Investment outlook as US/China force world to pick sides

Donald Trump has drawn a line in the sand with his global tariff onslaught, forcing countries around the world to pick a side in the trade war between China and the US. However, much like King Canute before him he may soon realise the tide of global trade makes fools of kings and men who try to bend it to their will. We look at the latest tariff updates and the possible winners and losers in the coming months.

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Time and tide of global trade wait for no man

Trump slamming the brakes on trade with China doesn’t mean it will stop, it will just ebb and flow elsewhere, and unfortunately for Trump it looks as though trade will trickle away from the US. What that means for the rest of the global economy is now becoming clear.

More importantly, the motivation for Trump and America is that they feel like they are losing ground to China with the tariffs aimed at reclaiming lost manufacturing power. Trump is trying to strong-arm the global economy to pick a side, but given the market response, it seems to have backfired. China, meanwhile, is continuing its steady strategy of soft power.

The European Union recently agreed to restart talks to settle a trade dispute over importing electric vehicles, with a delegation due in Beijing for a summit with President Xi in a couple of months. Spain has also recently pledged to make closer trade ties with China despite threats from the US. South Korea and Japan have done the same.

Just last week, Vietnam signed a raft of new economic deals with China, while Xi Jinping was in the country during his wider tour of Southeast Asia. The President of Kenya is currently in China and has pledged to strengthen ties in the face of economic turmoil. In September last year Nigeria and China agreed major investment in road, rail and energy for the African state.

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The US, meanwhile, has talked a good game, with Treasury secretary Scott Bessent claiming more than 100 countries have reached out to make deals, but as yet nothing is signed and the clock is ticking on the 90-day tariff pause. UK Chancellor Rachel Reeves is currently in the US trying to hammer out a trade deal, but there has been little sign of a breakthrough. It’s difficult to see the tariff strategy as having done anything but weaken the US’ reputation and standing.

It’s also difficult to see how the two sides can reach a resolution, as China will be in no hurry to offer America what it needs given the market response has strengthened their position if anything. Bessent claimed that any talks would be a “slog”, and any resolution seems a long way off.

Tariff shockwaves take effect

Economic forecasters are now predicting a short sharp shock from the tariffs, the latest International Monetary Fund (IMF) estimates have cut global growth for this year to 2.8%, from 3.3% previously, before growth returns to 3% next year. The hardest hit major economy is the US, with its forecast for growth in 2025 reduced to 1.8% from 2.7%. It’s a grim picture across the rest of North America, with growth in Canada down to 1.4% from 2%, and Mexico forced into contraction of 0.3% from a previous estimate of 1.4% growth. China will still be way ahead, growing at 4%, down from the 4.6% previously expected.

The UK with its large dependence on the service sector and global trade is also forecast to see annual GDP growth slump to 1.1%, from 1.6%. The eurozone doesn’t escape unscathed but isn’t as badly affected, with growth forecasts for the year trimmed to 0.8% from 1%.

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So, as expected when the US and China, which make up 43% of the global economy, put a freeze on trading relations, it’s the rest of the world that catches a cold. The impact is now starting to show in other key business surveys such as the flash UK Manufacturing Purchasing Managers Index (PMI), which fell to 44 for April, down from 44.9, driven by new manufacturing export orders collapsing at the fastest pace since the early months of the Covid pandemic in 2020. UK consumer confidence also fell to a record low, according to the most recent British Retail Consortium poll.

Team America or Team China?

There are no winners and losers in this trade war between the US and China. America is trying to force countries to pick a side by offering tariff reductions if they restrict trade with China. China, meanwhile, has responded robustly, promising its own raft of tariffs on any country that reaches a deal at the expense of Chinese interests. Currently, import taxes of up to 145% on Chinese goods coming into the US remain, while American products heading to China are charged at 125%.

The situation is dizzying, with Trump banging the drum one minute before softening his rhetoric on tariffs, announcing exemptions for smartphones, computers and cars. China has responded in kind, seemingly removing tariffs on medical supplies and jet engines. But the fact remains that we still have a serious breakdown in trading relations between the world’s two largest economies.

