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The markets are in a very glass half full mood at the moment. As our client portfolios are benefitting from this I am hardly complaining. And the moves we made in the summer in anticipation of Trump 2.0 –which included reducing our European equity exposure and taking some profits in fixed income – have helped in the last few weeks. Still, sometimes there seems to be a disconnect between economic reality and the market reaction. The most obvious example to me today is that Trump’s headline economic policy, namely tariffs, should mean lower US growth and higher inflation next year. And yet US markets are up strongly post-election? Markets did not like lower growth and higher inflation in 2022! It’s true that Chinese and European equity markets – the regions most effected negatively by Trump’s tariffs – are down since November 5th but the reality is these moves are pretty small and Europe at least has been rallying again recently.
How to explain this? Let’s start with the fact that a tariff is a tax rise. Consumers have less money (after tax) to spend on other things and there is also some uncertainty from companies about how and when tariffs will be implemented which could hit investment in the short term. Putting this together means US growth should indeed be a bit lower next year than you would otherwise expect. Goldman Sachs estimate the impact here:
And their base case hit is obviously larger than this for the countries directly hit by the tariffs: they estimate the 2025 hit to China at -0.7% for example. And this is is just the impact of the base case tariff package which would (in summary) mean upping Chinese tariffs to 60% on selected industries and increasing European auto tariffs. There is of course a risk case where Trump goes big on the tariffs and potentially imposes a 10% surcharge on all imports. The impact of this risk case on US inflation for example would be large:
So how to explain all this US post-election euphoria? First, on inflation, it’s important to remember that tariffs mean a one off increase in the price level (and hence inflation) rather than anything more long term. By 2026, there should be no tariff effect on inflation at all and hence the theoretically correct response from a central banker should be (pretty much) to look through all this and ignore them. That said, it will certainly now be harder to cut interest rates in 2025. I think part of the recent rise we have seen in bond yields reflects this reality.
Secondly, there is of course the other part of the Trump policy agenda. Some of the money raised from tariffs will probably used for tax cuts for US companies and individuals. And the focus on deregulation is of course market friendly to the extent they can actually pull it off. I am therefore very interested to see how far they get with this effort. If they can meaningfully restructure the government machine that would also give me some hope that the rest of the world might follow suit.
Finally, there was of course the usual post-election relief rally. A clear win for the (more business friendly) Republicans was a better result in the short term than a close, contested result. That said, and as I said at the start, this does feel all quite glass half full. If Trump does indeed bring in a 10% surcharge on all imports than I think the market reaction will not nearly be as friendly as it has been so far. At the end of 2022, markets were down a lot and there were plenty of reasons to be gloomy wherever you looked. That turned out to be a great time to buy! Today, we have recovered those losses and more and the economic outlook – even with Trump – is much more friendly. Still, I wouldn’t say I am any more relaxed today than I was back in 2022. I hope that caution proves to be as wrong today as it did back then! As ever, we shall see.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
