And so, it begins!
Donald Trump’s Presidential victory heralded the return of headline risk thanks to his off-the-cuff comments – nor has he changed his love of tariffs, or his method of communicating them (social media), which unfortunately has added unnecessary volatility to global financial markets over the valuation period (5 October 2024 to 5 January 2025).
However, we believe that, as we saw in his first Presidency, his bark will be worse than his bite with the threat of tariffs only being used as a negotiating tool rather than being implemented at the levels he has indicated (60% on Chinese imports and 20% on everyone else).
Additionally, as he likes to remind everybody about the strength of both the US economy and the US equity market, and how low inflation was during his first term, an aggressive trade war would prevent a repeat of this.
This is because tariffs he is proposing are effectively an inflationary tax on US imports, which could slow US economic growth as higher import costs will reduce consumer spending power (especially if the US central bank, the Fed, increases interest rates to ensure that this inflation doesn’t become embedded); and is likely to dampen business confidence and capital expenditure.
That isn’t saying we don’t believe tariffs won’t be imposed, just that we don’t believe they will be imposed at the debilitating rates he has proposed, as moderate tariff rates are unlikely to have a significant impact on economic growth.
It hasn’t just been Donald Trump that has been exhausting to follow.
Out of nowhere, South Korea’s President Yoon Suk Yeol, declared martial law. Although this was later rescinded and the President was impeached, the fact that this happened to a country that is not just home to companies such as Samsung and Hyundai, it also has around 24,000 US military personnel stationed there!
Similarly, the dramatic collapse of the Assad regime in Syria highlights how fluid the geopolitical landscape remains.
The French government also collapsed last month – but thankfully, while the high drama optics were fascinating, the financial implications were limited.
However, that has not been the case in the UK. As we indicated in our last valuation commentary, numbers 10 & 11 Downing Street talked the UK economy into a contraction with their constant downbeat, black-hole rhetoric as Gross Domestic Product (GDP) readings for both September and October 2024 were -0.1%.
Unfortunately, these GDP readings could deteriorate further after Chancellor Rachel Reeves’ Autumn Statement raised taxes by £40bn and increased spending by £70bn, with the shortfall being funded by increased government borrowing (via the issue of gilts).
With these tax increases predominately coming from higher employer National Insurance contributions, we are likely to see higher inflation (as companies pass these higher costs back to us by way of higher prices – which in turn could delay UK interest rate cuts) and higher unemployment (and thus slow economic growth) as companies make redundancies.
However, of greater concern to us is the level of gilt issuance needed by the government, coupled with the fact that gilt yields have risen sharply since the Autumn Statement. Even though Rachel Reeves relaxed the rules on UK borrowing to provide more fiscal headroom, as gilt yields have risen, gilt prices (which move inversely to the yield) have fallen – and consequently her fiscal rules could potentially be breached resulting in further tax increases and/or cuts in government spending.
Furthermore, as the gilt yields impact the cost of other lending products, we could see the cost of mortgages increase and the economy contract further just as we did in 2022 following Liz Truss’ mini budget.
On a positive note, this has resulted in a weaker pound. For example, since the Autumn Statement the pound has fallen from $1.30 to $1.24 against the US dollar – and what is bad for the pound is good for the FTSE-100. This is because around two-thirds of the FTSE-100’s total revenue is derived from abroad, and so a weak pound increases returns for exporters and the value of overseas earnings. Consequently, despite the fiscal uncertainties, the FTSE-100 has held-up reasonably well over the valuation period (down 0.68%), versus South Korea (martial law) which fell 4.97% over the same period; France (political uncertainty) -3.44%; and China (potentially the biggest casualty from tariffs) which dropped 11.3%.
In summary, while we remain optimistic on the outlook for financial markets in 2025 given the macro environment, it is very unlikely to be a tranquil year.
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