Navigating global equity markets amid the tariff wars

So Trump has temporarily stepped back from the ledge issuing a 90-day pause on reciprocal tariffs to allow for negotiations to take place. So the 10% universal tariff remains. Unfortunately, that still includes taxing the poor Penguins living on McDonald Island, coupled with the eye-watering 145% tariff on China. What are you observing? Is this part of some master negotiating plan?

Look, I think the 90-day pause, that came because the moves in the bond market were just too much for the Trump administration to bear. It's very unusual for the US equity market fall at the same time bond prices fall and the US dollar sells up. Now we're kind of still in this wait and see mode, but we expect the uncertainty to remain elevated. A 10% universal plus 145% on China tariff, I mean, that still implies a weighted average global tariff off 30%. That's from 2.5% previously. That's the highest tariff in US in over 100, and the market's only just now beginning to price in or give the US a much higher risk premium. Now, the final act, it's still yet to be written. Outside of China, negotiations appear to be progressing in a fairly positive direction. So we just have to wait and see.

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In terms of the US versus China, both Presidents, Trump and Xi seem unwilling to back down. How damaging is a 145% tariff on China's economy?

You have to remember I mean, the US represents 15% of China's direct exports, but we know China's supply chain extends beyond its own borders with indirect exports passing through other parts of Asia, Latin America, and Mexico before finally ending the journey in the US. Now we've had a go analyzing these trade flows, and then our work shows that there is tangible evidence that trade passes from China through Vietnam to the US and that's actually accelerated since Trump's first term. But the surprisingly very little evidence of such flow through other parts of Asia or Latin America.

Now, our best estimates is just kind of maybe that close to 20% of China's exports are actually destined to the US, which accounts for about 3.4% of China's GDP. Now, that's still a lot less than most of the US's trading partners. Tariffs, they'll have a huge impact on the profitability of certain Chinese companies, but I don't think it's going to cause a widespread recession, not in China. 3.4% of GDP is equivalent to around 6% of China's domestic consumption spending. So it's well within the power of the Chinese Communist Party capacity to replace a reasonable amount of any activity, lost trade with domestic stimulus.

Does China have any leverage in these negotiations?

I think they do. I mean, they've added their own retaliatory tariff of 125%. They're now restricting the export of rare earths, which is going to challenge the US's ability to reassure supply chains. And for some context, China accounts for 70% of rare earth extraction and 90% of processing. The US's dependence saw China's rare earths exempt from additional tariffs in the first place. So China has other levers at its disposal. I mean, they could depreciate their currency. And remember that China is the second-largest holder of US government bonds after Japan. The relationship between the US and China, it's increasingly dramatic and in tensions are escalating, but there are also counterbalancing realities. I think the US's final tariff on electronic imports, that could be really telling. These products account for almost quarter of China's exports to the US, and it's going to be challenging for the US to replace this supply chain. In terms of the US and China, we think a deal can be made such that both sites can claim victory. If not, it's difficult to see how a global recession can be avoided.

Given most US trade is in intermediate goods, it's hard to see how tariffs won't disrupt supply chains or be inflationary. Can you break down what this could mean for inflation? What these tariffs could mean?

Well US, we've done some numbers in this and a weighted average global tariff of roughly 30%, that could add almost 2.3% to core PC inflation, which is currently running at about 2.8%. So to state the obvious, this is going to create a significant demand growth shock. A weaker currency in the face of tariffs, that's also going to feed into inflation more so that was doing than what was experienced during the first round of Trump tariffs in 2017 where the dollar remained stronger.

So you've just called out a potential demand shock, but before tariffs even hit, the US consumer and business confidence was already weakening. And this was driven by policy uncertainty. So where to from here for the US?

The soft data coming out of the US, that was starting to deteriorate before tariffs were announced. And what I'm referring to here is weak business and consumer confidence surveys. And admittedly, this data was deteriorating against still strong reported economic data. So we have been getting some mixed signals, but let's bring it back down to first principles. The US is a consumption-driven economy. Personal consumption accounts for 70% of US GDP. So the most important drivers of real economic growth are wages and savings, both accumulated excess savings and the savings rate. Now if we start with wages. Real wages, they're still growing at around 2.5%. Now that's slowed from the peak of 4% around a year ago, but still well above the 25-year average of around 1% per [inaudible 00:06:31]. Now the labor market, whilst it looks pretty resilient, job ads have substantially fallen. So the heat has come out of what was a very tight market.

