President Donald Trump’s imposition of 25% tariffs on US imports from Canada and Mexico on 4 March initially shook markets. The turmoil quickly passed, however, after Germany announced a big stimulus package. Germany equities and Bund yields surged.
Listen to the article
At least some of the proposed tariffs have since been delayed – again. Alongside the tariff tumult, weak US economic data were a key driver of poor equity market returns, and arguably the more important factor.
Some numbers improved, however, particularly judging from the purchasing manager indices (PMI). The initial services sector PMI for the US was 49.7, marking a steep drop from 52.9 in January.
While slightly slower activity would not have been such a surprise, actual contraction (signified by a number below 50) was. The recently released final reading was rather better at 51.0. It was still lower than January’s, but remained in expansionary territory.
If subsequent data for the labour market and retail sales also show a stabilisation, US equity markets could rebound quickly.
Growth is not the only story
If growth were slowing alongside slower inflation, investors might be less concerned. The problem is: inflation has heated up over the last several months. This turnaround likely explains the recent declines in consumer sentiment, rather than any worries over proposed tariffs.
Many consumers still have painful memories of high inflation in 2021 and 2022 and react negatively to any resurgence. However, the inflationary impact of the latest tariffs may not be dramatic. A recent study by the Atlanta Fed estimated that “tariff[s] … could raise consumer prices on everyday retail purchases … covering about a quarter of the total consumption basket, by 0.81 percent to 1.63 percent,” so 0.2% to 0.4% for the broader index.
The short-term drag on growth from tariffs on imports should be considered in the context of what should still be positive medium-term factors such as deregulation and increased mergers and acquisitions.
Initial investor optimism after the US election was partly premised on an investment boom. Whether that will be enough to sustain a high rate of economic growth remains to be seen.
Several companies are planning to invest significant sums in the US, particularly in artificial intelligence (AI) related industries. At the same time, previously planned (green) investments linked to the Inflation Reduction Act (IRA) have been dropped.
The recent tariff announcement provided a test case of the notion that even if in aggregate, US tariffs are negative for global growth, they are worse for US trading partners than for the US. Returns on the day of the announcement showed US equities declining, but still outperforming most other markets (see Exhibit 1).
Within the US, the tech-heavy NASDAQ index (and to a lesser degree small-cap stocks) outperformed the S&P 500, highlighting the relative immunity of tech stocks from tariffs and domestic growth worries.
Earnings signals
As the latest US earnings reporting season wraps up, there are warnings signs.
While the results were broadly positive, particularly earnings surprises, the share of companies providing positive guidance fell sharply. Typically, only 24% of companies raise their guidance for profits.
For the quarter just completed, the rate fell from 30% to just 21%, not coincidentally soon after the DeepSeek AI announcement. Nonetheless, this pattern is similar to what occurred in the year-ago quarter as there is some seasonality at play (see Exhibit 2).
German stimulus
The dramatic change in the geopolitical landscape since President Trump’s inauguration has led European politicians to take previously unthinkable measures. The EU plans to significantly increase defence spending, while Germany intends to ease off on its debt brake to invest large sums in infrastructure and defence. This has led to European equities outperforming US equities so far this year, in contrast to most investors’ expectations.
The strong returns for European equities have nonetheless been driven primarily by financials (see Exhibit 3). The industrials sector has done well thanks to aerospace & defence, as well as the prospect for lower energy prices and reconstruction in the event of a peace agreement between Russia and Ukraine.
The question for investors is how much further this strong European equity performance can go. The outperformance of financials is unlikely to be sustained, in our view. While Europe (and Germany in particular) plan to increase spending, it is unclear how much the economy can absorb. Most stocks in the MSCI World Aerospace & Defence index are American, so any significant increase in spending will likely flow to US companies.
There is also a concern about financing. Germany is in a privileged position thanks to its low debt-to-GDP ratio, but the rest of Europe has little scope to finance additional spending by borrowing, and any move to curtail welfare spending will likely be unpopular. Finally, a peace agreement for Ukraine may curb some of the enthusiasm for much larger defence outlays.
Disclaimer
Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
