Recession or no recession, that is the question…

They say a week is a long time in politics, but in the case of the new US administration, that should probably be re-framed to a day is a long time in politics. Trump and his team are certainly ruffling some feathers in investment markets.

Last week, just a few hours after Trump announced he would slap a 200% tariff on European alcohol and Champagne, we spoke to one of our partners in the global food and beverage industry, and the resounding feedback was it’s impossible to do business in an environment like this. Quite amusingly, Trump did also announce that policy would be “great for US Champagne businesses”. Champagne of course being strictly from a French domain. There is no champagne industry in the US – just sparkling wine like in most countries. Similarly, we’ve heard stories from a number of business sectors that are facing equal measures of uncertainty resulting in a sharp drop off in commitments to projects until Trumps tariff trading abates.

Uncertainty is the key word really. Although we don’t hear about it much, tariffs are a very normal policy response to protect domestic economies, and as a result tariffs are in regular use across many nations. So, it’s not the idea of further tariffs, but the size and speed at which they are announced, and then often rolled back. Businesses who are part of any form of global supply chain will then find it much harder to make decisions, affecting suppliers and customers, so both investment and consumption stalls.

We kind of knew it was coming as well, right? In fairness, a key part of Trump’s campaign was based around ‘protecting American workers’, and as we saw from his first term, tariffs are his main tool. But step back to January, and markets, especially in the US were not really pricing any downside or risk of a global trade war. They have now started to, with the US equity market in particular falling more than 10% since the end of January.

Just quickly touching on our portfolio positioning, we have not followed the rest of the market by becoming more and more US central. In contrast, we know how important diversification and consistency is to not over-expose our clients to one particular risk, and so although we came into the year with some US exposure, it was blended with exposures in all other regions, including the UK and EU which have so far benefited from flows out of the US. In addition, as a team, we became increasingly cautious of the US market in January as pricing became extremely optimistic. We reduced our equity exposure several times across the first two months, primarily from the US, and built portfolio cash levels. We will cover this more in this month’s portfolio review, but throughout March the portfolios have been positioned defensively.

Now the trillion dollar question– will this policy uncertainty cause a US-led recession? In addition to the trade challenges, for extra context it is worth remembering that we have had restrictive monetary policy (interest rates that are substantially above inflation) for some time. Historically this has been a precursor of a growth slowdown/recession, as in this environment, businesses and consumers are incentivised to save overspend. In addition, there are a number of sectors vulnerable to a growth slowdown. Auto manufacturers for example, are already in the process of making redundancies and shutting manufacturing space given the challenging trends in the electric vehicle market. All that isn’t to say we now think we are heading for a recession, but more that the risk of one has certainly increased, and that requires a different portfolio approach to the last two years.

Now one key positive is that higher interest rates provide central banks with room to stimulate economies (by reducing them). If the Bank of England announced they were reducing rates from 4.5% to 2%, mortgage rates would fall significantly and provide a significant consumption boost, surely enough to stop a recession becoming significant in depth or length. In reality, they are unlikely to act this month or next month, and will likely wait to see if cracks arrive, which may never happen by the way, but the point here is if they do, policymakers can act fast and support the system.

From a markets point of view, this all provides an interesting backdrop from which to invest. In the short term, we are cautious, aware of the economic risks and we are currently positioned defensively. Bonds will perform very well if growth slows further, and therefore they provide an insurance policy in the current environment. In the meantime, they are paying a strong income yield into our lower risk portfolio’s. Even in our Medium to High and High Risk Portfolios we have added bond and cash positions, which have already been beneficial. We plan to stay defensively positioned for the coming months, with the portfolios continuing to benefit from the strong underlying income streams which will provide protection if economies slow faster than is currently priced in.

Then at some stage, likely towards Q3 this year when we expect inflation data to regain its trajectory towards lower levels, we will likely add more risk and become more positive again. Ultimately, cutting interest rates is the only tool policymakers have to avert a recession, as debt levels are simply too high to print more money as they did during Covid. We therefore will look to any market volatility to seize opportunities to buy great assets at cheap prices. Just as we did in 2020, and 2022, our objective is for the portfolios to come out the other side of any challenging period better than they went in. Perhaps a recession will never arise, but either way it is likely to be a busy few months ahead, for all businesses not just us!