Up and down and on and off
Posted 7 February 2025
The week began with, potentially, a very distasteful pill to swallow. On Friday evening, just before 6pm GMT and after European markets had closed, Trump announced another 10% of tariffs on China and new 25% tariffs on Mexico and Canada, the US’ closest and single largest trading partners, all to begin on the following Tuesday.
The S&P 500 fell back to close 1% lower than the 6pm level. With no further news through the weekend, Asian and European equities fell back as their markets opened, although there wasn’t a sense of panic. Through the day markets edged lower, and US markets followed suit in Europe’s out-of-hours trading, down over 3%. Bond yields went higher in the US but lower elsewhere.
From midday US onwards, markets began to move back upwards, following Mexico’s president Sheinbaum’s announcement that she had agreed improved border controls during a phone call with Trump that would halt the imposition of tariffs on Tuesday. And, on Tuesday morning, PM Trudeau of Canada said the tariffs were not going ahead. Trump confirmed a delay to March for both of his neighbours after they offered action on borders and drugs. China, not having been so lucky, promised countermeasures but they were deemed to be on things that were not so important to the US.
There is a debate in Tatton about investment management decisions in the face of such volatile policy making, i.e. how much emphasis the ‘Trump Show’ should have in it. If he thinks of his Presidency as a form of reality show (albeit subconsciously), then there will be drama and shock, ups and downs, temporary conflict and resolution. Meanwhile there will be progress towards goals but it might be difficult to see them clearly.
When some bout of tariff bullying looks particularly outlandish or extreme, such as the 25% levies on Mexico and Canada, perhaps we should expect that it will become less extreme when something is offered as a pacifier. Or in other words and as we said before, we are well advised to take what Trump announces seriously, but not literally.
As we have seen with China, the direction of travel is that more tariffs will be imposed. Goldman Sachs now believe that China will face another 10%. As for Canada and Mexico, they are not likely to face tariff imposition while the USMCA (US-Mexico-Canada Agreement) is renegotiated, probably concluding sometime next year. However, they both have to make progress on their recent promises or face renewed and unpleasant pressure.
Goldman Sachs (GS) believes that the average tariff rate (across all imports) will rise by 4.7% to 6.3%, much of which will be borne by China. Also expect tariffs on “critical” goods such as oil and gas, industrial metals, pharmaceuticals, semiconductors and other electronics, and critical minerals.
Some of it, inevitably, will be imposed on Europe, especially on vehicles (GS expects a 25% levy on Europe’s auto exports). It may be that the UK escapes levies, partly because the US actually has a trade surplus with us.
These estimates chime with Treasury Secretary Scott Bessent’s evidence in his confirmation hearing. He said tariffs would raise $3 trillion dollars over 10 years. A 5% rise would raise $315bn per year if levied now and there was no reduction in imports despite the price rise (our calculations derived from World Bank and USITC data).
GS estimates that US inflation would rise by about 0.5% but they don’t expect that this will generate any real dent in growth. Not everyone agrees. According to the Tax Foundation, the set of tariffs of Trump’s first administration lowered US GDP by 0.2%, capital stock by 0.1%, and employment by 142,000 full-time equivalent jobs. The estimated tariffs may be approximately three times larger this time around and upward pressures on consumer prices may well hinder the Fed in administering further rate cuts.
It is notable, that despite all the noise this week markets end the week broadly flat, with a “not so disruptive” scenario seemingly discounted. In fact, after all the Trump excitement, it was other news that had more impact.
The US corporate earnings season is in full swing and all of the Magnificent 7 have reported except for Nvidia. Amazon reported today (Friday 7th February) and investors seem to be disappointed with the results. Bloomberg reports:
“Amazon has joined with the other big AI tech bets in providing tepid revenue and profit guidance for coming months. The race to grab market share continues and companies are spending to get there and to expand capacity fast enough to meet the demand they’re seeing.”
Since the news about DeepSeek’s innovative AI approach in late January, investors have become warier of the story that AI dominance will be achieved through massive investment that only the largest companies can deliver. The results season has not been kind to these stocks, with Alphabet being the most affected after its results on Wednesday.
Yet there’s also another factor which is taking the shine off the MegaCaps. The mid-cap and smaller-cap companies are finally showing some earnings growth. Below is a chart, with data from Factset, of last-twelve-month reported earnings for the S&P 500 (large), S&P 400 (mid) and S&P 600 (smaller) caps:
While the growth levels are currently similar, over the longer term (since 2000) small cap growth has been twice that of the S&P 500, with mid cap earnings per share growth about 1.5 times that of the S&P 500. The period from late 2022 was awful, with interest rate costs hammering the more leveraged and smaller companies. However, despite only a small decline in rates, it appears that these companies may have managed to unwind some borrowing and can now cope with rates at these levels. That would put them back onto a better path, and it may also imply that companies no longer need a lower rate environment to succeed. A potential opportunity set closely monitored by us.
Turning away from the US, the Bank of England’s (BoE) rate setters of the Monetary Policy Committee came through with a welcome rate cut, taking the Base Rate (the BoE calls it “Bank Rate”) to 4.5% from 4.75%.
In brief, the arch-hawk Catherine Mann flipped, voting with the arch-dove Swati Dhingra for a 0.5% decrease. Despite Dr. Mann’s belief that the UK has an inherently inflexible and inflationary structure, her fear appears to be that near-term growth has taken a dive. Bond investors accepted Andrew Bailey’s words that the hawk had not really turned into a dove and bond yields stayed unchanged rather than falling. However, if Dr. Mann is right and the economy is currently on a weaker path which justifies lower rates, then the BoE didn’t do enough and the economy will not benefit from a small rate cut.
Still, investors in UK-listed equities seemed happier, with the FTSE 100 moving into new highs after the rate decision. That suggests investors suspect the balance of overall risks is improving even if it’s difficult to say that any one thing is great. Let’s hope so.