The Analyst: how to make sense of tariff turmoil

Investors are frequently overwhelmed with headlines of bold macroeconomic and geopolitical forecasts.

Recent headlines include: “JP Morgan boss warns trade tariffs could lead to US recession and stagflation”; “New Trump impeachment bid is imminent” and “Trade war with China escalates”.

While investors need to be mindful of the potential risks from so-called black swan events, investment decisions should not be overly influenced by these predictions. As history shows, many consensus forecasts have proved inaccurate.

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Last week, President Trump announced a significant increase in tariffs on US imports. Analysts remain divided on how these tariffs will impact key macroeconomic variables such as growth, inflation, and interest rates. The lack of consensus has amplified market uncertainty.

Markets reacted negatively to the news. Last week, the S&P 500 plunged over 9% in sterling terms, and the FTSE 100 followed with a 6% drop. Bond yields edged lower as investors focused on the potential drag on growth more than the inflationary impact, although this has sharply reversed since the start of this week. Meanwhile, the US dollar weakened against major currencies. Yesterday, Trump’s apparent U-turn in announcing delays to the tariffs of most regions (if only temporarily) has led to some recovery in the markets.

Consensus view – cautiously optimistic

The tariffs were larger and broader than anticipated and their longer-term effects remain unclear, especially as retaliatory measures by other nations may further escalate tensions. Analysts now expect US GDP growth to slow to below 1% for the year, prompting the Federal Reserve to implement 75–100 basis points of rate cuts. In a more severe scenario, a global trade war could push the US into recession, potentially leading to rate cuts of up to 300 basis points.

Although the Federal Reserve is in a very challenging position with slowing growth and rising inflation, any signs of labour market weakness could accelerate rate cuts. Over the medium term, the economic growth slowdown is likely to outweigh the inflation upside, resulting in a higher likelihood of rate cuts and increasing the probability of accommodative monetary policy. This reflects the prevailing economic consensus, but whether it materialises is still uncertain.

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With anticipated downward revisions to US economic and earnings forecasts, and the potential for ongoing tariff escalations, global equity markets may experience prolonged volatility. Nevertheless, many analysts remain cautiously optimistic that equities will end the year higher and continue to see strong long-term potential. While recession risk makes the picture look bleak for low credit quality fixed income – especially junk bonds - the case for high-quality bonds also remains intact given relatively attractive yields despite market volatility.

Trying to make macro and market predictions

While such macroeconomic forecasts sound sensible and even interesting, economists have a poor track record of predicting major turning points such as recessions or inflation spikes. In practice, most investors only need a general understanding of the economic environment and forecasts are rarely necessary for investment decisions.

It is typical for many investors to shun macro completely and focus entirely on bottom-up valuations. They often view economic slowdowns or recessions as good times to buy undervalued investments and hold them over the longer term. But they don’t really care because they know recessions occur frequently enough and they are patient enough to wait through economic cycle.

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Similarly, predicting market movements is extremely difficult. When equity markets are rising, it's easier to follow long-term investment principles such as staying invested, avoiding market timing, and focusing on long-term goals. However, discipline becomes much harder during periods of volatility, precisely when it's most needed. The current market volatility around tariffs presents such a challenge for all investors.

Historical data shows that while markets may initially react to macroeconomic shocks, they tend to recover. The 2008 global financial crisis and the Covid pandemic both caused significant short-term volatility, yet long-term investors who stayed the course were rewarded.

This underscores the importance of diversification and matching your risk level to your time horizon. Rather than attempting to forecast the next interest rate move or sector rotation, investors should focus on building resilient portfolios that can perform in different environments.

Portfolio positioning for uncertain times

If you're concerned that tariffs could trigger a recession, but are unsure when or how it will unfold, ensure your portfolio is positioned to perform under both slowing and recovering economic conditions.

• While equities are a key source of long-term returns and inflation protection, bonds offer diversification, income stability, and lower volatility, especially during downturns
• Commodities, especially gold, often act as hedge against inflation and geopolitical risk, while offering diversification due to their low correlation with stocks and bonds
• Many investors exhibit home bias. Expanding your investment universe to include both developed and emerging markets can uncover more growth opportunities
• For sector consideration, defensive sectors such as healthcare, utilities, and consumer staples typically outperform during economic slowdowns. In contrast, cyclical sectors such as technology and financials often outperform during expansionary phases.

By maintaining a balanced mix of assets, regions and sectors, you can increase portfolio resilience regardless of the market environment.

Beware of portfolio risks

Apart from selecting the right investments, it's important to understand your portfolio's biases and concentration risks. Tools such as Morningstar's Portfolio X-Ray can help analyse asset allocation, regional exposure, sector diversity, investment style, and top holdings.

Regardless of market conditions or political developments, maintaining a diversified portfolio and avoiding strong portfolio biases will help you successfully navigate uncertainty and market volatility and achieve long-terms positive results.