Quick Thoughts: Trump tariffs and what investors should consider now

On Wednesday, April 2, US President Donald Trump declared a significant moment in American history, asserting that his widespread tariffs on global trade would "restore America's wealth." However, the announcement of the highest tariffs in a century led to a swift decline in risk assets, culminating in nearly a 10% plunge in the S&P 500 Index as of the end of the week.

On Thursday I sat down with a panel of our senior investment professionals to get their reaction to the tariffs, the implications for markets, and what they anticipate going forward. The following summarizes key takeaways from Sonal Desai, Ph.D., Chief Investment Officer, Franklin Templeton Fixed Income, Scott Glasser, Chief Investment Officer, ClearBridge Investments, Andrew Ness, Managing Director, Franklin Templeton Emerging Markets Equity, Blair Faulstich, Managing Director, Benefit Street Partners, and Chris Galipeau, Senior Market Strategist, Franklin Templeton Institute.

Macroeconomic implications

While the tariffs are significant, our consensus is that a recession in the United States is not a foregone conclusion. But growth will slow globally. Our panel believed that the economic impact of tariffs will likely be asymmetric, less on the United States and significantly more elsewhere. Other countries, particularly those whose economies are more dependent on exports, are at greater risk of recession. The US economy, with its US$30 trillion size and only about US$3 trillion in exports, is better insulated. Nevertheless, uncertainty caused by tariff and other disruptive policies can and probably is curbing economic activity.

Despite some likely slowing of growth, Sonal Desai continues to expect a single interest-rate cut from the Federal Reserve this year, in part because inflation will move higher due to higher import prices. Still, she does not expect the increase to be dramatic or long-lasting.

Contrary to market consensus expectations, the US dollar has not strengthened with the tariff announcement. We believe that may be due to Germany's fiscal stimulus package, which has made the euro more attractive, as well as because of a backlash against the Trump administration's policies. Sonal feels that the dollar, already overvalued, is likely to weaken further.

Private markets

In the aftermath of the November 2024 elections there was a bout of euphoria in the merger and acquisition (M&A) markets, with expectations for a robust 2025. Trump’s tariff policy uncertainty is already curbing some of that optimism. Activity in the first quarter was considerably slower than anticipated. Tariff uncertainty has made it difficult for companies to price risk and to make investment decisions. Even businesses without direct import-export dynamics look to be affected.

Blair Faulstich noted that disruption in public markets can often be beneficial for private markets. With less appetite from banks to take on risk, especially in leveraged buyouts (LBOs), companies are more likely to turn to private markets for financing. This shift can create more opportunities for private credit investors. Despite some erosion in the syndicated and leveraged loan markets, there hasn’t been what could be considered panic selling, indicating that the market appears to still be relatively stable.

Equity markets

While equity markets are generally good at anticipating and discounting future events, the announced tariffs were far higher than expected, leading to this week’s significant selloff. Nevertheless, the panelists agreed that the tariffs, alone, are unlikely to push the United States into recession. Still, they may cause a 1%-2% hit to economic growth, while boosting inflation this year by 0.5% to 1%.

Scott Glasser feels a diversified portfolio with a quality bias, favoring stocks with steadier cash flows, will be best positioned to weather the storm. Investors are likely to rotate toward defensive sectors. International stocks and dividend-paying stocks also look attractive.

Regarding potential retaliation, countries in the European Union (EU) might target US services, including big tech and banking. The EU's Digital Services Act, which aims to limit the power of US tech companies, could be employed as a retaliatory tool.

Emerging markets

In the short term, tariffs are expected to reduce earnings and corporate margins in emerging markets. However, the market reaction has been more nuanced than anticipated. Asian markets have outperformed the US market, and Latin American markets, such as Mexico and Brazil, have shown resilience. This suggests that while the immediate impact is negative, the long-term effects are more complex. The potential for shifts in global capital flows, driven by a weakening dollar, could lead to increased investment in emerging markets, according to Andrew Ness. He noted that their research has shown these markets to be under-owned by international investors and offer appealing valuations.

China has been preparing for the impact of tariffs for some time. Despite the high tariffs China's share of global exports has increased, and the country's policymakers have incorporated the impact of additional tariffs into their deficit and funding plans. On Friday, China also responded with retaliatory tariffs.

Chinese companies have been pivoting away from US exports, as evidenced by the share of US imports from China declining in recent years. The relevance of US exports to China's gross domestic product has also decreased. While some exports may be routed through other countries like Vietnam and Mexico, Chinese companies have been diversifying their markets and reducing their dependence on the US economy for some time. This resilience and strategic adaptation suggest that emerging markets, including China, may present long-term investment opportunities despite short-term challenges.

More uncertainty ahead

Companies will need time to adjust to new tariffs, and though a US recession remains unlikely, our panel felt a slowdown is unavoidable.

Volatility is unsettling but it also creates opportunity. We think there are opportunities arising. Specifically, we focus on diversification and company quality as keys to navigating volatile and uncertain market environments.

Sentiment measures are at historic lows, which indicates a favorable risk-reward ratio for investors who can accept near-term volatility. The risk for equity and credit investors is a further ratcheting down of earnings estimates.

In fixed income, short-duration, high-quality portfolios look attractive. Municipal bonds, with potential tax advantages and good credit quality, are worth considering. High-yield bonds with minimal duration exposure are also appealing.

Overall, we favor a balanced approach, focusing on quality and active management.