Podcast: La semana que agitó los mercados: ¿qué nos espera?
Alex Tedder, Bob Kaynor y George Brown analizan las consecuencias del Día de la Liberación y lo que podría suceder a continuación.
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[00:00:01.360] - Announcer
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[00:00:40.390] - Announcer
Welcome to the Investor Download, the podcast about the themes driving markets and the economy now and in the future.
[00:00:54.080] - Announcer
I'm your host, David Brett. Hello. I hope you're all well. Today we have a special recording for you. It's all about the market chaos of the last week and what might happen next. The show is hosted by my colleague, Stu Podmore, and features fund managers Alex Tedder and Bob Kaynor, along with economist George Brown. Stu will do full introductions at the start of the pod. This was a live event, so there are also questions from the audience. We hope it covers all your burning questions, too. There aren't many technical terms used in this recording, but Treasury Inflation Protective Securities or TIPS, as they're known, are mentioned. They're a type of treasury bond that's indexed to an inflationary gauge to protect investors from a decline in the purchasing power of their money. Anyway, sit back and I hope you enjoy.
[00:01:51.280] - Announcer
On Apple Podcasts, Spotify, or wherever you get your podcasts, you're listening to the Investor Download.
[00:01:58.500] - Stuart Podmore
Hello, everybody, and Welcome. My name is Stuart Podmore. I work for the Client Group here at Schroders. Great that you could join us. In fact, you're joining us from all around the world today, so many thanks for that. This is the week that shook markets. What lies ahead? Well, news flash straight up front, folks. I think more markets are going to get more shakes from here. But one of the first things we've got to try and do is take a step back. It's very easy to be drawn into this. We worry about markets all the time. But in terms of 2025, we've had the DeepSeek surprises. We've had the defence spend surprises that are related to the German fiscal brake being loosened, and now we've had Liberation Day. I think to put this into context, we are definitely in a de-globalised regime with inflation shocks, having previously been in a globalised world with deflationary shocks. So there's definitely been a change there. We've talked about that for a while now through regime shift and what we described as the 3D reset. I think that goes a long way to explaining some of the populist policies that we've been seeing, particularly from Donald Trump on Liberation Day, given the fact that Western liberal democracy populaces have seen a reduction in their living standards, and they have reacted to that.
[00:03:17.140] - Stuart Podmore
Now, to help me discuss all of this today, I'm joined by a three-person panel. Firstly, George Brown, who is the Senior Economist here at Schroders, and he specialises on the US, so he's got plenty to say. We've Alex Tedder, who is the Chief Investment Officer for Equity here at Schroders. We've got Bob Kaynor, live from the US. Bob heads up our global small and mid-cap team, and he'll be talking very specifically about the experience stateside. I've got to say that actually the reaction or the tariff announcements that came from Trump most recently were worse, perhaps, than markets expected. He said everybody, I think this is a direct quote, "Everybody was getting a little bit Yippy." But actually, the question here is, if there's going to be some short term pain in Donald Trump's words for long term gain, just how long will that short term pain be? How intense will some of that pain be? And will we get round to that longer term gain? There's some really important questions there, given the fact that we've seen the fourth highest volatility with the VIX index currently above 30 points in 60 years. So With an introduction like that, it's quite a tough ask to go straight to George.
[00:04:34.950] - Stuart Podmore
But I wondered if it's possible for you, for the benefit of the audience, it's very difficult to keep up with all of this stuff, but could you just give us a reasonable summary of where we are on the tariff side of things?
[00:04:45.540] - George Brown
Okay, absolutely. As you say, it's hard to keep up. I was working Sunday morning, reacting to the announcement on Saturday. If we take a step back, before Trump was inaugurated, the tariff rate in the States was about 3%. Now, he's announced various tariffs, like 20% on China initially, 25% on Canada and Mexico, steel and aluminum, cars and car parts. But then, of course, we had Liberation Day, and that was where the big announcement on the tariffs came through, such that if you recall that the tariff rate was about 3%, the cumulative impact of these measures would have taken it to about 25%, the tariff rate. That's about the highest in about 120 years. Now, what does all that mean for the economy? Well, the framework that we've developed, which looks at how this will transmit through to the economy through growth and inflation, every 1% rise in the tariff rate would lead to inflation being 0. 1% higher and growth being negative 0. 05, so one-twentieth of a % down. When you think about that rise of about 22%, that's going to have an effect of about 2. 6% on inflation and drag down growth by about 1.2%.
[00:05:57.290] - George Brown
These are big, big shocks to the US economy. Yes. Now, what has happened since then, of course, is, of course, we have the turmoil in markets, not just in terms of equities, but obviously on the bond market as well and in the dollar. We've had some reversals. We've had the 90 day pause on various economies. They're going to go down to that 10% baseline tariff that Trump's talked about. But on the flip side of that, China is going to face 145% additional tariff. Those two measures, effectively, by our estimates, offset each other. That still leaves it 25.3%. But the news at the weekend is quite significant. The exemption for electronics and computers because that takes down the tariff rate by about five percentage points because computers and electronics are the number one biggest import for the United States. It's a big exemption. The net impact now is going to be, by our estimates, in terms of the tariffs, 2% on inflation, subtracting about 1% from growth. So still a big impact, but less than it was, say, a few weeks ago.
