Market developments in the first quarter this year have been quite unexpected, to say the least. At the beginning of the year, we highlighted the universal consensus in support of US exceptionalism. The market viewed the supremacy of US assets as unassailable in the context of an artificial intelligence (AI) future dominated by a few US information technology hyperscalers.
At the same time, the newly elected US president had barely taken his seat in the Oval Office when he started issuing numerous decrees emphasising one of his favourite policy tools: import tariffs.
At first, the market was not quite sure how serious Donald Trump was about actually implementing them. Towards the end of February, concerns intensified and the S&P 500 index began a rapid decline, briefly reaching 10% correction territory.
April 3, or "Liberation Day" as some may call it, has now come and gone, and the Trump administration deployed its well-established shock and awe strategy to push the rest of the world into a poor position for retaliation and negotiation. Everyone gets taxed for exporting to the US, and some at a higher rate than expected.
The high tariffs and their justification, namely that the US is being cheated on trade, suggest they are the starting point for negotiations that could include retaliation announcements, additional tariffs, and ultimately deals that result in lower trade barriers than those announced.
We expect the negotiations to drag on for 3-9 months, creating increased uncertainty, downside risks to global growth and upside risks to US inflation.
Countries other than the US will likely step up efforts to stimulate domestic demand through fiscal and monetary policy.
MANUFACTURING HIT
The most immediate pressure is being felt in manufacturing-heavy sectors, with industries such as automobiles, technology hardware and capital goods affected due to their heavy reliance on global supply chains. From an earnings perspective, assuming companies absorb roughly 30% of the tariff burden, the direct hit to global corporate profits could be around 2% of overall earnings per share.
However, the impact is not evenly distributed, as developed markets such as Europe and Japan appear particularly vulnerable due to their higher ratios of exports to GDP, making them more exposed to trade disruptions. Yet beyond the near-term earnings impact, the more pressing concern for investors is the sustained pressure on valuations.
While many industries face challenges, certain companies are positioned to benefit from these policy shifts. US-based manufacturers with minimal reliance on imports could emerge as relative winners, as they stand to benefit from higher domestic prices without having to bear the burden of additional tariffs.
That said, risks remain, as potential sectoral tariffs on key industries such as semiconductors, pharmaceuticals, copper and lumber could introduce further market volatility in the months ahead.
For now, we continue to caution against prematurely buying into market weakness, especially in the US. We recommend using any short-term strength in US equities to further diversify into non-US equities such as Europe and China.
STAGFLATION RISK
In terms of the dollar, markets have priced in a larger probability of Federal Reserve rate cuts in reaction to rising stagflation risks for the US, while dollar sentiment worsened, sending the euro above $1.10. As Japan was not on the list of countries with higher tariffs than the global 10%, the yen fulfilled its role as a safe haven, with the exchange rate dropping to 146.
Anticipating the larger willingness of the US to endure economic pain to achieve its policy goals, we have lowered our US dollar forecast to trade lower against the euro over the next 12 months.
With macro risks having increased, we reiterate our view that the approach to credit risk should be measured at this point, meaning we would reduce the weakest credit exposure.
Credit spreads are still far from recession levels and are likely not to tighten in the current environment, before we get more clarity on the economic fallout from the sentiment shift related to trade policy. Those seeking out US high-yield investments should focus on the shorter duration and highest quality, which we think still offer decent value at manageable default risk.
Lastly, when it comes to precious metals, gold is exempt from tariffs, while silver is not unless it is imported from Canada or Mexico. We remain constructive on both, as gold should continue to benefit from strengthening Western world safe-haven demand. Safe-haven flows into silver should pick up as well, but it is likely to trail gold as it will potentially face some headwinds from reduced industrial demand.
Kean Tan is Managing Director, Senior Adviser and Head of Investment Solutions at SCB-Julius Baer Securities Co Ltd in Bangkok.
