Transatlantic Reversal?

Uncertainty hurts everybody

Trade uncertainty will remain high for months, with an immediate price to pay in terms of growth, both for the targets of the new tariffs and for the US itself, which will materialise before the “real effects” transiting through prices. Using estimates from 2018-2019, uncertainty alone could cost 2 to 4% of US business capex. 

On the consumer side, Americans continue to be more depressed than what the “objective” state of the economy would suggest. This was true under Biden and remains true now. The post-election rebound in confidence was short-lived. We suspect the constant bombardment of news on tariffs is not helping. Sentiment matters: even when controlling for “hard” variables such as purchasing power or the unemployment rate, consumer confidence has a measurable impact on private consumption. It is unlikely to be powerful enough, at this stage, to precipitate the US into recession, but combined with lower equity prices and wait-and-see on capex, the significant US growth slowdown which we expected for 2026 could materialise faster.

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Of course, trade uncertainty is another headwind for Europe. Still, in Germany and France, the source of the significant rise in overall economic policy uncertainty pre-dates trade war 2.0 and is more domestic (doubts on the growth model in Germany, political instability in France). The confirmation of Germany’s new government success in decisively shifting the fiscal stance for the next 10 years, and in France the return of clearer political leadership in a context when defence and foreign affairs dominate, could offset some of the external headwinds.

Still, the sequence remains problematic: the tariffs are for today, defence spending is for tomorrow.

Markets anticipate huge political challenges ahead

Geopolitics is in flux, and it is too early to gauge whether there will be a sufficient public mandate for the hard choices ahead, especially if they mean increased taxation, higher interest rates, and reduced spending on welfare. Politicians are tasked with making the argument that to preserve the democratic model over the long term, defending it against escalating threats today is unavoidable. How this plays out is important for investors. If Germany’s plan is really a game-changer, as some commentators have argued, then new investment opportunities will open for investors. Spending on European companies across the whole defence and security supply chain will increase. Again, markets have started to front run this with European equities significantly outperforming the US market since the start of 2025.

Trumponomics not being rewarded

Just over two months have passed since Donald Trump’s inauguration, and a lot has already changed in terms of US policy, much of which has global implications. Tariffs will mean higher inflation and lower growth. The shift in geopolitical alliances will mean increased public spending on national defence in Europe and elsewhere. Globalisation as a theme was dealt a blow during the pandemic; US exceptionalism as a theme is starting to be tarnished by US policy making. This means businesses and investors need to adapt their own strategies. Recent data and surveys, as well as anecdotal evidence, all suggest more US companies are worried about the impact of tariffs on their input costs and whether they will be able to pass on higher prices. Consumers fear higher inflation, as highlighted in the recent University of Michigan consumer survey, and this comes despite Washington’s argument that American consumers will not pay the tariffs. Hard data has started to soften and earnings expectations for listed companies are moving down. The real bear case for the US is that uncertainty affects spending which is reflected in further stock market losses. In turn these will impact personal financial wealth, and spending will be cut further. A recession can quickly unfold under such circumstances. Such a scenario would see the Federal Reserve (Fed) cutting interest rates by substantially more than is currently priced in.

Possible shifts in global flows

Other investment themes which could flow from the direction of current political and policy events include shifts in global allocation of equity and fixed income portfolios. For reasons already stated, the outlook for US equities has dimmed. In 2024, large-cap technology stocks helped deliver a 20% increase in the S&P500. That looks unlikely to be repeated this year as multiples on technology stocks have been cut. The emergence of competition in the field of artificial intelligence (AI) developments is playing a role here, but so is policy uncertainty. We still have a positive view on technology and AI as long-term investment themes, but there is no guarantee that only US companies will lead the way in terms of applications and democratisation of their use.

Foreign flows into US equities have been huge in recent years. Foreigners own almost 18% by value of listed corporate equities, according to the Fed’s Flow of Funds data. If the “US exceptionalism” case for being overweight the US becomes tarnished, some of that money could reverse, or at the very least, net inflows could weaken. That suggests lower multiple premiums on US stocks relative to the rest of the world going forward. Keep in mind that the US has a large current account deficit which requires capital from the rest of the world to go into listed and private equity, Treasury bonds, corporate credit markets and real estate. A weaker dollar is inevitable if the rest of the world is less enthusiastic about owning US assets.

Europe should be a beneficiary of these shifts in global asset allocation. Higher public borrowing will change the savings and investment balance in the region, resulting in less capital outflows and more domestic investment. Part of that will be absorbed by bond markets through increased debt issuance. Improved fiscal stability in southern Europe should help those economies manage higher borrowing costs although France may face more challenges. Mutualisation of spending to boost Europe will help. For credit markets, closer financial integration seems inevitable as deeper capital markets will be needed to facilitate increased investment. This should benefit financials.

Equity markets are on the move in Europe. Defence and related stocks have performed well. Investors are shifting allocations to those companies and making the argument that “there is no sustainability without security”. There will be broader growth impulses too, as Germany’s plan is to increase spending not only on defence but on transport, energy, technology, and telecommunications. The industrial-military complex in Europe will be boosted. In the US, technology leadership in recent decades has been based on the US having a higher share of defence spending. There will be multiplier effects in terms of GDP spending, but also, potentially, in terms of productivity.

For now, Europe has better valuations than the US, and decent earnings growth that should be sustained in years to come, as well as a policy direction that is less unpredictable than in the US. The euro may not become the global reserve currency, but Europe can benefit from the US losing a little of its “exorbitant privileges”.