Monitoring trends in the labor market, it's critical, but in this sort of environment, real wages can fall back to the long-term average of circa 1%. In terms of savings, the current savings rate has been below the long-term average for the last few years, and we kind of expect this to normalize for a few reasons. The excess savings that we built up during Covid, they've been exhausted and the soft data indicates households are increasingly concerned about job security, and we've seen a fair amount of wealth destruction in retail equity portfolios if the equity market doesn't recover quickly. So if wage growth and the savings rate both normalize trends levels, the US economy will slow, and that's without factoring in any demand shock from tariffs. It's going to take time for the full impact of tariffs to be fully understood.

If uncertainty around tariffs and the unpredictability of the Trump administration, that it persists, we are going to see weaker corporate investment. We're going to see a looser labor market and an even higher savings rate from nervous households. And then add to this, the risks around the potential of DOGE spending cuts. But today, tariffs imply revenue of roughly 3% of GDP, which all else equal, can create some headroom for additional tax cuts on top of extending the Trump 1.0 tax cuts. And this can be used to reduce the US's fiscal deficit from six naps in a GDP, but in reality, there's going to be a cost tariff revenue as a weaker economy equates to lower tax receipts. But my point here is that there are puts and takes from this tariff policy.

Okay, so based on what you've just said, pressure on the US economy can intensify from any tariff driven demand and supply shocks. Do you think this is being adequately priced by the market?

I think that's still very unclear. I think the Wall Street meets tech bro's narrative around Trump being good for business, that's definitely faded. But whether or not the market is adequately pricing, potential demand is supply shocks from tariffs and potentially tighter immigration policies, that remains to be seen. If economic growth comes under pressure, high inflation from a tariff-induced supply shock, that actually may limit the Fed's ability to respond. And there is real risk that Trump's shock therapy approach to re-industrialization is just too much for the US or the global economy to bear. And the US stumbles into stagflation or a Covid crisis. Starting multiple for US equities, it's still 21 times earnings, and that's before tariffs have factored into bottom-up forecasts. As for prices, they're not only to be impacted by EPS downgrades, but also a higher discount rate, like to compensate for Trump's, his imperial court-style approach to policy, which suggests that US volatility is likely to remain elevated. What we've seen displayed before, we've seen in China where policy became unpredictable and we saw that with President Xi's common prosperity program.

You mentioned earlier how tariffs could spur China to stimulate and how Trump's aggressive policies have already galvanized Europe into spending more. Now, tariffs aren't positive for the global economy, but can Trump protectionism ironically lead to benefits in other regions?

I think we could see relative winners. Any tariffs will undoubtedly be a headwind to the European economy, and a recession in the US would drag down the region. And while Germany, they have announced a defense infrastructure spending program that equates to a fiscal boost of about 3% of GDP and probably an additional 2% to Germany's GDP growth. Fiscal stimulus will take time to flow through to the economy. That said, the change in attitude in Europe is important. And on top of this, the ECB is actually cutting rates. And likewise with China, tariffs may be the catalyst that finally forces Beijing to rebalance its economy.

And in terms of our global portfolios, our exposures to China, they remain purely domestic. We are focused on higher quality consumer businesses, including stimulus beneficiaries, platform companies that are going to be AI winners and some more cyclical exposures to property. I think another region to watch is Latin America. Mexico is firmly at the negotiating table and the reality is low-end manufacturing isn't going to come back to the US but it could come back to Mexico or South America. And Brazil is, yeah, they're one of the few countries out at the firing line as it has a trade deficit with the US. If the previous trade war history repeats, we could actually see China shift demand for agricultural products from the US to Brazil further supporting its domestic economy.

Final question, Rameez. The moving equities this year represents a real break from the trend that we've seen over the last several years. The US is down around 6%, while Europe is up two and a half percent and China is up around 9% and all those indices measured in local currency terms, the MAG-7 is down 14%. Is the current broadening in the market sustainable?

I think we need to remember where we've come from. I mean the US has been exceptional due to both structural and cyclical forces. Now, the cumulative fiscal deficit in the US from 2016 to 2023, that was more than 50% of GDP versus 25% in Europe, 35% in China. Now that level of spending, it cannot continue at the same pace with government at 120% of GDP and it remains to be seen where DOGE actually lands in terms of cost cuts. And then when we think about Europe and China, they finally received the memo that fiscal stimulus is the cure to cyclical weakness. And the change in that fiscal impulse, it suggests that in the original shifts that we've seen, they can continue.

Now the days of US mega cap exceptionalism may also be waning. Sector shifts can also persist driven by fraud, infrastructure-led investment cycle, and evolution in AI. The arrival of deep seek type innovations, and there are going to be others demonstrate that the stakes on foundation model development are very, very high. And as new technology matures, value often shifts. As the cost of AI plummets, adoption is going to accelerate and value will likely shift from the hardware layer to the application layer, from the enablers to the adopters, and that means that there's going to be new winners.