[00:06:54.580] - Stuart Podmore
In your previous forecast, you talked about an aggressive Trump scenario. I think you put a probability of 23% on that, George. So are we in aggressive Trump territory now? Does it mean that, therefore, as your forecast stated at the time, that we could now see a risk of stagflation in the US?
[00:07:12.460] - George Brown
Absolutely. I mean, stagflationary is probably the best outcome we can hope for right now. Recession is very much on the cards, I would say. In terms of the probability, it's hard to say, but it's probably 50/50. It's a coin flip probably at this stage. But yeah, in terms of whether or not we're in that aggressive Trump world, in terms of the effective tariff rate that we'd assumed, that average tariff rate, it was about 25%, so about where we were with Liberation Day. Certainly, the box is ticked on that side. But the other element of aggressive Trump that we haven't seen so far, which we assumed in that scenario, is a very aggressive policy on immigration. On the campaign trail, we had JD Vance, the vice President, talking about deportations of maybe 1 million immigrants a year. That's very significant because if you look at the jobs market since the pandemic, a lot of that has been driven by foreign labour, whereas the so-called domestic-born part of the population has effectively stagnated. That's a demographic story. Very much, foreign workers have been the big source of supply for a lot of companies. If we would see a clamp down on that, then that would take us certainly, I think, into a recessionary world.
[00:08:22.000] - Stuart Podmore
He softened a little bit on immigration of late. Did you spot that?
[00:08:24.640] - George Brown
Yeah, he softened a little bit on Saturday. It got missed a bit because of the tariff announcement or the the exemptions on electronics. So there's been a bit of a softening on that. But of course, Trump is quite temperamental, and there is still a lot of uncertainty. So I wouldn't necessarily put that to one side and say that that has been settled definitively. I still think that is a key risk.
[00:08:46.010] - Stuart Podmore
Sounds like he was burying some good news. How strange. But look, thank you, George. We've got plenty to cover in terms of... I want to get on to deficits, and I want to get on to bond yields. But if I could come to you first, Alex, does... It's a blunt question, but does Trump care about what happens in the markets? He said to everybody they were getting a little bit yippy and that people needed to stop panicking and just to calm down.
[00:09:11.900] - Alex Tedder
He definitely cares, he definitely cares, Stu. We could see that on the weekend. It was actually Friday night, wasn't it? Not Saturday. But the backtracking on a whole bunch of tariffs that we've seen since then, whether it's electronics or cars, is a huge deal. To my mind, what he's responding to is two things. One, the bond market telling him, and George alluded to this already, telling him that actually there could be a problem here if he carries on at this rate. I think that's a very valid concern. It's always the bond market. Think of Liz Truss in the UK back then. It's probably no different for Donald Trump, ultimately. So you could say that check is already working. Also the equity market, which is a simple fact that we were discussing this before. Americans hold a lot of shares, a lot of stocks and shares. 42% of household assets are invested directly in the US stock market. Therefore, every drawdown, and we've seen a big drawdown in US shares this year, every drawdown hits them in the wallet, and that is going to feed through into his ratings and ultimately into his legacy.
[00:10:23.860] - Alex Tedder
I think the checks and balances are working. So the question is, what do we end up with and has the damage already been done?
[00:10:29.970] - Stuart Podmore
Yes. But would you feel more optimistic at the moment, Alex, though, as an investor, global equity, first and foremost, without perhaps the thematic important angle there, but just global equity, straight perspective on this. Would you feel better right now, given that we at least have an understanding of how it's all been calculated? Do you feel as if you can start pricing risk again?
[00:10:51.040] - Alex Tedder
I will say that I do respect the fact that tariffs in the United States at 2. 8% prior to the whole Liberation Day thing were very, very low. Trump actually has a point about tariffs relative to other countries. It's just the way he's doing it that is creating this complication, this uncertainty, and ultimately this drawdown in markets. And so the longer that uncertainty persists, the more damaging it is to the real economy and to markets.
[00:11:24.790] - Stuart Podmore
So we go into an environment where negotiations are taking place on a bilateral basis. It takes a bit of time. I mean, it's not easy to work through, is it, George? I would imagine the extension of that time just gives a greater sense of uncertainty in the markets. Stuart, by the way, online has said, well, if there's going to be 90 days before the tariff are reimposed? Are we going to go through the whole similar shock process?
[00:11:49.670] - Alex Tedder
That is the question.
[00:11:50.620] - Stuart Podmore
How do markets then price that in? Exactly.
[00:11:54.230] - Alex Tedder
George, you give your view in a sec. But from my standpoint, as an equity investor, you've got the S&P back at 5,400. We got quite low. You've got markets actually rallying somewhat on this news about backing off from some of the tariff arrangements. The market is incredibly dialed into the level of tariffs and what actually is going to happen. So volatility is definitely the name of the game. Uncertainty is the name of the game. The question is, what do we end up with? And that is where I really don't have an answer yet. Because 10% tariffs, you could probably accommodate in most countries. You might disagree, George. 145% tariff for China, you definitely can't accommodate. So what do we actually end up with? I'm not sure. If we don't end up with a solution, there is drawdown risk in the S&P, and there is drawdown risk in other markets globally. Okay, George, do you want to add anything to that?
