Trump’s tariffs

Investors remain, quite understandably, disturbed. Sifting meaningful signals from the white noise of incoming news and data is certainly not getting any easier. Here, we have another go at doing exactly that following President Trump’s rose garden hobbling of global trade.

Seriously?

The scale of tariff increases announced on ‘Liberation Day’ topped most expectations. On some estimates,¹ the average effective tariff rate in the US is now back at levels last seen in 1909. The degree to which this protectionist lunge leans on a basic misunderstanding² of concepts such as VAT is almost beside the point. We will now have to see how the world economy absorbs (and responds to) this assault on post-war norms.

Figure 1: The US average effective tariff rate is now the highest since 1909

Source: Historical Statistics of the United States, Datastream, Barclays

We can guess that if these tariffs remain as announced, the world will suffer a disinflationary shock. The hit to growth should ultimately dominate the one-off boost to price levels. American consumers will likely end up paying more for imported goods and will therefore have to reduce consumption in other areas.

The shock to the US and global economy is potentially even sufficient to usher in the next recession. That stepped-up probability is part of what financial markets are grappling with in the wake of Wednesday’s announcement.

Literally

The extent to which these measures are a negotiating gambit is obviously impossible to determine (by design). Even if this is all a giant bluff, the poker equivalent of ‘taking down the pot’, then there will still be negative real-world consequences. Investment plans may be shelved, important decisions deferred.

Admittedly, the fact that the latest industrial revolution is already raising trend growth in the US and perhaps elsewhere, provides a more forgiving context – all things are never equal when trying to analyse the effect of tariffs and other blows to the economy.

The broader question on many investors’ minds will be the degree to which this represents a permanent disfiguring of US exceptionalism. The richest of the rich punching down at others to correct what some will understandably see as domestic distributional issues is a difficult look to pull off.

Some other countries do have a case to answer, as we’ve pointed out previously. China and Germany are two that could certainly have done more in recent decades to correct global demand imbalances. The current US administration’s more abrasive posturing has already been helpful in ushering policy in both important economies in a more globally constructive direction.

However, it is possible that the US is misdiagnosing the sources of its own success in its attempts to force others to correct. Playing host to the world’s reserve currency certainly does come at a cost. There is some lost flexibility associated with the ‘dollar smile’.³

Such inelasticity has surely helped inflict costs on domestic manufacturing capacity, as this administration argues.⁴ Nonetheless, looking up at the global dominance of her technology, media, banking and other titans, it is hard to argue that the US economy in aggregate is suffering a competitiveness problem.

There is possibly something akin to the Dutch disease⁵ suffered by the Netherlands’ tradeable goods sector in the wake of North Sea natural gas discoveries in the late 1950s. The resulting surge in the florin was seen as making Dutch exports less competitive, with deleterious consequences for domestic industry.

In the case of the US today, it is not a windfall resource discovery but the appeal of her institutions and corporations that is creating a comparable effect. From the breathtaking dynamism of Silicon Valley to the august central bank and wider patchwork of federal and state infrastructure, the US has stood tall in the world of investments for many decades.

The country’s clear unipolar moment since 1991, cemented further by the Federal Reserve’s stepped-up global role in the wake of the (US born) global financial crisis, has seen US assets come to dominate the world of investments.

What to do?

Diversification is a central theme in long-term investing, the idea being that spreading risk across a range of assets can help build a more resilient portfolio. It often includes investing in less-loved areas of the world’s capital markets – if you don’t ‘hate’ part of your investment portfolio or fund, you are probably not diversified enough.

This year’s developments have offered a valuable reminder of the importance of diversification. Government bonds and other perceived safe havens have provided some offset to increasingly messy equity markets so far. There has also been an accelerated rotation out of many of the winning trades of the last several years, such as the Magnificent 7 into hitherto less appealing parts, such as European banks and Chinese stocks.

This rotation hints at something else for investors to consider, beyond the noise from the Oval Office. The industrial revolution is real, suggesting investors need to keep their eyes on the longer-term prize of a step-change in global productivity, which can only be managed by sticking with it. However, there are valid concerns that the eye-watering step-up in capital expenditure from the US corporate titans cannot possibly deliver the returns promised.

Earnings expectations for US stocks still look too high, for both this year and next. That is even without a sharp slowdown in the wider economy, which is now all but assured. Earnings expectations in Europe and Asia look more palatable. Global diversification is the answer of course.

The final reminder is that the pullback in stocks so far has not simply left us with the same goods at a cheaper price. In the context of last night’s news, these are new goods, incorporating an updated range of possible outcomes, at a necessarily different price.