Investors Come Around to Trump’s Uncertainty
Are the effects of geopolitical and tariff uncertainty on the economy still to come, or were they overestimated?
Uncertainty is usually the enemy of investment. This year not so much. Twin uncertainties about tariffs and whether President Trump will honor U.S. security guarantees have prompted governments and companies to pour money into defending themselves, helping stocks.
For now.
The biggest change is geopolitics. Doubt over Trump’s commitment to protecting Europe led the European Commission to permit extra borrowing for defense, with Germany adding 500 billion euros, equivalent to $588 billion, for infrastructure on top of boosting military spending by more than 1% of gross domestic product. Far from hurting stocks, investors were delighted that Europe in general and Germany in particular are pouring government money into the economy, and share prices soared in anticipation of fat profits ahead.
“We might look back and say the geopolitical uncertainty was what Europe really needed to get their act together,” said Vincenzo Vedda, chief investment officer at Germany’s DWS.
Markets are anticipating big improvements in Europe, led by defense stocks. The Stoxx aerospace and defense index has just had its best six months ever, leaping 54% in the first half of the year—and 74% in dollar terms.
In the U.S., meanwhile, the impact of tariffs was blunted or delayed, or both, as companies stocked up on imports before the extra taxes were imposed. As a result, inflation has been under control and close to target, coming in below forecasts in both April and May. After an initial nasty selloff when the biggest tariffs were announced, stocks have fully recovered, helped by Trump’s delay to most tariffs and a few trade deals.
The question for investors is whether the effects of geopolitical and tariff uncertainty on the economy are still to come, or were overestimated. Here are three possibilities:
Uncertainty came back down. Markets think they have the measure of Trump. Stocks have rallied in part because the big selloff forced Trump to delay most tariffs, and he retreated from punitive tariff levels on China after it withheld vital minerals.
Next week we get Trump’s self-imposed deadline for countries to do a deal or face the much higher so-called reciprocal tariff rate. So far only the U.K. and Vietnam have agreed to provisional deals, and both could still face new import charges on sectors including pharmaceuticals, copper, timber, aircraft and trucks where pre-tariff investigations are under way. Few believe he will simply reimpose crippling tariffs when, as seems likely, deals aren’t cut with every country in time.
Markets might, of course, be wrong. According to the daily trade-policy uncertainty index compiled by academics Scott Baker of Northwestern and Nick Bloom and Steven Davis of Stanford by analyzing newspaper articles, uncertainty remains extraordinarily high. Sure, it spiked higher in March and April, but on Wednesday it remained higher than at any time before Trump took office. It was its 16th-highest day since its 1985 start, with all previous 15 higher days being in the past four months.
Uncertainty did hurt, but showed up only in the dollar. Investors and governments outside the U.S. have been notably less keen on American assets both when stocks fell and when they rebounded, and the greenback had its worst first half since the Nixon devaluation of 1973 (though it has had worse six-month periods at other times of the year).
In dollar terms, foreign stocks beat U.S. stocks by the most in the first six months of a year since 1993. Still, if an effect of the geopolitical uncertainty is better policymaking and more growth in Europe, the higher global demand should help American companies too.
Uncertainty will hurt, in time. Faced with policy uncertainty, CEOs typically hold off making critical decisions, which should depress corporate investment.
“You cannot commit to long-term investment when the rules of the game are not clear,” said Claudio Irigoyen, head of global economics research at Bank of America. “[But] it’s going to take time to see it. We’re not seeing the effects of uncertainty on capex yet. We’re not seeing the effects of tariffs on inflation yet.”
Purchasing managers surveyed by the Institute for Supply Management, who are on the front line of tariff uncertainty, appear to agree. In the latest survey one called the situation “hellacious.” This comment attributed to a tech-sector executive was typical: “The erratic trade policy with on-again/off-again tariffs has led to price uncertainty for customers, who appear to be prepared to hold off large capital purchases until stability returns…Operations has planned additional weeks of downtime at multiple plants to accommodate reduced orders.”
The argument that tariffs mean higher prices and slower growth is virtually the same as it was in April, before the market went into rapid-recovery mode. It is easy to see why investors have tired of waiting for the bad news to appear in prices or profits.
Even if uncertainty does delay corporate decisions, the economic impact may be obscured by the boom in spending on data centers for artificial intelligence. That could take up the slack from delays or cuts to other long-term investment projects. Equally, delays to new projects as chief executives wait for policy clarity take time to show up, and while it might feel like an eternity to anyone whose job involves tariff rates, it is only five months since Trump took office.
The scale of uncertainty helps explain the stark divide between bulls and bears. Bulls look at how the economy’s been doing, and say all is good: Corporate investment is high (thank you, AI), spending is still decent, profits are great and growth looks OK.
Bears look at the effects of uncertainty in the confidence surveys and other “soft” data and fear that weak consumer and corporate sentiment will eventually show up in lower spending, profits and growth.
I suspect the tariff effects will come through into at least some inflationary pressure and weaker growth, and I’m less confident than investors are that Trump will fold whenever he faces tariff pushback. Most of all, with U.S. markets back at highs and again so highly valued, it feels like a decent time to take some money off the table. Uncertainty won’t be a good thing forever.