sensitivity to tariff-driven cost shocks [5].

7. Consumer Staples: Essential goods like food and household products remain relatively insulated from economic volatility, making them attractive in a stagflationary climate [2].

8. Inflation Hedges:

9. Gold and TIPS: Investors are increasingly turning to gold and Treasury Inflation-Protected Securities (TIPS) to preserve purchasing power. Gold ETFs and TIPS have seen inflows as inflation expectations rise [5].
10. Energy and Geographically Diversified Equities: Energy stocks and international equities are favored for their ability to hedge against U.S. policy uncertainty and currency risks [2].

Strategic Rotation and Defensive Positioning

For investors, the path forward requires a dual focus: mitigating exposure to tariff-sensitive sectors while capitalizing on defensive and inflation-protected assets.

1. Avoid Overexposure to Tariff-Impacted Industries:
   Sectors like apparel, footwear, and household goods are prime candidates for divestment. The Yale Budget Lab estimates that these industries could see a 6% GDP reduction and 5% wage decline in the long term [6]. Investors should prioritize companies with diversified supply chains or those less reliant on imported goods.

2. Lean into Defensive Sectors:
   Healthcare and utilities offer stability in uncertain times. For example, healthcare providers benefit from consistent demand, while utilities are less cyclical and insulated from trade policy shocks. Similarly, consumer staples—such as food and beverage producers—provide a buffer against economic downturns.

3. Embrace Inflation-Linked Assets:
   Gold, TIPS, and energy ETFs are critical for hedging against purchasing power erosion. The Federal Reserve’s cautious stance on rate cuts—acknowledging the delayed effects of tariffs—suggests that inflationary pressures may persist longer than anticipated [4].

4. Geographic Diversification:
   International equities, particularly in regions less affected by U.S. tariffs, offer a counterbalance to domestic policy risks. Emerging markets with strong export sectors (e.g., India, Southeast Asia) may outperform as global trade dynamics shift [2].

Conclusion

The U.S. tariff regime under the Trump administration has created a precarious economic environment, with stagflation risks looming large. While the immediate effects of tariffs are being absorbed by supply chain adjustments and stockpiling, the long-term consequences—reduced GDP growth, higher inflation, and regressive impacts on households—are undeniable. For investors, the key to navigating this landscape lies in strategic sector rotation and defensive positioning. By avoiding overexposure to tariff-sensitive industries and leaning into resilient sectors and inflation hedges, portfolios can weather the storm of stagflation while positioning for long-term growth.

Source:
[1] Inflation holds steady, but Trump's tariffs are boosting some ... [https://www.cnn.com/2025/08/12/economy/us-cpi-consumer-inflation-july]
[2] Stagflation Risks and Market Vulnerabilities in 2025 [https://www.ainvest.com/news/stagflation-risks-market-vulnerabilities-2025-navigating-dual-threat-equities-bonds-2508/]
[3] Where We Stand: The Fiscal, Economic ... - Yale Budget Lab [https://budgetlab.yale.edu/research/where-we-stand-fiscal-economic-and-distributional-effects-all-us-tariffs-enacted-2025-through-april]
[4] Where We Stand: The Fiscal, Economic and Distributional Effects of All U.S. Tariffs Enacted in 2025 through April [https://budgetlab.yale.edu/research/where-we-stand-fiscal-economic-and-distributional-effects-all-us-tariffs-enacted-2025-through-april]
[5] Stagflation Lite: Implications for Investors in a Trump-Tariff-Driven Economy [https://www.ainvest.com/news/stagflation-lite-implications-investors-trump-tariff-driven-economy-2508-28/]
[6] State of U.S. Tariffs: August 7, 2025 - Yale Budget Lab [https://budgetlab.yale.edu/research/state-us-tariffs-august-7-2025]