A measured response to intemperate actions

The shock and awe of President Donald Trump’s tariffs has proved greater than even the most anxious forecasters predicted. His imposition of what he terms ‘reciprocal’ tariffs amount to action that will meaningfully slow global trade.

The basis for his calculations appears so crude that frankly nobody thought it’s possible that they would be used by an institution as sophisticated as the United States (US) government. The assumption appears to be that every country running a deficit to the US must be manipulating its trade through tariffs. This ignores two basic issues. Firstly, if every country was in surplus to the US as President Trump appears to want, then how would anyone have any money to buy his stuff? Secondly, is he really saying that the reason that there is a deficit in, for example, the sale of bananas from Latin America to the US is as a result of trade manipulation and tariffs? Because, well, bananas mostly don’t grow in the US.

Until yesterday the market held to two key hopes around Trump. Firstly, that the tariff talk may simply be a negotiating ploy designed to extract deals, and secondly that he would be tempered by the reaction of the stock market, as he was in his first term.

Both these hopes appear misplaced. Of crucial importance here is that many have comforted themselves with the idea that an unpredictable president could reverse his actions quickly. The challenge though is that the genie is now out of the bottle. Whilst his actions may be enacted by dictate, the responses that now come from more cumbersome institutions such as the European Union and China cannot be reversed anywhere near as quickly. You can start a trade war with the EU in 15 minutes, but you probably can’t end one in much less than two years.

The question then is how do we frame a response to such action and how does it impact portfolios?

It is right to acknowledge that portfolios had already been to some extent ‘turned into’ this corner through the addition of more defensive quality-focused equities at the end of last year.

Secondly, it would be wrong in our view to simply assume that ‘selling the US’ is the answer to this challenge. The tariffs are likely to produce a slowdown in economic activity and an increase in inflation. Such an acceleration of a cyclical downturn will leave few places to hide and it is actually counter-intuitive and out of step with history to assume that leaving the world’s strongest economy and strongest currency at that moment in time will necessarily prove a simple protective move.

There is however much we can do. It must be acknowledged that over the past weeks the chance of a recession has grown significantly. Many global banks placed this risk at around 35-40% ahead of the 2 April announcements. We can now raise that probability in our own estimates closer to 50-50. Certainly, it seems inevitable there will be a meaningful hit to US economic activity over 2025 that could well pull the growth rate below 1% and perilously close to contraction. A real contraction will likely be seen in personal consumption just as the Fed’s most closely watched measure of inflation, PCE (Price Index Annual Change), moves close to 4%. This puts the central bank in a very difficult bind.

Our response will be built around our factor-based process. We will seek to adjust our overall equity exposure towards lower volatility and lower beta areas of the market. This strikes the right balance between over-reacting and selling shares after a drawdown of 10% whilst also acting to protect portfolios.

We believe our investors expect and understand that there will be pullbacks commensurate to the level of risk they are taking in their portfolio and that to some extent riding out these challenges is part of the deal when investing for growth.

Yet there are things we can do to ensure that they retain their participation in the ultimate recovery that will eventually come (no doubt at an unpredictable moment) whilst also insulating and protecting portfolios.

One source of lower volatility exposure in portfolios is the FTSE 100. It will be part of the answer, but we are pursuing broader more global paths to lowering the volatility alongside this.

It is worth stepping back at inflection points such as this and remembering why stock markets do eventually recover from shocks they experience. When a recession becomes a strong possibility, markets fall sharply. They do this even though the value of shares is not based solely on their earnings over the coming say 2-3 years in which they would be affected by this recession. In reality, their price is based on their earnings over the next decade and for high quality companies over even longer periods. Therefore, to some extent a sharp stock market sell-off in the face of a recession is invariably an over-reaction, fueled by behavioural bias that leads us to catastrophise when faced with unfamiliar threats. Therefore, in time, markets do recover.

This means that our job at moments like this is never solely to protect portfolios from volatility but also to protect our long-term investors from missing out on long-term recovery. Striking the right balance on this is an art not a science and one that we are focusing on each day as we navigate this complex economic situation.

In the coming days we will be providing a more detailed analysis of the changes that will be made to portfolios in our April re-balance and our whole team is on hand throughout this period to discuss our plans and the economic situations with you.