Investment and risk implications of Trump’s Liberation Day

The Trump administration’s tariff decisions on so-called Liberation Day are a hallmark of new US economic policies that are re-shaping the investment landscape.

Tariff developments portend a range of investment risks that investors must navigate carefully. From market volatility and rising consumer prices to sector-specific challenges and recession fears, the implications are wide-reaching. We believe investors need to prioritise diversification, downside protection and nimbleness to create resilient portfolios in this ever-evolving economic backdrop.

Read also: Multi asset: investing in a period of tariff-induced uncertainty

The ripple effect of tariffs

Tariffs have a way of creating ripples that affect markets, consumer behaviour and overall economic growth. On the one hand, tariffs can be used to boost the size of the US manufacturing sector. On the other, tariffs unfortunately elevate uncertainty, which has a negative impact on household and corporate spending decisions. Tariffs also potentially harm corporate earnings as companies experience higher production costs.

Uncertainty may have declined modestly in recent weeks, but the next step is for tariffs to begin to adversely affect corporate earnings over the coming quarters. Combined with the risk of retaliation, this is typically bearish for the S&P 500 index.

The implications for markets and investors

The implications of the new trade regime are manifold.

Market volatility. Most importantly, the latest US tariff announcements and the reciprocal actions by other governments will temporarily increase market volatility. Historically, such announcements, especially if they contain unanticipated elements, have caused considerable upheaval, triggering capital flows that can send stock prices into a tailspin. The uncertainty that accompanies tariff discussions tends to heighten anxiety within the market, making it crucial to stay informed and prepared for market fluctuations.

Inflation and performance. Investors must consider the impact that expectations of tariffs are already having on consumer prices. If history is any guide, the implementation of reciprocal tariffs could lead to higher costs for a variety of consumer goods, ranging from electronics to automobiles. As importers pass these costs onto consumers, consumer spending – an essential driver of economic growth – could take a hit. A decline in consumer sentiment may further dampen economic activity, which in turn could detract from investment performance.

Growth impact. The potential for reduced economic growth is another critical factor. The Centre d'Études Prospectives et d'Informations Internationales has already predicted that new tariffs may exert downward pressure on the US economy¹. Such a scenario could create a negative feedback loop where diminished investment leads to lower growth, further eroding investor confidence, leading to diminished investment etc.

Diversifying sectors. Certain sectors may bear the brunt of these tariffs more than others. Industries that heavily depend on imports from targeted countries – such as automotive and electronics – could face significant challenges, in our view. This prompts our portfolio managers (PMs) and risk managers to reassess our positions in these sectors and consider diversifying our investments to mitigate potential losses.

Global trade relations. The broader implications for global trade relations also weigh heavily. The possibility of escalating trade tensions and retaliatory measures from affected countries could complicate investment decisions in a world already facing geopolitical uncertainty. As investors, we must remain vigilant about how geopolitical and trade developments might impact our holdings of multinational companies, as they may be particularly susceptible to these changes.

Recession risks. Finally, we cannot ignore the increasing recession risks that accompany these tariff announcements. Goldman Sachs suggests a 35% chance of recession and Moody's Analytics estimates a 40% likelihood within the next year depending on the patch of tariffs and other factors.

A precarious economic juncture

The economic landscape appears precarious.  As investors take steps to safeguard portfolios against a potential downturn, we believe the best risk approach is to:

• Reduce risk
• Hold more cash and
• Be prepared to take advantage of investment opportunities if they arise.

Depending on the strategy, it may be appropriate to focus on higher-quality bonds in less impacted countries and sectors. In other strategies, it may be suitable to reduce exposure to US growth factors. The use of options to hedge or profit from volatility may be fitting in other circumstances.

Staying nimble

At LOIM, our ethos is to respond to the lack of clarity by remaining nimble and adaptable, however the tariff developments play out. We also remain aware that specific announcements may create openings, such as the opportunity for some of our strategies to buy bonds with wider credit spreads to add risk.

In short, we believe investors should stay nimble.