SUMMARY
Trade uncertainty seems likely to weaken US growth in the quarters ahead. We explore which equities might better endure this environment.
KEY TAKEAWAYS:
Trade uncertainty has spiked recently
US economic growth may soften in the next couple of quarters
Any weakness may not be as bad as markets fear
We see high quality balance sheets and dividend growth equities as appealing
High quality balance sheets and dividend growth may be the first place to add for investors who are below their benchmark allocations to equities.
A 10% drop in US equities has not dissuaded President Trump from announcing escalating tariffs on particular imports from Canada, the EU and others. However, with US equities dropping 0.7% on average per day since peaking on February 19, we suspect that a near-term peak in trade policy uncertainty will be reached by the President’s deadline for a “reciprocal tariff” announcement on April 2.
While complex to measure, we expect reciprocal tariffs to be significantly smaller in absolute size than the 10%-25% tariff increases across a range of North American and Chinese imports. This does not prevent future rounds of tariff uncertainty or “trade wars” from recurring.
Even in a hypothetical “best case” in which US tariffs are dropped as foreign tariffs decline in negotiations, the rise in trade uncertainty is likely to result in a net weakening of the US economy in the next couple of quarters as production and investment slow. With this said, the drop may not be as severe as peak market fears to come. As an example, in the first quarter to date, US small business confidence has fallen less than 5%, pointing to a moderate slowdown.
Potential portfolio implications
US large cap tech shares have fallen 20% from their peak, but merely to September 2024 levels. With the “Magnificent 7” as a group up 160% over the two years ending 2024, they won’t look “cheap” unless one takes a very robust view of future earnings per share (EPS) growth. Nonetheless, investors should consider the grouping’s historic EPS growth rate of 16% compounded.
Last year, the software group rose 19% after Trump’s election, with the idea that they would contribute more to AI solutions, but also that software trade was less susceptible to tariffs. Software maker shares have erased all of the gains and more, matching the decline in retailers, despite less tariff exposure.
US healthcare has acted as a defensive trade as we had hoped, with a 7.5% year-to-date gain. Non-US equities have broadly stayed on their late 2024 recovery track, rising 7% year to date. China is showing global investors that US firms are not the sole innovators.
US tariff and immigration policies are more fundamental to the outlook than last August’s “yen carry-trade” driven market pullback. We don’t see signs of extreme “capitulation” in markets. Nonetheless, future returns improve as values drop. We also see first quarter EPS estimates as unusually weak in advance of results. High quality balance sheets and dividend growth may be the first place to add for investors who are below their benchmark allocations to equities.
