US tariffs: what’s the price of uncertainty?

Will “liberation day” be the end of US exceptionalism? Following Trump’s tariff announcement last Wednesday, US equities finished last week with their worst two-day performance since the Covid-19 sell-off in 2020, the dollar fell and energy commodities like oil were down around 13%. Although markets globally were not immune, US asset markets were the hardest hit.

At its core tariffs are a tax for consumers, which, if passed on by importers, will represent the largest tax increase on US households and business since the Revenue Act of 1968, which preceded the 1969-70 recession.

Source: 7IM, Tax Foundation, JP Morgan

Now even if this does convince big companies to move production to the US (JCB have already announced a doubling in size of their new Texas factory), that doesn’t necessarily spell good times for US equity markets. After all, jobs in construction in the southern US aren’t what US markets have built their performance on over the past decade – tech has been front and centre there. And not only will any possible American winners from tariffs be unlikely to be based in San Francisco, there’s also the problem of retaliation. The big tech companies are a huge target for Europe or Asia to aim at – and governments have been looking for an excuse for a while.

Following the initial market reaction on Thursday, a key driver of the further move down on Friday was China’s announcing an increase of tariff rate on all US imports by 34%. Chinese and Hong Kong markets were closed on Friday and so part of the movement this morning is a case of “catch up” from the week before.

When shocks like this hit the system, it can be difficult to accurately predict their effects. IMF model estimates a 20% US tariff hike, with retaliation from China and the Euro area, which could reduce US GDP by 2% and global GDP by 1%. Clearly tariffs are also inflationary globally in the first order, but it is likely the impact on the US will be even more pronounced given the impact on the dollar – a depreciating currency increases the costs of imports even before retaliatory action. Much of the dollar weakening is on the expectation that the Federal Reserve will step in and bring forward any cut in rates to support the economy and lower interest rates make the dollar less attractive. The longer-term inflation story is less clear, as lower growth reduces longer-term inflation impacts of the tariffs.

Regardless of the eventual outcome from negotiations/trade conflict, it’s this uncertainty which will itself be a drag on economic growth around the world. While it’s unlikely to be as painful for the global economy as Covid-19, or the Financial Crisis, tariffs knock confidence.

Our starting point for 7IM portfolios is our strategic asset allocation. Our approach here diversifies equity content away from a cap-weighted, US-centric approach, which reduces our US equity weight versus others. Tactically, our models have been neutral on any over or underweight to equities, which we reduced slightly on Thursday last week in funds. We have retained a modest overweight in bonds for lower risk portfolios, which we also reduced very slightly within funds on Thursday. Our portfolios have a large number of diversifying assets. Bonds provided portfolios with defensive protection last week and our alternatives portfolio continues to add positively to portfolio returns this year.

When responding to news, our investment process focuses on a data-driven approach to decision making. There will no doubt be continued uncertainty on what Trump will or won’t reverse when it comes to tariffs, as well as how others will react. Instead of trying to predict any actions here, we will continue to monitor the impact on the data, shifting positioning accordingly, safe in the knowledge our starting point for portfolios emphasises diversification. Process-driven actions like rebalancing will ensure we keep client portfolios in line with our latest thinking.