“Liberation Day” – Anything but a liberating move

Donald Trump's “Dismissal Day” has sent shockwaves through global capital markets. Although the recent postponement of tariffs has provided some relief, considerable uncertainty remains, especially as China, the world's second largest economy, was excluded from the postponement. Indeed, the trade war between the US and China shows no signs of abating. In addition to tariffs, export restrictions on certain raw materials on the one hand and computer chips on the other now appear to be a preferred weapon in the trade conflict. If the world's two largest economies are damaged by such an aggressive trade war, the rest of the world will not remain unaffected.

The reaction of capital markets shows clear signs of uncertainty. The MSCI ACWI has fallen more than 10% in just a few trading days. Risk premiums on corporate bonds have also widened since then, albeit from extremely low levels. Long-term US government bonds have been volatile. Initially, Treasuries reacted (as expected) with price gains, living up to their role as a safe haven, but this was short-lived and yields suddenly jumped (with corresponding price losses). Contrary to many expectations, the US dollar also came under pressure, which is likely to further increase import prices and thus the risk of inflation in the US. It is quite possible that the performance of Treasuries and the US dollar ultimately prompted the US President to tone down his aggressive trade policy, at least temporarily and against most of its trading partners.

Uncertainties likely to remain a burden

The outlook is more uncertain than ever and depends on Donald Trump's mood. The situation could change abruptly, for better or worse. Even if the recent postponement of tariffs suggests that the US administration has reached its pain threshold in terms of capital market feedback and that Donald Trump is primarily interested in making deals with his trading partners (why else would he allow more time for negotiations?), negative surprises are always possible. In particular, further escalation with China has the potential to severely disrupt global supply chains.

In any case, the confidence of trading partners and the business community in the US government is likely to have been damaged in the long term, which could be reflected in cautious corporate investment. If tariffs remain in place for an extended period, albeit at a reduced level, uncertainty among US consumers is also likely to persist, weighing on the US economy, which is 69% dependent on consumption. Against this backdrop, a return to the optimism seen at the start of the year seems unlikely for the time being.

How much optimism or pessimism is currently priced into equity markets?

Stock market valuations paint a very mixed picture. In Europe, the expected price/earnings ratio is now almost 10% below the ten-year average, reflecting at least some pessimism. In the US, on the other hand, valuations are still some 7% above the ten-year average, despite the fall in prices. The interesting thing is to look at the equally weighted indices. These ultimately show how the average stock in the region is valued. Here, valuations are below the ten-year average not only in Europe but also in the US. So, at least for optimistic stock pickers, bargain hunting could be starting.

Even if further price falls are likely in the event of a recession, there is still potential for positive surprises based on valuations, particularly in Europe. The bargain hunt could therefore begin, at least for the more optimistic stock pickers.