The tariffs announced on 2 April represent a step-change in US trade policies, with the effective US tariff rate expected to rise to over 20%, its highest level in a century. We’ve since seen the S&P 500 experience one of its sharpest short-term declines in decades as investors fear a global recession.
The initial market reaction demonstrates the extent to which the tariffs have been more severe than expected in both magnitude and scope. Perhaps most surprising has been the action taken against many of the South East Asian countries where many US and international sportswear and apparel companies had re-routed supply chains following Trump 1.0’s tariff action against China. The ability of global companies to circumvent tariffs is significantly reduced relative to Trump 1.0.
Focus on structural winners and companies with strong competitive positions
The fluid nature of the situation calls for caution before taking immediate action, but we acknowledge that market volatility will present opportunities, as we saw during the market dislocations caused by the Covid pandemic. Importantly, the market moves year to date, which have intensified in the past couple of days, are driving significant dislocations in areas that we believe remain structurally attractive on a multi-year view.
Quality companies that think about long-term planning, supply chain resilience and diversification, and customer relationships ought to be better able to navigate these tariffs and consequential changes in the competitive landscape. These types of companies can typically see selling pressure initially at times of heightened uncertainty and market risk but could potentially offer greater risk-adjusted returns as trade dynamics adjust and markets normalise.
For sectors in the crosshairs of the trade policy, we believe the focus should be on companies with a strong competitive position which should drive pricing power, longer order back-logs as uncertainty impacts capital expenditure decisions, and greater domestic exposure. Clearly, industries less affected by trade disputes – banks, healthcare, utilities - may provide some respite from tariff-driven uncertainty while areas which offer defensive growth attributes may fare better as their relative earnings stability delivers resilience at times of increased economic risk and uncertainty.
Major disruption and readjustment to existing regime
While the White House has indicated that the reciprocal tariffs could be negotiated down, most tariffs are likely to be kept in place which represents a major disruption and readjustment to the existing trade regime.
There were strong reactions from global leaders, using terms like "countermeasures" and "retaliation," indicating a confrontational stance. As such, the risk appears to be skewed towards higher-still tariffs, as we’ve already seen in the case of China’s retaliatory tariff announcement at the end of last week.
It is a fluid situation with further developments to be expected in the days and weeks ahead as global leaders determine their own course of action and negotiations intensify. We also need to consider the potential for a reaction from the monetary authorities and the potential for interest rate cuts. Market volatility is therefore likely to persist near term.
Implications for US stock market exceptionalism and non-US equities
The current US administration is seemingly willing to tolerate significant short-term economic pain in its ambition to reshape perceived global trade imbalances. The immediate impact of these tariffs is expected to increase costs and inflation, reduce economic activity and growth, decrease company profitability, and harm consumer and business confidence, affecting both the US and the global economy.
A buoyant consumer has been a key pillar of US stock market exceptionalism over the past couple of years. The US consumer, however, is likely to bear the brunt of price increases. We’ve already seen signs of consumer weakness and frailty, particularly among the lower income cohort. So their ability to absorb price increases is diminishing and consumer companies will instead likely see profitability impacted.
It is still unclear the extent of retaliatory tariffs but higher savings rates as well as looser fiscal and monetary policy in other regions may provide some relative resilience, particularly in Europe.
Given that the US relies on foreign nations to fund its twin budget deficits, this unconventional economic policy is likely to test investor confidence in US stability. The US dollar has continued to weaken this year from elevated levels reaching a six-month low on the back of the tariff announcement, amidst waning confidence in the growth outlook. This may support continued flows toward non-US equities.
Respite for the US economy – and indeed market sentiment – could come in the form of more consumer- and business-friendly policies given tax reform and deregulation remain on the agenda for the current administration. Their positive impact on US growth, however, is unlikely to fully offset the potential negative effect of tariffs in their current form.
The short-term and long-term effects of these measures are uncertain, and markets dislike unpredictability, but we are already seeing downgrades to global growth estimates as companies delay capital investment plans and consumer spending slows in light of increased uncertainty and adverse near-term implications of Trump’s proposals.
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