Still waters run deep

Where does all this leave investors? Well on the surface we’re seemingly not much changed from where we started on 2 April’s Liberation Day, with markets only down 2-3% from where they were before the tariffs were introduced. But this feels like a serious error in the triumph of hope over experience.

In situations like this where we are bombarded by contradictory and market-moving statements daily, it is perhaps important to turn lessons from the father of history himself, Thucydides, who, after spending 30 years writing about the Peloponnesian war, focused his analysis on events and human motivation rather than putting much weight on rhetoric or the crowd’s response to headlines.

So, if we leave aside the Trump bluster, what have we got? Sticking to the facts, we have some concerning signals. The US dollar is the world’s reserve currency and a barometer for confidence in the US economy, with Trump threatening to have the chair of the Federal Reserve sacked, that confidence is being seriously tested. The US dollar is down to a three-year low against the pound and the euro, and analysts from Goldman Sachs see it heading lower.  Political turmoil is not good for business.

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When investment professionals or senior executives make decisions, they must answer to an investment committee and shareholders. Given the political risk and market volatility in the US, it’s a job-threatening prospect to choose to invest in US markets if they fall a further 10% from here, then have to justify that decision. It’s much safer to look at better value markets in the UK or Europe, both in terms of returns and job security.

There’s evidence that some investors are moving money out of US assets after a weak performance for North American funds during the first three months of the year. Fund manager Jupiter said as much in its recent first-quarter update, with investors “looking to reallocate away from the US and towards other markets, such as the UK, Europe and Asia Pacific”.

Credit markets are beginning to show warning signs. What is beginning to appear across government debt markets is a steepening of the yield curve. Investors are looking for safe havens and buying shorter-dated government bonds such as two years and five years, which is driving up the price and forcing the yields down, while the longer-dated maturities such as the 10-year and 30-year are being sold so their price falls and the yield rises. If all these yields are fed into a graph, the curve becomes steeper as the front end, or short-dated maturities, falls while the back end, or long-dated maturities, rises. All this suggests credit investors are worried something like a recession is looming.  

There are other signs that should concern investors too as the price of gold, the ultimate safe haven, has been hitting record highs of almost $3,500 per ounce. Although it has since come back from this peak, it is still up over 19% this year. Conversely, the oil price, another indicator of world trade, has slumped to $66 per barrel. That’s down 22% from around $85 per barrel at the same stage a year ago, and is now at its lowest level for over four years.

Calm before the storm?

The violent market swings have already begun to claim casualties, with AIM-listed currency specialist Argentex Group (LSE:AGFX) having its shares suspended and seeking an emergency sale after large dollar movements sparked a liquidity crisis. Given the speed and size of recent market movements, it seems unlikely to be the only one in trouble.

Retail investors have been at the fore, buying the dip after the Trump slump. Institutional investors, meanwhile, have been rotating out of US stocks, but this seems like an incredibly risky strategy given the weakness of the dollar, the slowdown in the US economy, and the rising chance of a recession. And we also have no agreement on a way forward for trade negotiations, just a temporary pause to step back from the brink.

Given this outlook, and despite some softer talk on tariffs from both sides, it’s highly likely we will see further volatility in the coming months. Investors must now decide whether to sit on the sidelines until we have a clearer picture of what lies ahead, sell down holdings to avoid sleepless nights, or stay fully invested and perhaps even buy more on the assumption that things will eventually get sorted. There is no wrong answer. As always, personal circumstances and attitude to risk are the key drivers.

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In terms of investment prospects, while the UK is exposed to the slowdown in the short term, it looks well placed for long-term investment returns. The UK government offers a relatively stable and predictable platform for investment, and the FTSE 100’s low price/earnings (PE) ratio of 12.4 makes UK blue-chip shares attractive compared to the S&P 500’s PE of 28 and Nasdaq 100 on 39.

Other encouraging factors are the almost certain interest rate cuts coming to the UK, with most analysts expecting three reductions by year end to 3.75% from 4.5%, which would be positive for equities. Also, any rotation by China away from the US to alternative markets in Europe and the UK, would be a tailwind.

John Ficenec is a freelance contributor and not a direct employee of interactive investor.