The financial world is currently in turmoil, with the Trump “liberation day” tariffs causing incredulity and concern amongst economists and business leaders, driving retaliatory measures by trade partners and wreaking havoc in stock markets across the globe. The underlying agenda of the new US administration is difficult to decipher – and its predictability regarding future decisions very low. What does seem clear, though, is that US consumers will bear most of the pain, via imported inflation and negative wealth effects, making it even harder for the Federal Reserve to cut interest rates further. An opportunity for Europe to regain economic and geopolitical leverage?
Our highly diversified approach to portfolio allocation, alongside below-average exposure to equity markets (including US technology stocks), has helped contain damage over the past days. Still, we must recognise that there are currently very few places for investors to hide and that the overall situation is both worrisome and highly unpredictable.
The question on most observers’ minds is the following: what is the rationale behind such a simplistic and punitive approach to import tariffs? Is it a matter of destabilising world trade, just as the Trump presidency has already destabilised international institutions? Or might it be a means of indirectly “taxing” US households in order to finance the extension of lower corporate taxes?
On top of this, Trump would like to see a lower dollar to boost US exports and (according to rumours) is toying with the idea of consolidating US government debt. Already, the US pay more interest charges per annum on their considerable debt than they spend on defence. This is a thorn in the president’s side and he wants that interest burden to shrink. Forcing the exchange of existing Treasury bonds for new ones with (very) long maturities and low (or no) interest rates is a scenario currently haunting the Trump wings.
Not a particularly realistic scenario, but with Donald Trump one never knows. After all, such a move could undermine the global financial system, and make the US dollar lose its reserve currency status. No wonder, then, that US Treasuries are currently being dumped.
Whatever the intentions of the Trump administration, the economic outcome can only be, in our opinion, lower growth and higher inflation in the US – raising the ugly spectre of stagflation. We are particularly concerned about negative wealth effects, pertaining not just to the direct impact of higher import tariffs on consumers (it is widely estimated that only 25% of the price increase will be absorbed by companies along the supply chain) but also to the indirect impact via the US pension system, amongst others. A severe market decline will certainly seriously hurt US pension fund returns, given their high exposure to equities. In turn, this will weigh on households’ confidence, curtail their purchasing power and limit their ability to borrow money to finance consumption.
The idea that a large number of foreign industrial enterprises will decide to build factories in the US – to remove the impact of punitive import tariffs – seems overly optimistic to us. Such investment plans are developed on a multi-year horizon, while the policy situation in the US currently varies by the week. Not to mention the risk of opening a new plant in a country where the rule of law might (in the future) no longer function properly.
For Europe, as discussed already last month, we see considerable opportunity amid the current chaos. The region’s long-standing issues (ageing population, excessive government deficits, rising populism) have not gone away, but a way forward is emerging. Major public spending plans are being drawn up, focussing on defence and infrastructure, and there is ample room (outside of France, Italy, Greece and Belgium, amongst others) to finance them via sovereign debt. We also note, since the publication of the Draghi report, the beginnings of a change in European mindset with regards to regulation and bureaucracy. At a time when the US outlet is under threat, simplifying EU procedures could provide a big boost to intra-European trade.
It will, however, be important that EU member countries respond jointly, as a bloc, to the latest US tariff terms – rather than each try to negotiate individually. In turn, this means that fiscal transfers will need to be introduced, such that a country particularly affected by tariffs (e.g. France because of its champagne and wine sector) be helped out by other, less impacted, fellow members. Such fiscal transfers have, of course, long been the missing piece in the European construction puzzle. Will this crisis provide the impetus for a more complete union?
Another opportunity for Europe lies in the strengthening of ties with other regions of the world. Japan notably, but perhaps also China and India, by virtue of the old adage whereby “the enemy of my enemy becomes my friend”. The global geopolitical scene is evolving at lightning speed right before our eyes.
From an investment standpoint, at this point we can only reiterate the importance of diversification and limited exposure to US (and other richly valued) equities. Markets could stage a rebound, depending on the tariff news flow, but there is little evidence so far of smart money aggressively buying the dip. We will obviously monitor the situation carefully, striving to protect portfolios as best we can, while looking out for longer-term investment opportunities…
