Back
This year has been an example of why it can be good to be diversified. Many investors’ highest conviction sector at the start of the year (US equities) has underperformed year to date. Meanwhile some of the least loved equity markets (Europe, China) have bounced. Even with all the uncertainty around inflation and long term government deficit levels, bonds have made us a (small) amount of money. And we have been helped by some winners in our alternative assets (especially gold and some of our trust investments).
But I wish I could say I had a lot of conviction about where we go from here. I would hope 2nd April marks the highpoint for US tariffs and tariff announcements. Any concessions or deals after that date should (you would hope) take the tariff level down not up. But there is then the secondary effect of tariffs and the uncertainty they bring on business spending levels and investment. Partly for this reason US Q1 GDP estimates fell sharply at the start of the year. But recently they have been stabilising and even starting to rise again. There is no sign of a US recession yet in the hard data. As an example, here is the latest Atlanta GDPNow estimate (the dotted line is the right one). The next release is out today and I’d expect this line to shift up again:
The second interesting dynamic is that there was a woosh of optimism after Trump came in that he would be good for business and good for the US economy. But final tariff levels look to be a lot higher than people thought would be enacted at the time of the election. This, along with all the other standard Trump dramas, mean that we have seen much of this optimism evaporate. Here is a chart of US large cap equities (excluding the technology giants which are marching to their own AI driven drumbeat) relative to the rest of the world. You can see that the post-election US optimism has fully come out of the market.
This then leaves government spending cuts (via Musk’s DOGE initiative) and the large reduction we are already seeing in US immigration levels. Both of these are, in the short term at least, negative for growth. Less immigration should push wages up but lower government employment should push them down again. It is hard to estimate where we will end up here but the US (and UK) economy proved much more resilient than people initially thought to the shock of higher interest rates in 2022. My instincts are that we will see some resilience here too.
However, the big risk remains the size of the deficit the US is running today. Economic theory says to run surpluses in boom times and deficits in recessions. Below are the latest forecasts for the US deficit under the Trump administration and beyond: this means deficits remaining over 6% even with the economy staying strong. What happens in a recession?! Separately – for all the mortgage borrowers out there – it is hard to see interest rates falling by that much when government borrowing levels are expected to remain so high.
Which brings us to the UK and the struggles of the Labour government to come up with a credible budget plan. Rachel Reeves was helped this week by UK inflation numbers that came in a bit below expectations. But the £100bn of extra spending they have announced has pushed 10 year government bond yields back up to near their recent highs. As investors this of course means better returns on our fixed income investments. But as taxpayers we also have higher interest bills to pay. As an example, the US now pays more in interest on its debt than it does on its defense (the final chart below). When interest rates were near zero I was pretty relaxed about government debt levels and government debt servicing costs. That is not the world we live in today.
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.
