By Rob Morgan, Chief Investment Commentator at Charles Stanley
The widely observed US S&P 500 index fell more than 10% from its highs, representing a ‘correction’. Investors were particularly spooked when Trump failed to rule out the possibility of recession in the US, as well as his reference to a “period of transformation” for the American economy. This ignited concerns about higher inflation, a slower pace of interest rate reductions and lower growth in the near term.
Yesterday, these worries escalated with the unveiling of widespread tariffs on all goods imported into the US at higher levels than markets had previously anticipated. A baseline 10% tariff and ‘reciprocal’ arrangements for specific countries including 20% on the EU and 34% on China. Unsurprisingly, the news was met with further market falls.
What does it mean for investments?
We now have certainty of sorts, but there are still far more questions than answers as to what it means for the global economy. In the near term, there is likely to be a negative impact on economic activity and company earnings, although the extent is difficult to quantify. The uncertainty around what the tariffs will mean for industries and individual businesses means we can expect a high level of market volatility.
Meanwhile, global inflation is likely to be higher than it otherwise would have been, creating doubt around the pace of interest rate cuts from central banks, and overall, there is the probability of more ‘economic nationalism’ around the world. This stands to reconfigure supply chains and again push up business costs and prices. However, we mustn’t become too negative and lose sight that the wheels of commerce will keep turning and that there will always be opportunities in businesses that engineer growth over the long term – and well past Trump’s tenure as President. In the meantime, the US economy is likely strong enough to avoid recession, which should help mitigate the fallout.
There may also be some comfort in that the current tariff plans represent a ‘high watermark’ and that there is room for negotiation and concessions. Headline rates could be walked down over time as trade balances out to the President’s liking, though any ‘tit-for-tat’ exchanges, particularly with the EU or China, could be detrimental for all sides. Closer to home, with its lower baseline tariff of 10%, the UK could come out of the situation less affected, if only on a relative basis.
A ‘rotation’ in markets has been playing out for a while
Seasoned stock market investors will perhaps be less surprised about the significant sell off so far this year. Coming into 2025 US stocks were priced for a rosy outcome off the back of an initial wave of optimism surrounding Trump’s reprise as president. There were also concerns that US and global equity indices no longer offer the diversification they once did owing to the highly concentrated nature of the market. A tumble in just a handful of tech heavyweights was always going to result in a fall in the index – and the ‘Magnificent Seven’ have been hit hard recently.
Behind the scenes other areas have been doing better. The first quarter of 2025 was the worst for three years for the US index, but a good period for the German DAX, revealing the speed and extent of changing investor expectations and sentiment. It highlights the unpredictability of short term moves and the need to diversify geographically, as well as the fact investors can be hamstrung over the long term if they only buy fashionable companies at high prices.
Are there reasons to be positive?
While tariffs are immediately disruptive, particularly if they lead to tit-for-tat measures across the globe, some of the more market-friendly policies from the Trump administration such as tax cuts and deregulation will be more of a slow burn. Plus, if economic conditions do deteriorate, there is scope for Central Banks to cut interest rates to support activity, and this could buoy investment sentiment. That’s why we believe that market gyrations this year may provide good opportunities to pick up good quality investments that were previously rather too expensive.
Market moves have also highlighted that opportunity can lie in a variety of places. Just look at the defence sector. Previously unloved and overlooked by many, it’s been one of the top performing areas so far this year as much bigger defence budgets across Europe are thought to lead to bumper orders.
Overall, we believe it is a time for sticking to time-honoured investment principles: Diversifying appropriately and committing for the longer term. Investors should always maintain a diversified portfolio that insulates them as far as possible from the impact of different economic scenarios, which are particularly wide-ranging. Diversification means spreading money across investments, a mixture of asset classes, countries, and investment styles, so as not to be overly reliant on certain ones.
It may be that your portfolio has become increasingly reliant on the US, and tech stocks in particular, and as recent market moves show it makes sense to spread your money around as different markets perform at different times. It is notable that unloved, cheaper areas have been among the most resilient in this year’s sell off. Going forward we do expect less dominance of the US big tech stocks as a bloc which could mean investors won’t be penalised for taking a more diverse approach.
The other good news for investors is that some of the diversification benefits of the two main asset classes, shares and bonds, have re-established themselves. Bonds stand to benefit if deteriorating economic conditions ultimately result in subsiding inflation and a lower trajectory for interest rates. Meanwhile, equities offer the prospect of better returns from a benign economic scenario than expected and, perhaps whatever the outcome, some exciting longer term structural themes.
How should investors react?
At these times it is usually best to keep a clear head, stick to your investing plan and keep focused on the fact that sharp short-term moves should pale into insignificance over multiple years and decades. It’s rather like avoiding sea sickness by keeping your eyes on the horizon rather than the rolling waves below. Although there could be further volatility ahead the destination is what matters rather than the journey, even though it can be stomach churning at times.
It’s often the case that the market falls more quickly than it rises, which is psychologically challenging. It’s particularly bad luck if you have just invested a lump sum, but there is consolation from the fact that time spent in the market is far more important than timing the market over long periods, so if you have a long term view you shouldn’t be too concerned.
Selling out in fear can be the worst thing to do. Large falls can be followed by large rises, so you risk losing on both sides – selling when prices are depressed and not buying in until they have moved higher. Sadly, this is a trap that many investors fall into. Being out of the market also means you are no longer collecting – and potentially reinvesting – any income your investments are paying. In the absence of a crystal ball, keeping invested is often the best strategy, no matter how uncomfortable.
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