KMD Economic & Market Update – Spring 2025

In the midst of chaos..

President Trump’s announcements on tariffs have not been well received by financial markets. “Liberation day” proved anything but for stock markets as shares fell sharply on US plans to put punitive tariffs on those who are taking advantage of “our generosity” by running trade surpluses with the US.

Since then, there has been a certain amount of backtracking from the US administration with various exemptions being announced and a scaling back on the level and number of tariffs. The focus now seems to be on China (which faces steep 145% tariffs) whilst the global 10% minimum tariff and 25% tariffs on cars and steel remain in place for everyone else. However, the stance on China has also softened somewhat this week.

It may be tempting to attribute the President’s change of heart to the realisation that the cost of his next iPhone would double to $2000, however the move owed much to the breadth of selling of US assets. Not just equities, but bonds and the USD fell in value. Such a combination is a classic sign of investors losing confidence and is more often associated with capital flight from emerging economies.

Hence, the sell-off in US Treasuries seems to have particularly rattled the administration as it indicated that the US was losing its safe haven status. The bond market continues to exert its power by virtue of the fact it sets the interest rate paid by the US government on its not inconsiderable debt.

President Trump is only offering a temporary 90 day reprieve on tariffs and, as we have seen much can change. It is hard to see the President rowing back completely, tariffs are widely supported by his base who might be described as the losers from globalisation as they have seen their jobs exported abroad.

To put recent events in perspective here are four points.

First, at the time of writing the US equity market, the S&P500, is still up more than 4% over the past year. The recent falls make all the current headlines, but for long term investors they have reduced the gains after a stellar year in 2024. The UK FTSE-100 is up nearly 6% on the same basis.

What we have seen is an unwinding of a remarkable rally which was based on a misplaced view of what Trump would do in his second term. It is not comfortable, but markets now recognise that tariffs are more than a bargaining strategy.

Second, before the tariff announcements the macro news had been good. Growth in corporate profits continued and economic activity had been firming in economies such as the UK. Growth prospects in Europe had improved as Germany lifted its debt brake and governments across the continent geared up for more spending on defence and infrastructure.

The outlook may now be more uncertain and growth is likely to be weaker as trade gets disrupted, but stockmarkets have become cheaper. Profit ratios and dividend yields are now more attractive, indicating that markets have priced in much of the bad news.

Third, there is scope for central banks to ease policy. Underpinning this is the continued improvement in inflation. Now running at 2.6% in the UK, annual CPI inflation has been lower than expected in recent months. It’s a similar story in the US where inflation dropped to 2.4% last month. Lower oil prices have helped, but price inflation particularly for goods has eased considerably. There are still challenges as tariffs will add to prices in the US and wage costs continue to rise, particularly here in the UK. Nonetheless, lower inflation gives the central banks scope to ease policy as activity in the economy slows in response to the shocks emanating from Washington.

Fourth, as the saying goes “in the midst of chaos, there is also opportunity”. Companies are having to rethink their supply chains in the wake of the tariffs, a process that will create winners as well as losers as new business is created. This should increase the pay-off for company research and stock-picking. For example, alongside the tariffs the desire to be more independent of the US in areas such as defence will create opportunities for domestic companies.

At the macro level, there is now even greater pressure to rely less on export growth and provide stimulus to boost domestic demand. As mentioned, Germany has now lifted its self-imposed debt brake, opening the path to greater public spending. China can also do more to boost domestic demand. Such responses by businesses and policymakers will create regional, sector and stock level opportunities for investors.