Deciphering a week of dramatic moves

The last several trading days have been extremely volatile for global markets, with US President Donald Trump unveiling a harsher set of tariffs than expected on “Liberation Day”.

The S&P 500 index in the US fell 10.5 per cent in the two days following the initial announcement.

We’ve only seen a move like that a few times in the last 80 years – during the worst days of the pandemic in March 2020, in November 2008 during the GFC and in October 1987.

It’s been slightly calmer since then, but investors are still on edge.

If sustained, the proposals would equate to the largest US tax hike since 1968 and would see the average US tariff rise to the highest in more than 100 years.

These moves are aimed at eliminating bilateral US merchandise trade deficits, but they’ll also put upward pressure on prices and stifle economic activity.

The effect will potentially be magnified by retaliatory trade barriers, supply chain disruptions and falling confidence.

It is impossible to predict what this means for the global economy as we don’t know whether we’ll see an escalation (as has been the case with China) or if negotiations will take place to lessen the impact for some.

So far, higher growth stocks (like the “Magnificent 7”) have been hit hardest, in part due to their exceptionally strong performance in 2023 and 2024.

This makes them a natural source of funds for investors looking to take some chips off the table.

Other industry groups have fared better.

Longer-term interest rates have fallen as risk aversion has taken hold, with the US 10-year Treasury yield dropping below four per cent for the first time since October.

Similarly, the New Zealand five-year swap rate ended last week under 3.5 per cent, the lowest since March 2022.

These moves have seen bonds and fixed income rise in value, partially shielding investors with diversified portfolios.

Interest rates could easily go lower if things worsen, so fixed income could still offer some attractive opportunities, despite yields having fallen.

Markets have also moved to expect more rate cuts from central banks.

The OCR is now seen falling to 2.75 per cent by the end of the year, while four cuts of 0.25 per cent are expected from the Federal Reserve in the US.

I can see the OCR starting with a two, but the Fed will need to balance slowing growth against higher US inflation.

The NZ dollar has provided another important shock absorber for local investors in recent days, with the currency falling to around $0.55 against the greenback.

The NZ dollar typically performs well when global growth prospects are strong, commodity prices are well-supported and sentiment is positive.

When things move in the other direction, it is often one of the first to fall.

That gives a boost to our export sector, while it can offset weakness in international assets for domestic investors.

Should the outlook or risk sentiment deteriorate further, the currency will likely go lower.

As for global sharemarkets, the outlook is finely balanced.

The S&P 500 in the US ended last week down 17.4 per cent from its February peak, not far from bear market territory (a decline of 20 per cent or more).

If a US recession is to be avoided, the market is likely oversold already and due for a bounce.

However, if America is headed for a severe or prolonged downturn, there’s more downside to come.

This is where it gets extremely difficult for investors.

Up until now, the US economy has looked very solid, with unemployment at low levels and corporate earnings growing at a healthy clip.

Inflation had been brought under control and while the Fed was on hold, that was due to a robust backdrop (rather than rampant price pressures) and its next move was still likely to be down.

Many of those positive characteristics are still in place, and it’s unlikely we’ve past the point of no return that makes a recession inevitable.

However, if the tariffs remain in place (without any negotiation or a softening in stance) or even worse, if we see further retaliation, all bets are off.

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