Turning point
Just a little over two months ago, “Liberation Day” caused a wave of panic, yet it is already history. Equity markets have returned to very close to their highs of February, volatility has declined to extremely low levels and investors are relatively indifferent to the various announcements from one or other party on trade tariffs. With the arrival of summer, markets now seem to be catching their breath, relieved to have escaped the worst but in wait-and-see mode after an impressive rally.
In many respects the present situation looks like a turning point. On the trade war front, things have ground to a halt after the de-escalation of recent months. We are still waiting on those imminent trade agreements promised each week by the US government. The closely scrutinised meeting between the US and China in London ultimately resulted in maintenance of the status quo, after two days of discussions. There has been no mention in recent weeks of the rise in trade tariffs on pharmaceutical products that was regularly cited in April and May. In contrast, tariffs have been raised on aluminium and steel, and Donald Trump has evoked the possibility of doing the same thing on cars. Whilst significant re-escalation now seems remote, is this relative stability the prelude to renewed easing, or the start of a long stalemate that will see trade tariffs remaining at current levels – the highest since the nineteen-forties – for a long time? This would mean a radically different economic impact.
Indeed, on the economic front, the next sets of hard data on employment, consumption and industrial production should reflect the initial consequences of the trade war, if there are any consequences! Having thwarted the forecasts for two years, will the US economy again surprise us with its resilience? Or will the multiple shocks delivered by Donald Trump ultimately weaken its foundations? Here again, the response will have a very different impact on the direction the markets take.
Within markets, questions are surfacing about the sustainability of certain trends. Having opened up an historic gap versus their US counterparts in the first half, will European equities continue to pull away, helped by the weakened dollar? Will domestic European securities continue to outperform the exporters, having wiped out four years of underperformance in less than six months? Does the defence sector still have fuel in the tank for the coming quarters after practically doubling since the start of the year[1]?
In this situation – and given that certain responses will not be based purely on rational facts – it looks like a good time to diversify risk, particularly by reconsidering neglected market segments such as European small caps or emerging markets, whilst taking advantage of the still attractive risk/reward ratio of European corporate bonds to add some stability to portfolios.