Please see below, this week’s Monday Digest from Tatton Investments Management:
Europe First?
A dramatic week in global politics ended with Chinese and European stocks outperforming the US, the dollar falling back and gold prices soaring. This unusual constellation of trends points to economic sentiment re-evaluation – and perhaps declining confidence in in US institutions.
US consumer inflation unexpectedly increased, pushing back expectations of the next Federal Reserve interest rate cut. The retail sales data was better pointed to decreasing inflation pressure, but the Fed will be nervous about sticky inflation. That coincided with investment flows out of the US. The longer this goes on – especially for big tech stocks – the more likely it will trigger negative momentum trades. US investors are less buoyant, but this hasn’t yet spread to consumer confidence. Inflation and government disruption could change that, though.
European stocks benefitted massively remarkably – even though Donald Trump’s negotiations with Putin are considered a nightmare scenario by European politicians. Investors see an end to the war as good for Europe, and recognise that growth is already improving. Higher European defence spending could support growth further, since it will have to come out of fiscal expansion. This applies to the UK too, even though the Office for Budget Responsibility (OBR) removed Rachel Reeves’ fiscal headroom and while she promised discipline regardless. Reeves will be aware that OBR forecasts came before last week’s rate cut, and surprisingly positive Q4 growth.
Rallying gold prices could be a sign of investor fears. One explanation for this – explored last weekend in the FT by Nobel-prize-winning economist Daron Acemoglu – could be declining faith in US institutions. Anecdotally, we are hearing that wealthy Americans are concerned about Trump moving fast and breaking things.
These concerns might mean higher gold demand, a weaker dollar and US bond yields moving above elsewhere. If we squint, we can see those trends now, but it’s too early to say and they can be explained by many factors. Still, long-term investors should not dismiss the signs altogether.
China’s stars align
Investors have turned positive on China again – with Hong Kong stocks up 16% over the last month. It’s worth remembering how negative China sentiment was as recently as September, when many deemed the sluggish economy “uninvestable”. The government’s autumn stimulus promises stemmed the capital outflows and boosted domestic stocks, but Beijing’s record on demand-side stimulus has been mixed since. That is unsurprising, given the communist party’s ideological focus on production. Chinese stocks went sideways into the end of 2024, as the fundamental problem remained: will the party allow them to profit over the long-term?
Low-cost AI DeepSeek at least shows where profit could come from. Chinese tech stocks rallied 25% over the last month, following an apparent “Sputnik moment” in the US-Chinae tech race. A key part of shaking the “uninvestable” label is that domestic Chinese seem happier to invest in their own stocks. The old savings model relied on unstable shadow banking and an inflated property market, and it seemed that the government wanted to make property less attractive while encouraging equity ownership. That may beis happening, but it still remains to be seen whether profits get locked up by Beijing or sanctioned by Washington.
It helps that the communist party wants to lead the tech race and won’t want to upset the investment flows it needs to do so. That has eased investors’ concerns about capital controls, and so too has the fact that Trump seems much more concerned with trade imbalances than geopolitical rivalry. The signs are looking good for Chinese stocks – but optimism should be tinged with caution. Trump might not care about geopolitical rivalry but many in his orbit care deeply. President Xi may allow tech profit for now but this could turn the moment big tech clashes with the party’s priorities. For western investors, Chinese optimism should always be cautious.
Will tariffs work?
Donald Trump likes to threaten tariffs as a negotiating tactic, but he clearly thinks they are viable policies too. Economists usually disagree, but the case against tariffs isn’t as simple as sometimes presented.
The tariff question is the one that began modern economics. Leaders used to think that international trade was zero sum, but Adam Smith – the father of classical economics – argued trade could be mutually beneficial. David Ricardo underpinned those arguments with theory, and critiqued Britain’s corn law tariffs in the 19th century. Smith and Ricardo’s ideas still underpin free trade organisations like the WTO today, but pro-tariff arguments have always been around. The most common is the idea that tariffs protect infant industries. US President William McKinley used this to argue for sky-high tariffs at the turn of the 20th century. Trump is so fond of McKinley that he (re-)named Alaska’s a highest mountain after him.
The WTO maintains that tariffs are universally bad, but even they acknowledge the ‘infant industry’ argument and make allowances for developing countries. Empirical evidence suggests tariffs damage a country’s long-term economic output, but that they can also boost short-term production and growth. You can’t really apply this infant industry argument to the US, though; it’s the largest economy in the world.
Still, the output argument probably misses the point of Trump’s tariffs. Voters favoured them because globalisation hasn’t rewarded the average citizen – even if it’s boosted aggregate profits and output. Trump doesn’t wants to address this discontent without old-school redistribution, which might upset the capital-owning winners of globalisation. But trade barriers will curtail growth and, in the end, hurt capital owners and steelworkers alike. What’s more, trade protectionism tends to create the conditions for oligopoly, rent-seeking and corruption. Trump doesn’t seem to be worried about those social effects, but they might be the real legacy of his tariffs.
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Andrew Lloyd
17/02/2025