[00:12:56.170] - George Brown
No, I thought that was pretty comprehensive. It's just if I look at it from a macro perspective, for corporates, it's going to be a really challenging environment. This is the concern that we might ultimately get these extension after extension after extension and such that the tariffs never get to as high as they're threatened. But I think that the risk that they do get to that level. We're already seeing corporates take action. We've seen reports, let's say, of Apple chartering this plane out of India, let's say.
[00:13:23.450] - Stuart Podmore
Shifting five train loads of iPhone back to the US.
[00:13:27.830] - George Brown
Absolutely. There's there's been news of various other companies already starting to put tariffs into their pricing structure and having a separate line as well. That's certainly going to feed into Trump's approval ratings. But that uncertainty is clearly going to have an impact on hiring and investment. To the extent, we just don't know yet in terms of how severe that will be. But that uncertainty, even if we do get those extensions, even if we do get some resolution, that's not going to go away. That's probably now going to persist for the rest of Trump's term. That's going to be a big headwind for the US economy.
[00:14:00.450] - Stuart Podmore
I want to come back to you on China, but actually, I want to bring Bob in because I just wondered, is it possible, Bob, for you to give us a couple of sentences on what the mood is like? You're talking to a lot of those Russell 2000, Russell 2500 companies. You're picking those stocks. What do you hear?
[00:14:18.700] - Bob Kaynor
So I think what we've been hearing probably for the last month is that business is really on hold. Decisions are not being made around CapEx. Strategic decisions are just on hold. We talked to a number of our companies when this kicked off at the end of February and early March, and their hands were up, and it feels like everybody's taking a knee. And I think it's going to be really interesting when you go through earnings season, which is really just kicking off. I suspect that companies are just going to pull guidance. Our initial thought process was, how much risk is there to guidance? And I think they have an opportunity just to pull guidance altogether in the face of the uncertainty that we're seeing. So I think that that's the reality. I think there is a tremendous amount of volatility, but I also think we've all seen a few cycles. Our market was down 22 2% at it's worse. It's not exactly the time you're supposed to be taking a defensive position. I feel like that opportunity probably sailed a month or so ago. And so it really is, how are you going to capitalise on this?
[00:15:26.490] - Bob Kaynor
And the nice thing, or if there is a nice thing about these this highly correlated sell offs, is it creates opportunity. Companies get penalised just because risk is coming out of the market. And so there is an opportunity to upgrade and find better companies that are a little bit more protected in a period of significant uncertainty.
[00:15:47.660] - Stuart Podmore
I think that's a fair point. And I suppose when the Russell 2000 was down about 20% year to date, in very short, brief, simple language. Are you seeing that as a buying opportunity as a stock picker?
[00:16:06.160] - Bob Kaynor
I would say absolutely on the individual stock level. I think there is an increased amount of dispersion that you're seeing in terms of the way stocks are behaving or maybe the way they should be. So one of the things that we always look at is return on investment capital. And companies with very high return on invested capital are not really outperforming those with low return on invested capital. And for us, that's an opportunity to upgrade the portfolio, if you will. But I do think that when you see a market that's down 22%, which it was a couple of weeks ago, I think there's lots of opportunity there. And I know last week, I think the headline was, it was the best week in the equity market since November. I don't think anybody felt like it was the best week in the equity market in a long time. So I think sentiment is really negative, right? And the sentiment indicators are on a floor. And if you look at the University of Michigan consumer confidence numbers, there's cohorts of those respondents that are at COVID and great financial crisis lows. And I just don't think that's where we are, at least not yet.
[00:17:18.420] - Stuart Podmore
Right.
[00:17:18.930] - Alex Tedder
Can I add something?
[00:17:20.230] - Stuart Podmore
Yes, of course.
[00:17:21.600] - Alex Tedder
See, I agree with Bob. It's interesting because it's a two-way pull for me from a large-cap perspective because S&P earnings, the consensus is still assuming about 13% year-on-year growth for S&P earnings this year. It started the year about 20, 21% year-on-year. It's now come down to 13. That still strikes me as quite high, maybe. Maybe not. We'll have to see. But certainly the trend is downwards. The S&P is still trading at around 22 times earnings. So on that relatively elevated number, it's still trading on 22 times earnings. The long term average for the S&P is around 18, 19, depending on which time period you choose. So the S&P is still expensive versus its history and earnings are coming down. But to Bob's point, what's happened is that a lot of stocks are sold down and the good companies have sold down as much or more, in many cases, as the less good companies. So that could be an opportunity. I think it is an opportunity.
[00:18:23.030] - Stuart Podmore
It strikes me that it was only a few weeks ago at the Schroders Investment Conference when I was talking to you, Alex, about the Magnificent We've had a complete flip. The rest of the world, stocks in the MSCI, All Countries World Index, is now flipped. And 90% of those companies around the world are now outperforming the Magnificent Seven or have outperformed in recent weeks. So as a global investor, then, presumably, you've got your work cut out seeking those opportunities as a result of all that's happened.
