Key takeaways:
- The imposition of new tariffs from the US, and the elimination of previous exemptions, are intensifying trade uncertainties, hitting Asian economies particularly hard and leaving little scope for diplomatic trade negotiations.
- US equity markets have taken the brunt of investors angst, reflecting investors’ concerns about the growing risk of recession (driven by reduced consumer spending and increased inflation) and a shift away from US allocations.
- With the impact of these tariffs affecting the global economic outlook, those investors seeking to navigate the heightened uncertainty could seek to explore broader portfolio diversification to safeguard their investments.
Despite high expectations for a poor outcome on ‘Liberation Day’, the reality was even worse. Tariffs were higher on key trading partners, with Asian export powerhouses seeing the most severe impact. In addition, there was a new baseline tariff of 10% applied to all countries and the “de minimis” exception that had applied to Chinese goods was removed.
In a blow to those looking for negotiations to bring down the applied rates, the timeframes laid out for implementation are very short, leaving little room for specific deals to be carved out. While that perhaps brings greater transparency in some respects, markets will await any reciprocal tariff response from the larger economies around the world, and any potential consequent escalatory ‘retaliation’ from the US that follows. With the potential revenue to be generated from tariffs featuring heavily, it is also far from clear that the US administration is going to strive for deals that might reduce the money raised from imports. Uncertainty over how the dust ultimately settles looks likely to hang around for some time yet, frustrating investors who crave clarity.
The risk of recession is now higher
Even the US administration is willing to admit that tariffs are unlikely to be good for the economy in the near term. With recession probabilities already rising before Liberation Day and the applied rates being higher than expected, we expect to see consensus expectations price in an even greater probability of a US economic contraction, increasing concerns about the risk of recession elsewhere as well. Within the US, the fear is that inflation is forced higher as suppliers refuse to cut costs and retailers are forced to push up prices. A weaker dollar has not performed the shock absorbing function that many had assumed a few months ago.
Incomes are already being squeezed once adjusting for inflation and the fear is that the tariffs act as a ”tax” that leads to a contraction in real consumer spending, the backbone of the US economy. Consumer confidence has already ebbed significantly, and companies have shown signs of losing confidence. With many other major economies benefitting significantly from exports to the US, a slowdown in trade could be painful around the world.
US equity markets have continued to take the brunt of investors angst, with the large cap growth NASDAQ 100 Index and domestically sensitive small cap Russell 2000 Index seeing heavy losses overnight. European stocks have remained more resilient, perhaps due to the prior announcements of fiscal stimulus. However, there is a time horizon gap that investors need to be mindful of, given when the negative effects of tariffs may bite and when support from government spending might arrive.
The case is similar in China where, onshore, more domestically focused stocks have held up well compared to other markets, although the government has already made it clear that it is ready to deploy further stimulus measures. As might be expected, government bond yields have fallen as investors fret about higher recession risk and lower interest rates. Surprisingly for some, the US dollar has slumped against the euro as it appears investors are worried about a US recession first and foremost.
Markets are now pricing in these changed expectations
Such a broad negative policy catalyst for the global economy rightfully demands a reassessment of the general outlook. If the announced tariffs are implemented and remain at the levels laid out, the danger of the global economy slipping into contraction has certainly jumped higher. This is not to say that recessions are a certainty, only that the likelihood is now meaningfully higher.
Markets have clearly taken note but are still far from pricing in the most negative scenarios, with valuations on many equities still elevated vs history. We can find some evidence that markets are oversold in places but deterioration in fundamentals could easily make these irrelevant. Similarly, government bond markets would likely need to see a further shift lower in yields to price in more dramatic responses from central banks to support employment levels.
Attention is turning to the US labour market report (due on Friday, 4 April) for signs of economic momentum coming into Liberation Day, and then for any signs that deals are being struck to reduce the worst of the drag from tariffs. While risk assets may take some comfort from solid payroll growth, it is important to recognise that this is unlikely to fully reflect rising uncertainty. Similarly, within markets, we expect investors to keep an eye on lower-quality credit for signs that the shock is becoming more dangerous for financial conditions. The benefits of wide diversification are being seen and investors might be wise to continue to look for ways to spread their risk.
Definitions
The Nasdaq 100 Index is a collection of the 100 largest, most actively traded companies listed on the Nasdaq stock exchange.
The Russell 2000 Index is a stock market index that measures the performance of the 2,000 smaller companies included in the Russell 3000 Index.
Diversification: A way of spreading risk by mixing different types of assets/asset classes in a portfolio, on the assumption that these assets will behave differently in any given scenario. Assets with low correlation should provide the most diversification.
Economic cycle: The fluctuation of the economy between expansion (growth) and contraction (recession), commonly measured in terms of gross domestic product (GDP). It is influenced by many factors, including household, government and business spending, trade, technology and central bank policy. The economic cycle consists of four recognised stages. ‘Early cycle’ is when the economy transitions from recession to recovery; ‘mid-cycle’ is the subsequent period of positive (but more moderate) growth. In the ‘late cycle’, growth slows as the economy reaches its full potential, wages start to rise, and inflation begins to pick up, leading to lower demand, falling corporate earnings and eventually the fourth stage – recession.
Protectionism: The practice of restraining trade between countries, usually with the intent of protecting local businesses and jobs from foreign competition. Measures taken typically include quotas (limits on the volume or value of goods and services imported) or tariffs (tax or duty imposed on imported goods and services).
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
There is no guarantee that past trends will continue, or forecasts will be realised.
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