Tariffs, Crashing Equities, Recession? – What On Earth Is Going On?

I’ve spent much of the past quarter of the year zigzagging across Europe and the US, cursing Vladimir Lenin as I went. He is reputed to have coined the phrase ‘there are decades where nothing happens; and there are weeks where decades happen’, which in turn has been repeated back to me wherever I went. I shouldn’t be too grumpy though, because the ‘Levelling’ is now playing out at high speed.

Since Donald Trump entered the White House for the second time, so much has happened that I want to use this note – coming at the end of the first quarter of the year, to discern new emerging trends from noise, across four different domains.

Bonfire of Diplomacy

The first emerging trend can be characterised by the image of the bonfire of diplomatic relationships, which started at the Munich Security Conference and has continued apace since then. Gone is the cosy globalised world of Bill Clinton and even George W Bush, where America was a benevolent colossus, keeping the peace, spurring prosperity, and putting out financial fires. In my travels, I found myself recommending investors to read Adam Smith on the topic of mercantilist economic behaviour, Palmerston on foreign policy (‘we have no allies, only interests’) and that they acquaint themselves with Peter Hopkirk’s ‘Great Game’.

In brief, my sense is that the Trump team wants the US to become a hyper-charged nation-state, rather than the hyperpower that it was. Whilst there is much consternation in Europe and parts of Asia about this, I do not yet detect widespread disapproval from many Americans I speak with.

Aux Armes!

A consequence of this is Defence Union in Europe. Echoing the French president, we are all ‘strategic autonomists’ now. Many of the urgent phases in this journey are already being undertaken – the publication of the pragmatic EU White Paper on defence, the EU’s new Eur 800bn loan facility for defence spending and critically Germany’s decision to loosen the debt brake provision on defence spending.

Some intelligence agencies (Denmark and Finland for instance) estimate that in the event of a peace deal in Ukraine, Russia would be ready to launch a war on a European country in two years’ time, and in five years could have rebuilt its military to a level that it could consider a war against the EU. The Nordics, Baltic states, Poland, Germany, France and of course the UK appear to buy into the seriousness of this threat, but there are notable defence laggards, namely Spain and Ireland.

Neither does it seem that there is sufficient urgency on the security front – my experience was that Russians were omni-present in the cafes of Vienna and arguably not enough is being done to sanction governments that are apologists for Moscow (i.e. Hungary).

The one aspect of the European revival story I need to be convinced on is the cultivation of a pro-growth socio-economic outlook in countries like France, and specifically, of the need to instigate capital markets union (CMU), which whilst not a vote winner for politicians, is a necessary development for a stronger European economy.

Oops – muscle not fat

The economic policy of the Trump administration is difficult to decipher through the noise of chainsaws and crashing of markets. At its core, I detect a nihilistic fiscal conservatism – a desire to shrink the fiscal deficit and by extension the enormous debt load that means that the USA pays out far more in interest payments What is causing dismay is that the policies enacted to temper the growth of the economy are cutting economic muscle not fat. Universities, researchers, and essential parts of the science establishment are being undercut, and socially it is disturbing to see veterans bearing the brunt of DOGE. More importantly, the shredding of the rule of law and politicising of justice have never helped any economy (Turkey is the case in point).

Whilst much of the media coverage of the Trump economic policies has focused on the harm caused by tariffs (they should be applied in small, not massive doses), not enough attention is given to how corporations will react to policy uncertainty. In a recent note I described Avinash Dixit’s theory of how macro uncertainty causes companies to ‘wait and see’. In that respect the forthcoming earnings reporting season and corporate action calendar bear close watching.

Exceptionally expensive

Allied to the outlook for the US economy is a growing realisation on the part of investors that American assets (the dollar, stocks and corporate bonds) are very expensive, and dominate portfolios. In this regard, the Liberation Day announcement should worry investors. One is the sheer carelessness and apparent incompetence of the tariff policy – it has exposed the lack of analytical capacity in the administration and a lack of concern for the economy. Trust in the administration is draining.

The other is that it has reminded investors of their exposure to US assets. At this stage, the majority of asset allocators in the investment industry still appear content to persist with very conventional portfolio structures, that are arguably not configured for a rapidly changing world.

One thought experiment I perform with investors is to show them how portfolios have changed through time. For example, in 1900 nearly 50% of stocks were railway companies, and the UK made up 25% of the world stock market (close to 3% now). Today the US weighs in at close to 68% of world equities, and my sense is that with the dollar still relatively strong, allocators should start to sell American exceptionalism in the sense that it is impounded in stock valuations.

A final lesson from Lenin might help them. For much of the period of the first wave of globalisation (1870 to 1900) Russian equities comfortably outperformed American companies. But, having been shut for much of the First World War, the Russian exchange opened again in January 1917. Then came the Revolution and the market dropped to zero and shut for 75 years.

Political risk matters!