[00:18:53.310] - Alex Tedder
You do. So the tariffs on electronics, the flip flopping, obviously doesn't help the Mag7. So let's be I'm sorry about that. But you're right. The Mag7 as a group I've done pretty poorly, actually for quite some time now. It's a very disparate group, but generally speaking, they've done really poorly, and some have done exceptionally poorly like Tesla. It just doesn't seem right. To Bob's point, these are great businesses. That hasn't changed. If we can have some confidence around the macro picture, the tariff picture, actually, these companies could start to do a lot better. We'll see, but that would be our base case. That's one aspect. And the other aspect is the simple fact that the rest of the world is still a heck of a lot cheaper than the US, which maybe we'll come on to.
[00:19:38.100] - Stuart Podmore
Yeah. Well, yeah, I think we will. We've had a question from Domendra, actually. I've got a very quick question for both Alex and Bob. Before I come back to George, it's pretty blunt, actually. Is US exceptionalism over? Bob, what do you reckon?
[00:19:53.960] - Bob Kaynor
I would say that the evidence would, at least the recent evidence, would say yes. When I look at all the major markets around the globe, Germany, France, UK, Japan, Australia, China, they're all outperforming every index in the US. Other than the Dow, actually, the Dow Jones is the best performing index in the US right now, which I find interesting. But yeah, and I think we were talking about it earlier before we went online. I think the relationship between the dollar and bond yields are significant and something that I don't think you can lose sight of. And if you I want the ultimate auditor on US exceptionalism, I do think it is the dynamic that you're going to play out between the dollar and bonds.
[00:20:38.910] - Stuart Podmore
Okay. I might come back to you on that one. But just Alex, US exceptionalism, the same question for you, or were you going to add something?
[00:20:45.840] - Alex Tedder
I never want to bet 100 % against the S&P. It is a lot of very good businesses there, and it's the deepest market, the most liquid market. There's a lot of opportunity in that market. But, to Bob's point, you have a currency that's working against you right now. I mean, the Euro is strengthening very materially. You also have expectations in Europe, in Japan, in China that are very low relative to the US. And you have valuations that are very low relative to the US. Take Europe, for example, probably trading on around 14 times this year's full year earnings compared to the US on 22 times. So at some point, that gap will close. I'm not saying it'll be.. What do you call it? Aligned. But you could see the gap closing further. And therefore, I think incrementally, it makes sense to move, if you're an asset allocator, to move some money away from the S&P into other areas. And that has been happening. I think that will continue.
[00:21:46.950] - Stuart Podmore
Well, I know for a fact, a multi-asset team is considered that.
[00:21:49.310] - Bob Kaynor
If I can just add on to that, because I think it's an important distinction that we've been trying to make in our asset class for a number of years. While the US is expensive, that is entirely a function of what's happening in the the large cap market. The Russell 2000, which is a small cap benchmark, is currently trading at 14 times earnings. So if you believe in the dynamism of the US markets, and it said it will continue, we'll obviously go through some short term machinations here. You can access the US market at the same multiples that you're accessing the rest of the world. And I think that's just something people lose sight of. There are two separate markets in the US. There is the large cap market, and there is everything else.
[00:22:27.960] - Stuart Podmore
That's a good point. I was going to come back to you, George. It seems the right moment just to come back and talk bond yields then and also just talk a little bit, and bob touched on this, the US dollar valuations and the weakening of the US dollar. Just explain a little as to what's been happening there for our audience.
[00:22:47.360] - George Brown
Yeah, it's a good question. To this point about, is it the end of US exceptionalism? Well, just as it is for the markets, it does seem to be for the macro as well, because this isn't some exogenous shock. This does seem to be... Well, it is a self-inflicted economic pain that they're going through, and it's going to hit the US the hardest. That's been reflected in, let's say, the dollar, which is down about 9%, and actually, when we're thinking about the economic impact, when I gave those numbers earlier, the 2% on inflation that's going to be higher as a result of the tariff as they stand today, 1% lower on growth. That does assume the regression is based on history, and that assumes that the dollar does appreciate, which it historically has done during these episodes. The fact it's going the other way means that inflation might be another of a 0. 5 percentage point is higher than that, so 2. 5%, and growth might be down 1. 25%, so another 25 basis points. Now, to the yields point as well, obviously, there are lots of different factors at play, and some parts of it are question marks over the fiscal sustainability of the United States, given that it's going down this road.
[00:23:50.170] - George Brown
There's also various technical factors, like hedge funds are being closed out of basis point trades, we won't go into that. But then obviously, there's this question as well about China's response. I think that's really interesting because China obviously holds a huge amount of treasuries. Directly, the tick data, it's the treasury data from the US, something like $760 billion, the last time I checked, is owned by China, but actually it probably owns more than that through clearing banks in Luxembourg and Belgium. That number is maybe close to $1.5 trillion. There's a risk there that if China were to sell down its holdings of US Treasury bonds, you could see a further rise in yields as a consequence.
[00:24:31.830] - Stuart Podmore
Yes. I suppose the impact on the capital account and that risk of capital flow could become more significant in the short term. That actually the demand or the financial flow into the US dollar will start to dry up a little in spite of its reserve currency status. It's so bizarre.
