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The British have a reputation for loving underdogs. The flip side of this is that we also enjoy seeing the mighty have a wobble. And there’s nobody mightier than the US president.
The investment consensus in London has been consistent with the dinner party consensus: President Donald Trump is a bluffer and his tariff threats are hollow; therefore our portfolios should hold few US equities.
The US court rulings this week, the first finding the bulk of Trump’s tariffs to be unlawful followed by the reprieve on appeal putting this decision on pause, have only added to the schadenfreude. Perhaps the president missed the issue being outlined in rap in the musical Hamilton: it was, after all, only a central matter in the new constitution since independence had been triggered by tax and tariff issues.
Whether this should have come as a surprise or not, the only important issue is how investors ought to respond. Should we carry on diversifying away from the US and piling into European stocks?
It’s the kind of sentiment that does well at dinner parties, but I have found that you shouldn’t let your dinner party views determine your portfolio — at least not without good reason.
Firstly, Congress taking a greater role in tariff policy may alter the path, but not the direction. After all, it followed a firm line with China, escalating under the first Trump presidency, but one which continued under Biden. And trade disagreements between the US and EU predate even those with China.
So we could end up with increased tariffs whatever happens. And even a modest increase can play havoc with companies’ operations.
If the current 10 per cent tariff on European exports to the US remains, or is increased slightly, the EU may choose to ignore it, or it might mirror them, raising the price we pay for US made goods.
In an attempt to get my head around US tariffs, I tried to add up how much stuff I buy was made in America. It doesn’t amount to all that much — and a 10 per cent price rise due to tariffs would probably mean I substituted some local equivalents. Maybe I have shown myself as being a non-Bourbon drinking, non-Harley riding bloke who no longer looks good in jeans, but I am not alone.
Tariffs are only part of the reason investors are switching from the US into European stocks, of course. There is also the budget situation, the perceived lower valuations and a belief that the US is a less reliable place to invest than it has been. But investors switching out of the US and into Europe face one major hurdle — the shorter list of companies with interesting growth potential.
Not surprisingly, European defence stocks have led performance. I doubt that anyone will be sending a thank-you letter to JD Vance, but his calls for European nations to boost their own defence spending have brought the bloc together on security policy in a way that Putin didn’t manage.
That said, the larger European defence companies sometimes seem to make the kit of past wars — tanks and battleships, rather than drones and cyber attacks. Given how far the shares have risen, one needs to select stocks which will see significant new orders.
Nearly a quarter of the European equity index is made up of financial stocks. European banks are enjoying the higher interest rate environment.
But the extra income they receive from higher lending rates will seem modest compared with any rise in bad debts from the companies they lend to. And even a middling-bad tariff outcome is likely to bankrupt quite a few
As we started from a situation where US equities seemed significantly over-represented in global indices, even a modest reduction in US allocations has left a lot of money looking for a home. Having money burning a hole in fund managers’ pockets is always a worry.
The good news is that, for longer term investors, a number of Europe’s top stocks from the 2010s have been poor performers in the 2020s. I should know — my funds own them. What they have in common is that they were premium rated for their China business five years ago, but the China slowdown since then has both slowed their growth and led to lower valuations for the stocks.
From Louis Vuitton to L’Oréal to Schneider, large European companies have focused on China rather than the US over the past decade and we own all three. There are now signs that the China property slump is past the worst, and the People’s Bank of China policies to restore confidence, announced a year ago, are having an effect. Chinese consumers could use some of the product that the US does not want to receive and China seems no longer to be buying so many US bonds.
Thinking back to the European property crunch in 2008-9, it is worth investing in strong companies whose businesses have coped with the problem years, but being wary of weaker companies which may have made cuts to survive. Although L’Oréal is quite a pricey stock, its US rival Estée Lauder might find any US-China tariff outcome harder to handle than it does.
Lastly, it’s worth mentioning that tariffs might not be the main market drama of the summer.
That might come from Republicans in the Senate who have objections to Trump’s tax giveaway and its impact on US debt. We have already seen the president “pause” some tariffs when 10-year bond yields hit 4.5 per cent — we are back there again and longer-dated bond auctions are struggling to sell around the world.
The argument is that the tax cuts will lead to stronger growth in the end. Some will take the view that this gives the US a longer-term growth story absent from Europe; others will think they heard this before from Kwasi Kwarteng.
If you wish to let off steam about Trump and his diplomatic style, it would probably be no challenge to arrange a dinner party for like-minded guests. Then, in the morning, you can get back to investing in the best companies regardless of their country of origin.
Simon Edelsten is a fund manager at Goshawk Asset Management