Weighing up 'Liberation Day'

Pitching ‘Liberation Day’ at the start of April has shone a light on the stock market’s assessment of Donald Trump’s reset of global trade in the first three months of the year. The numbers are in for the first quarter, and they are unambiguous. Investors think tariffs are bad for growth and inflation, and they believe they will be at least as damaging to the country levying them as they are for the apparent targets.

The January to March quarter was a tale of two halves, with global shares peaking in the middle of February. By the end of the three-month period, shares were modestly lower overall as the last two years’ bull run hit the buffers. That, however, only told half the story. It disguised a wide dispersion of returns, with Japan 10 per cent down on the quarter and Wall Street 5 per cent lower but Europe and the UK 5 per cent to the good and Hong Kong’s Hang Seng index 16 per cent higher than it started the year.

For the US, it was the worst quarter since the low point of the interest-rate fuelled bear market in 2022. From the mid-February high point, the S&P 500 is down by 10 per cent, led by the Magnificent Seven technology stocks, which have layered concerns about the efficacy of artificial intelligence (AI) spending onto the growth and inflation fears impacting the rest of the economy. The tech-heavy Nasdaq index fell more than 10 per cent over the quarter and is 14 per cent off its February high.

Investors have adopted a ‘sell first, think later’ approach to this week’s tariff announcements, which were well-flagged but uncertain - what Donald Rumsfeld would have called known unknowns. Even if the scale and reach of the measures has been unclear, the direction of travel has been easier to see. At the weekend, Goldman Sachs raised its inflation forecast, increased the chance of a US recession from 20 per cent to 35 per cent and warned that it was too soon to call the bottom for US stocks.

What is notably different about this latest market wobble, compared to the broad-based 2022 sell-off, is the fact that there have been places for investors to hide. The rethink of America’s AI dominance was in part triggered by China’s demonstration, via DeepSeek, that it retains the ability to innovate and compete with the US. Foreign investors generally play the China story via Hong Kong and that has helped the Hang Seng to the top of the leaderboard year to date.

The other unexpected winners in the first quarter were European stock markets. In some ways Donald Trump has been a gift to the region, providing a wake-up call to countries that have for too long enjoyed the comfort blanket of US security guarantees and cheap Russian energy. Having to stand on our own two feet may not be such a bad thing from the perspective of economic growth. You could argue that Trump has given China a similar boost - the threat of tariffs has galvanised Beijing into stimulating domestic consumption.

While these impacts are clear in the performance of the market indices, it is at the individual stock level that the effect is most obvious. The dispersion of returns over the past three months between the winners and losers is breathtaking. An investor who looked at Elon Musk’s rise to prominence in the Trump White House at the start of the year and invested $100 in Tesla shares would have $64 today. The same investor who held their nose and backed Chinese tech and consumption would have seen a $100 investment in Alibaba grow to $155 today. If they had taken a punt on German defence spending, their $100 in Rheinmetall has more than doubled to $215.

The main takeaway from the performance numbers for the first quarter is the importance of diversification. Few investors called it right at the start of the year, when most were still singing along to American Exceptionalism. Trying to pick the winners and losers in the year to date has been beyond the brightest. For the rest of us, spreading our eggs around a range of baskets has never looked such a good idea.

Timing the swings has been no easier than picking the winners and avoiding the duds. And as we weigh up ‘Liberation Day’ and set a course for the second quarter, big bets continue to look risky. The US faces an ongoing battle between reflation - fuelled by fiscal and monetary easing - and stagflation. But while the immediate outlook for America is unclear, Trump’s endgame of an improved trade balance and more domestic manufacturing could keep US market leadership going in the longer term.

It is very easy to get carried away by market noise, to become over-pessimistic about the losers and too bullish on the winners. Just as betting against the S&P is generally considered an unwise long-term strategy, the market’s enthusiasm for Europe today is starting to ring alarm bells. Investors have welcomed the promise of higher government spending, but it is not clear how that filters through into higher earnings much beyond the obvious defence and infrastructure beneficiaries. The region’s demographic and productivity challenges remain.

If we have learned anything from the past three months, it is that easy narratives are likely to be the enemy of good investment decisions. If anyone was predicting three months ago that the Hang Seng would outperform Wall Street by 20 percentage points, gold would hit a string of new highs and Treasury yields would fall to just over 4 per cent, I missed the memo. After a wobbly first quarter, and as we weigh up what looks like a new world order, I’m even less inclined to make bold calls.

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Please note that the views expressed in this article are my own.