[00:24:50.570] - George Brown
Yeah. Obviously, for decades, for hundreds of years, the United States has enjoyed this exorbitant privilege and managed to fund its twin deficits through the kindness of strangers as Mark Carney, the now Canadian Prime Minister, used to say when he was the Bank of England governor. Yeah, it's an interesting dimension to this. Just coming back to this China point, though, I I'd say that to our minds, in terms of that risk materialising, I would put probably quite a low probability on China dumping its treasuries. Number one is it's a bit like shooting yourself in the foot because, of course, it's going to cause the value of China's assets to plummet as a consequence. Obviously, interest rates would rise quite sharply in the US. That's going to weigh down on US demand that's going to hit the Chinese economy in the process. But then you've got the question mark of what do you pivot into instead? Do you move away to other emerging market debt, for instance, or do you move into gold, which looks more likely? But it's difficult either way. But then on the other side of the equation, what could happen is the Fed could just restart QE as a consequence.
[00:25:55.870] - George Brown
The numbers I gave you earlier, $760 billion that China owns directly, It owns about that, presumably, if we're making some very generous assumptions in Belgium and Luxembourg, $1.5 trillion in total. Well, guess what? The peak of the Fed's balance sheet in terms of treasuries was 1. 5 trillion higher than it is today. We could go back to the pandemic peaks and purchase all those bonds if China was to sell. It just seems to be a zero sum game there.
[00:26:22.850] - Stuart Podmore
Okay. While we're on China
[00:26:23.950] - Alex Tedder
Can I ask George a question? Is inflating away effectively the federal debt, ultimately? Could that be an objective?
[00:26:30.020] - George Brown
I forget the number of the amount that TIPS makes up of the treasury market. This is the issue. I think it's something like 25%, I could be wrong. But this is the issue that this argument about inflating away the debt, people forget about the TIPS market, and that's a big part of that, and that adds the element. Then you've got the flip side of that on the yield front. If you've got inflation, it's higher as a result, then interest rates have to be higher as a result. No, I don't really believe in this argument about inflating the debt away, but you can get this fiscal financing, I think is the term for it, which is effectively what the Bank of England was doing at the peak of the Liz Trust crisis. It was lending a hand to the government, and that's certainly what you could see in the US if you're were to see a big, prolonged, and excessive period of treasury selling.
[00:27:19.460] - Stuart Podmore
But I just want to on the China side of things, I know when we had Trump one in the first presidency, and there was talk of of tariffs and a trade war with China at that point. There was a commitment from China to buy $200 billion additional US goods. It didn't materialise, but actually, the inflation print in the US didn't really change as a result of that. So what's different now?
[00:27:43.250] - George Brown
Yeah, that's right. So when we did the analysis, obviously, the trade war was just with China, it wasn't with the rest of the world. And so, yes, China was facing these much higher tariffs, but there was two responses that Beijing took. One was to devalue its currency, and that helped to cushion some of the blow. And that seems to be its strategy this time around as well. But the other part of its strategy, which might not be repeated this time, is it was able to reroute shipments. Let's say a good destined from China to the US, it might stop off on Vietnam along the way. They might have peeled off the made in China sticker, stamped it made in Vietnam. For all intents of purposes, it was a Vietnamese good, but realistically, it was a Chinese good. It circumvented the tariffs that way. But the fact that now the rest of the world is facing this baseline 10% tariff means that maybe that's not going to be quite as feasible. The administration also said they're going to clamp down on that. I'm not sure how they're going to police that. But certainly, if you've got 145% tariff on China, 10% on the rest of the world, there's still a big gap there.
[00:28:40.850] - George Brown
There's still some scope to use rerouting, but it's obviously not going to be quite as effective as it was in the past.
[00:28:47.210] - Stuart Podmore
Before I go back to Bob, actually, I just wanted... Glenn's asked a really good question, actually, about American tax cuts, because we did mention it. But do those tax cuts that have been proposed, potentially, especially, corporation tax reductions, do they negate the impact of those consumer price increases and associated sentiment? Do you think that that will... I think what Glenn's getting at here is, could we not be, or could we be more open to the idea of a stronger, wealthier US in five years time. I think we shouldn't dismiss that. We shouldn't dismiss it. Yeah. Okay.
[00:29:20.220] - George Brown
So medium term, it could be a positive benefit. Like the Tax Cuts and Jobs Act of 2017, these are the big tax cuts by Trump. These have clearly, although they faced a opposition from the Democrats at the time, realistically, they're going to back them this time around. That has been a positive force for the US economy, clearly. But in terms of the near term impact, I don't think it's going to be enough to, let's say, prevent the US from falling into recession. But longer term, coming back to this point that Bob and Alex are raising about long term US prospects, actually, that could be a continued positive dynamic for the US.
[00:29:58.120] - Stuart Podmore
Thank you for that, George. Now, Bob-Sorry.
[00:30:01.540] - Alex Tedder
I may-Yes, Alex. Because the positive scenario, I think a lot of these deals are going to be done with the quid pro quo that the country where Trump takes the tariff away or reduces the tariff invests more directly in the United States. We started to see that. You have Novartis the weekend announcing that they set up a huge new facility in the US, billions of dollars in new capacity directly in the United States for production. Nvidia talking about reshoring it's a super computer manufacturing directly into the United States. You're going to see, I think, a lot of deals that will bring capacity back into the US, and they could ultimately be pretty positive for the economy. So I think there is method in the madness. Do you know what I mean? It's just the timing to George's point.
