While markets were clearly expecting tariff impositions by the Trump administration, it goes without saying that those announced on ‘Liberation Day’ were bigger and more comprehensive than the market had expected and, as one Chinese politician suggested yesterday ‘ the market has spoken’. Depending on their impact on the absolute level of imports if these tariffs are maintained then they are estimated to raise somewhere between $750-850bn of tax revenue. Whilst some of this may be absorbed by participants in the supply chain, the vast bulk will be paid by US consumers, with a skew to lower income cohorts.
Unfortunately, the announcements do not bring clarity on where the trade policies ultimately land. Although it does show the scale of their intent to fundamentally reset America’s trading relationship with the rest of the world. Already the Commerce Secretary Howard Lutnick has asked other countries to bring forward policies that could see tariffs reduced. Indeed, retaliatory action is likely from some (we have already seen China and Europe respond in this manner) while smaller nations, hit with punitive levies from the arbitrary nature of the tariff calculation, such as Vietnam (46%) are coming to the negotiating table (they have no option but to do so, and no doubt, that was part of the Trump plan, variable as it is). Trade with Mexico and Canada remains undecided and sector specific tariffs on pharmaceuticals and chips are still to come. It will be interesting to see in the coming days whether or not negative market moves and polling lead to any pivot in policy.
In our view, it is yet too early to accurately assess the exact ramifications of recent actions on asset allocation or their expected longevity however there is growing consensus on the following:
For the US
- The tariffs will be inflationary in the US. We have seen estimates of between 1-1.5% due with inflation peaking at close to 4% in Q4. On top of this a weakening in the dollar has provided a further headwind. Similar to the impact of the UK budget, we know the tariff hit is one off and so we can expect the inflation hit to be transitory.
- In the very short term, the US has been labelled with the ‘stagflation’ narrative – the key question remains unanswered, however, regarding how quickly the Fed indicates that it is looking through the inflationary impact of the tariffs and can start focusing on the risk to growth.
- More broadly the scale of the tariffs and uncertainty around the policy will have a big hit on US corporate and consumer confidence. The fall in the US stock market will magnify this.
- Similar to Brexit the opportunity cost for corporations from having to manage tariffs/re-jig supply chains is likely to be significant.
- In the short term (1-2 years) there is likely to be little in the way of reshoring to the US. Companies can rejig existing capacity, but it will take time to make wholesale moves and companies will be reluctant to upend supply chains on the directive of a whimsical administration (it could change again tomorrow). Some industries, such as clothing and textiles, may still not be competitive with a domestic labour force vs the current tariffs. In these cases, there seems limited ability to re-source significant volumes from lower tariff countries. Hence US consumers will have to pay the bulk of the tariffs.
For the UK
- UK goods exports to the US are just £60bn annually, currently of which just over 25% is cars which are subject to the higher tariff. Whilst likely a headwind our overall direct economic exposure is low at just 2% of GDP.
- A weaker dollar is helpful for inflation.
- If the UK does not retaliate with tariffs on countries that have been hit hard by US tariffs and now have excess capacity looking for a home the UK could see cheaper imports. Potentially bad for some domestic industries (autos, steel etc) but again should lead to lower inflation.
- All of the above should play well for UK domestic exposed stocks – particular consumer spend focused ones where the fund retains a large overweight.
Rest of World
- Outcomes feel quite dependent on how the different economies/economic blocks respond. We have already seen Canada and the EU talk of more co-operation as well as Korea and Japan. There is also a likelihood, should this continue for the longer-term and not prove a near-term bargaining chip, that countries exclude the US from their trade negotiations altogether, given that the US accounts for only 13% of all global goods imports.
- Similar to Brexit it feels possible to overreact to the scale of the impact. Ultimately, as the countries with the highest deficits also have the highest tariffs, the ability for the US to re-source from other locations with low tariffs in the near term is limited. It will be the US consumer who pays the higher prices, and the question is what will be the price elasticity on individual products.
Market Reaction/FIM Capital Strategy
In the equity market, we have seen defensives hit least (pharmaceuticals and consumer staples) which is a standard flight to quality response, while bond investors have also gravitated towards shorter maturities on the yield curve. FIM Capital’s investment strategy reflects the views of our investment committee, which, for several quarters, has advocated the following and, at present, remains unchanged:
Remain underweight US equities relative to the MSCI World Index:
This has modestly hurt upside performance in certain strategies (primarily US dollar growth) but protects on the downside, given the stretched valuations already in evidence prior to these latest developments. Where we have exposure to US equities, we also include a bias towards equity income alongside our ‘growth’ candidates.
Remain overweight UK and European equities relative to the MSCI World Index:
Again, this was primarily a valuation call with a significant UK overweighting and a more modest European overweighting (recognising geopolitical risks in the latter as more acute).
Maintain exposure to gold bullion:
Our average weightings range between 5-7% in gold bullion. While it generates no income for our investors, it continues to act as a suitable insurance against geopolitical uncertainty and inflation.
Neutral on listed real estate:
This has been a beleaguered sector for some time, and we have moved from an erstwhile overweight to a more neutral position (in favour of fixed income) in recognition that discount rates (interest rates) have remained at a more elevated level than previously expected. One can achieve lower risk returns at the same level, albeit with less inflation protection, in conventional bonds (see my comment below). In recent trading days, some of our real estate investments have fared well on the expectations of higher inflation and as a more defensive asset (as the spotlight has moved away from the US growth story).
We remain invested in high quality, diversified global private equity which has also been held back by concerns over higher-than-expected financing rates however, as a modest allocation to less cautious portfolios, this remains a lucrative long-term asset class diversifier.
Remain focused on shorter-dated fixed income:
We have remained resolute in our focus on the shorter end of the yield curve, maintaining exposure to only short-dated positions within our sovereign, corporate and higher yielding bond and bond fund exposure. This was in prior recognition of the fiscal concerns (UK, Europe and US) which are likely to continue to affect the ‘term premium’ at the longer end of the yield curve (as borrowers lose confidence in the longer-term outlook). We have also increased our exposure to inflation-linked bonds in our client portfolios over the past year or so, which is one of the few asset classes which can perform well during any prolonged period of ‘stagflation’ (high inflation, low growth).
In short, we are doing what we always do in times of increased volatility, which is to remain faithful to our investment process, staying close to our companies and our funds to see if the consensus on tariff impact is actually aligned with the reality in the real world, and where they are not acting quickly, where we might see an opportunity.