Market reaction to ‘Liberation Day’ tariffs
US equities had underperformed year-to-date in the run up to Liberation Day on April 2nd as concerns around slowing growth and declining business and consumer confidence weighed on investor sentiment. Trump’s announcement of greater than expected universal and country specific tariffs triggered fears of a trade war and growing risk of stagflation, or worse a global recession.
US exceptionalism of faster economic growth, higher profitability and premium valuations came under scrutiny as investors shifted to a risk-off approach, leading to a marked de-rating in US markets and global equities as a whole.
The realisation that the announced tariffs are unlikely to be temporary and that retaliation may unfold intensified investors nervousness. Widespread bilateral negotiations with the US by affected countries are expected, which is likely to fuel volatility as speculation of constructive progress ebb and flows.
Economic impact and recession concerns
The bottom line is that tariffs are a tax and whilst the Trump administration believes this will raise $600bn in additional revenue, they mistakenly assume no change in consumer behaviour – something which history has shown never to be the case. Regardless, economic models predict that the new tariffs will cost every American household $1,200 each, almost the reverse of the covid stimulus handout of $1,400 to eligible taxpayers. The implication of this is the likelihood of a notable contraction in consumption. Consumption represents almost 70% of US GDP, therefore a significant reduction raises concerns over the growing probability of a technical recession.
Compounding this is the collapse in business confidence leading to a deferral of capex and investment activity and risk of hiring freezes turning to firing. As a result, economists, analysts and investors are on heightened alert.
Corporate earnings outlook
The upcoming Q1 results season, whilst likely to be solid due to increased pre tariff activity, is expected to be all about management forward guidance and their outlook for the year ahead. However, given the unpredictability of Trump, his policies and tariff negotiations, comments are expected to be limited and cautious.
Market weakness has been broad, initially led by the US but then latterly spilling out more broadly. Downward earnings revisions are underway, but more is to be expected. Quality, cash generative companies with solid balance sheets are expected to navigate their way through this period of uncertainty. Dividends and global government bonds with attractive nominal yields are expected to draw investors' attention as a source of reliable and resilient return.
The long-term perspective – remain patient and cool headed
Importantly for medium to long term investors its critical to remember that periods of heightened uncertainty pass, and economies and corporates regain their poise and upward momentum at some point (as demonstrated below). Given there doesn’t appear to be signs of financial distress, and corporate and household balance sheets are in a relatively good position we just need to be patient and cool headed. We should also not forget that there are also potential positive catalysts on the horizon such as central banks pledging to cut interest rates, announcement of stimulative fiscal programmes including tax cuts, deregulation and of course a moderation in tariffs as negotiations bear fruit. As such we continue to monitor things closely looking to lean into opportunities as and when we believe the risk reward moves in our favour.
Returns after economic and geopolitical shocks
Source: Bloomberg, S&P Global, J.P. Morgan Asset Management
Our position and performance
Our current positioning
We have been neutrally positioned for a while due to concerns over elevated valuations (especially in the US) and lofty earnings expectations leaving little margin for error. This positioning has been a headwind for us as markets climbed progressively higher though our discipline has retained our focus on quality across a variety of investment styles supporting our belief in diversification.
Recent portfolio strengths
Our overweight to global government bonds has been helpful as investors sought safety from risks of a growth shock.
We recently moved overweight in Diversified Alternatives to add to our real asset exposure to protect against the risk of inflation as well as increase uncorrelated positioning to both equities and fixed interest.
To fund the overweight in Diversified Alternatives we moved underweight corporate bonds due to growing concerns that spreads were tight and susceptible to widening out towards their historical averages, which has proven timely.
We neutralised our index linked positioning at the end of last year when real yields were close to 2.4% and breakevens attractive at 2.3%.
The counter cyclical characteristics of China A shares has been helpful to portfolios and with further domestic oriented policy support expected by the Chinese Communist Party we expect this to continue.
UK equity income has been a source of relative resilience as investors look for security of dependable short duration cashflow.
Underweight to US has been helpful versus our strategic asset allocation as well as many of our peer group. The US remains a broad market rich with opportunity for the good active manager, as a result we continue to look out for opportunities.
Recent portfolio challenges
Small cap exposure has weighed on returns despite historically deeply discounted valuations.
Japan has struggled year-to-date due to concerns over the prospect of a strengthening Yen and more latterly as a result of high tariffs on autos.
Asia Pacific ex Japan has been lacklustre as north Asian tech has been weighed down by weakness in global technology sector and India has been weak after a stellar 2024.
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This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.