[00:30:50.150] - Stuart Podmore
Bob, would you agree with that? Do you see in your space at the moment, in your universe of stocks, do you see companies starting to consider that reshoring aspect here?
[00:30:59.310] - Bob Kaynor
Yeah, I think we've actually been under, I don't want to call it a manufacturing renaissance, but probably for the past 15 years, we've started to see a reshoring, near-shoring initiative, certainly around the Tax Cut and Jobs Act there was a lot of incentive to do that. And it was interesting, there's the carrot and the stick. In the first Trump administration, it was more carrot. In the second, it feels like it's a little bit more stick. But we are seeing that. We are seeing increased manufacturing coming near shore or on onshore. I think one of the interesting pieces is, do we have the labour? We're going to have to modify our immigration policies if we're trying to bring all these jobs back because you can do the math. And I don't think we have the people to build the factories. So we will see how that plays out over time. But the onshore and near-shoring is something we've been seeing. But the reality is, even with that, we do have a global supply chain. And so whether you're a small-cap company or a large-cap company, your supply chain is global. And that's, I think, what we're trying to navigate right now.
[00:32:04.930] - Stuart Podmore
And while I'm with you, Bob, could I just ask as well around any... You mentioned dispersion earlier, and we talked about the stock-level dispersion, but I just wondered if you're getting a sense for the audience about any sector dispersion that might be of interest. Are you looking at any particular sectors that might be beneficiaries here, that you identified?
[00:32:26.300] - Bob Kaynor
Yeah, and I'm interested to hear Alex's take, because I think that has been the initial knee-jerk reaction from the market, at least in equities, it's to go to the safest places. You've seen staples, you've seen utilities outperform, but you haven't seen that distinction within particular sectors, if you're an industrial company, you're considered at risk. And wherever you are in the industrial supply chain, you're getting repriced along with everything else. And that's where I think the opportunity is. I think the initial reaction from the market has been very much, if you're going to stay in equities, reallocate to the classic defensive part of the market. But Alex, I'd love to hear your perspective on that as well.
[00:33:12.390] - Alex Tedder
Yes, you're absolutely right, Bob. That has been the classic knee-jerk reaction every time there is this economic slowdown or potential economic slowdown. And in this case, it happened very, very quickly. If you think about January, that was still a great month for growth. It was a great month for technology. It It was a great month for anything related to better than average return on capital. And yet in the following months and weeks, we've seen a classic about face towards stocks that are defensive and sectors that are defensive, tobacco being a case in point. I think that right now, the opportunity is beyond those sectors. To your point, I think it's within industrials because there clearly will be a lot of beneficiaries. And within technology, To give an example, if a lot of manufacturing capability is going to come to the US, whether it's Taiwan Semi or NVIDI or whoever, they're going to need lithography in the US. ASML is a great company based in the Netherlands. That is obviously a leading supply of lithography equipment. It's been a very poor performer for some time over tariff worries in China and all the rest. But actually, there's a bull story that says there's a whole new leg to the demand for for lithography equipment that really isn't priced in at this point.
[00:34:33.070] - Alex Tedder
So I think it speaks to Bob's point is that actually now is the time, painful as it feels, to look at some of these areas that have been hit really hard.
[00:34:42.020] - Stuart Podmore
Because Graham, actually, in the audience has said, well, he thinks that Trump is in do or die mode. And I'm not asking you, Alex, to look into the mind of Trump. I don't think any of us can do that. But he says, well, if you're going to force this reshoring process, it takes a while. We discuss reshoring as if it's the easiest thing in the world, But actually, Graham's point here is you're going to run out of time. And when do you start doing that? When do you not start doing that?
[00:35:09.050] - Alex Tedder
I'm sure it's a mess. But look, this is the issue, which is, and this is what we're all dancing around and struggling with, is the short term versus the medium term. I mean, on a short term basis, there is 8 to 10 % downside in the S&P, right? If the tariff stuff just goes the wrong way and there aren't any agreements and the data starts turning down, which I think it might, confidence is definitely turning down, then we could have another pullback in the market for sure. So that is a concern for all of us, very difficult to hedge and expensive to hedge if you want to do it fully. So clearly, you want to stick with some of these defensive names. But at the same time, you want to be looking ahead and finding those opportunities that have been sold down around the world quite aggressively based on the whole tariff uncertainty. So I think it's a combination of both. I know that sounds easy, and it's not, but that's what we're paid to do as active managers.
[00:36:08.480] - Stuart Podmore
Yes, absolutely. Now, I want to come back to you, George, because we talked a little bit about China previously. We're going to be running towards the end of this broadcast shortly, but I just wanted to ask a little bit more about Europe, and in particular, the idea that the impact that this might have on Europe's economies, what also might be the implication for the ECB policy rate and policymakers in Europe, and how that might continue or extend the opportunity that we've seen, definitely in European equity, particularly European value equity. So what are your observations? Because we've had a couple of questions here from people about what an opportunity is there for Europe? What does this mean for the dumping of cheap stuff onto the markets? We're all thinking in China here. What's your view?
[00:36:56.180] - George Brown
Stolen my thunder with that last bit there with the dumping of goods. So If we look at where the reciprocal tariff was supposed to be 20% on the EU, but now they're going to be 10%. At the time when we ran the numbers on the reciprocal tariffs at 20%, it was going to be a hit of 0.3 to 0.4% on European growth. Now, that's going to roughly half with the 10% baseline tariff. There's an argument there for the ECB to start to cut rates, especially though, because even before Liberation Day, we had the tariffs on automobiles, and obviously, that's a big, big component of EU exports, not just obviously concentrated in countries such as France, Germany, and Italy, but right through the supply chain as well, through other countries and services as well. Then, as you rightly point out, on the flip side of that as well, or in addition to that, the risk is that we get this dumping of Chinese goods, and especially with tariff rates at 145% being imposed the US on China. There's certainly a very elevated risk that China just floods the market with cheap goods, and especially electric cars as well.
[00:38:00.640] - Alex Tedder
You're already seeing that in the UK, aren't you?
[00:38:02.530] - George Brown
We're massively seeing it. The UK has imposed, I think it was last year, car tariffs on Chinese electrical vehicles to offset some of that dumping. We could get some tariffs that go on to try and offset that. But what I thought was interesting is that you are seeing some companies now as well just hiking prices globally. So Sony, for instance, are hiking the prices of its PlayStation console globally. In response, well, they haven't quoted the tariff. It's very clear that it's something like exchange rate movements and uncertainty. But clearly, that seems to be challenging that notion that you might get deflationary pressure from the tariffs. But in terms of what it all means for ECB policy, clearly there's clearly an opportunity there for them to cut rates more aggressively in response. Whereas if we compare it to the Fed, let's say, they're between a rock and a hard place. Yes, you're going to have the hit to growth and it It could be a recession. But at the same time, Bob rightly pointed out that you've got the inflation expectations from the Michigan survey now, the highest since the 1980s.
[00:39:08.580] - George Brown
That puts them in a really difficult predicament as such that they're probably not going to be able to cut rates, at least from our perspective on the Schroders economics desk.
[00:39:17.300] - Stuart Podmore
Two further questions that come out of that, which I just want to raise as well. Just on China first, do you see the playbook changing at all for China? Some people have said, Well, might this be the moment when through the loosening of fiscal policy, that China really makes a commitment to domestic consumption, or do you think it'll just go the usual route?
[00:39:39.440] - George Brown
Yeah, it's hard to see how it would try to encourage that. One issue for China that has plagued consumption is there's got a very high savings rate. I'm not really sure what the authorities can do there. Maybe they can increase the Social Security net, but there's clearly a cultural barrier there to reducing that saving rate. But that's something they could tackle there. But in terms of what... I think from China's perspective, really the game, or at least the ultimate objective, ought to be reducing these tariffs as soon as possible. That would be the best possible outcome. It comes back to that phase one agreement that was agreed between Trump and China in 2020, which is they were going to buy 200 billion extra worth of US goods. Maybe striking some deal along that line and buying more US, investing more in the US is probably the best course of action for China to take rather than hunker down and try and weather this, the best result is clearly going to be, how do we get Trump to come to a negotiating table and get a deal that gets these 145% tariffs down?
[00:40:39.920] - Stuart Podmore
Best guess on economic growth? Can I hold you to a forecast for China in 2025?
[00:40:45.910] - George Brown
Probably not, no, because the China Economist is away, but clearly, the forecasts are under review. For the US, at the very least, I think we're looking at calendar year growth of 1% for this year. To give you some perspective, before all the tariff announcements, we were assuming 2.5% growth. That's a big downgrade on that. But if you get a recession, it's easily going to come down to not 0. 5% or 0% for the US.
[00:41:09.340] - Stuart Podmore
We've heard a lot about the political relationships. I don't want to get deep into politics here, but the political relationships. A lot of people have been comparing and contrasting the Mexican President, Claudia Scheinbaum's response to Trump versus that of Mark Carney in Canada. I just wondered, how do you anticipate Europe might play this with with the US?
[00:41:31.310] - George Brown
Yeah, so the European response is more difficult because, of course, they all have to come together in a unified response. Obviously, Trump is trying to pick them off. That is the leaders individually. We're seeing Meloni, for instance, going after the White House on her own, trying to get Trump to make some concessions. I think the European response is going to be more challenging versus, let's say, the US in terms of how they retaliate. But I think what is clear is that there will be some unified response in terms the fiscal response. There seems to be definitely some, while there are disagreements on how to retaliate against the US, there's clearly seems to be some consensus there amongst European leaders that some fiscal stimulus will be needed if you do get a big tariff war with the US.
[00:42:16.510] - Alex Tedder
Well, above and beyond what Germany is already...
[00:42:20.140] - George Brown
Precisely. The defence spending that Germany is going to unleash is going to be a huge, huge benefit. But I think that's more of a medium-term story rather than short-term. But it's interesting about how that's going to play out as well, because we're talking about these deals that can be struck. The deal for the EU and the US seems to be on the LNG front, liquefied natural gas. Natural gas. Natural gas, sorry. But also on defence spending is clearly somewhere where Germany and other European nations could be appeasing Trump by purchasing more defence equipment from the United States.
[00:42:55.320] - Alex Tedder
I'm sure that is part of the deal.
[00:42:56.770] - Stuart Podmore
Okay. That's interesting. You think that as well. Is that something you've looked at?
[00:43:02.290] - Alex Tedder
Ultimately, pragmatism will prevail. It has to, because otherwise, looking at an end to the current world order, I just don't see that happening. So my base case is 10% probably sticks. I think we probably end up with 10% tariffs, and we end up with a bunch of deals where Europe buys more from US. So I think it does settle down. It's just the speed at which it settles down. It's a big question.
[00:43:23.610] - Stuart Podmore
Well, look, we're getting close towards the end of our broadcast today. Thank you very much indeed for those audience members who've sent in questions. I think if you want to start as a collection of guests thinking about how you might summarise what we've talked about, and indeed, maybe slip in the odd prediction, if that's not too much to ask. I think I might come to you first, Bob. In a way, maybe answer this question, because this is a great question. Is there a scenario where the US prospers here?
[00:43:58.380] - Bob Kaynor
Yes. I think we're I think there is a little bit of a painful rebalance that's going to occur around global trade. I do think that when you go through these periods, historically, you can look back over time, and there's usually either a fiscal or monetary response. And I think George laid out why it's unlikely you're going to see the Fed come in and save the day. The fiscal response is a little bit harder. I think the off-ramp looks more like a series of deals and negotiations with trading counter parties that you can see play out over time. I recognise that what happened last week, I think it was Wednesday, challenges that a little bit. But I do think it's the fiscal response, if you will, that we're going to see is going to be a little bit more measured. It's not going to be a big bazooka. It could be. Trump's very unpredictable. But I think that's the working order from our mindset. But I think ultimately, you go back over time. I mean, you can hear politicians on the right or left talk about how the US tariff system is unfair and things need to change.
[00:45:10.520] - Bob Kaynor
So I think Trump's doing what he believes is right for America in the long run, it's going to be very painful. And I think one of the realities that we didn't touch on is that he's got a very narrow window here to make these changes, which is why it feels so chaotic for everybody, both companies that are trying to manage businesses as well as us who are trying to to manage money.
[00:45:33.520] - Stuart Podmore
Well, thank you for that, Bob. I think for you, if I could come to you, Alex, as that global equity point, and also weave in maybe a final question from Wolfgang, which is if you were taking European investor's perspective here, would you go US small mid-cap with Bob or multinationals? I think I know what your answer is going to be.
[00:45:54.330] - Alex Tedder
I'd do both. i do both, for sure. And that is the point slightly is it's so fluid, the situation. There's clearly, I think any investor has got to look at the bear case, which is extremely negative, which is a fiscal issues, debt issues, deficit issues, the whole thing spiralling. That would be extremely negative for global markets. There's a bull case, which is an accelerated process of adjustment.
[00:46:27.530] - Stuart Podmore
Yes.
[00:46:28.000] - Alex Tedder
Neither of those is very likely. To Bob's point, the most likely aspect is a central aspect of a muddle through with deals, and eventually, you get to a situation that's stable. In that environment, the only thing you can do as an equity investor is to look around for those areas that have been unfairly neglected or where expectations are very low. You have those in US small cap, you have those in Europe, definitely, you have those in Asia, too, for example, in markets like Japan. That would be my approach.
[00:46:55.770] - Stuart Podmore
Combined with your insight into earnings and the forecasts for earnings, For sure. Which is where you often find anomalies you can exploit. Absolutely. Okay. Maybe the final word for you, George. We started with you. Are we going to finish with you? Can you leave us with one or two sentences about the future under these circumstances?
[00:47:17.260] - George Brown
I can do. Maybe I'll start with the glass half full and I'll end with the pessimism, which is probably the wrong way around. But the attention that's going to turn to in the second half of this year is very much on the tax cuts. There's certainly some good news to look forward to on that front. I think there could be something that's being underpriced by the market at this stage, and that could be that positive catalyst. The downside is that the midterms are next year, and that after that, Trump looks very likely to lose his majority in the House. That's just history. The midterms are rarely kind to the President. That's right. What happened during Trump's first term after the midterms, when he was hit very, very hard and lost his majority, is that then he did things that he didn't require Congress to do. What was that? It was the Trade War, it was Tariffs, and he could turn his attention to immigration as well. I would say that we've maybe got some positive news to maybe come through later this year, maybe early next year, but the flip side is after the midterms as well, we could see, again, this aggressive Trump come through, at least on the protectionist front.
[00:48:25.860] - Announcer
That was the show. We very much hope you enjoyed it. You can subscribe to the investor download wherever you get your podcast. And if you want to get in touch with us, it's schroderspodcasts@schroders.com. And you can find out much, much more at schroders.com/insights. New shows drop every other Thursday at 05: 00 PM UK time. In the meantime, keep safe and go well.
[00:48:50.330] - Announcer
The value of investments and the income from them may go down as well as up, and investors may not get back the amounts originally invested. Past performance is not a guide to future performance. The information is not an offer, solicitation or recommendation of any funds, services or products, or to adopt any investment strategy. This pod is marketing material issued by Schroder Investment Management Limited. Registered number, 189-3220, England. Authorized and regulated by the Financial Conduct Authority for informational purposes only. Please contact your financial advisor before making any investment decisions..
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