Following a chaotic first quarter for geopolitics and stock markets, things got even more disorderly in early April following Trump’s ‘Liberation Day’ tariff announcement. The correction in global stock markets, having initially begun in February, has gathered further steam in the aftermath of the announcement.
A new era
We are cognisant of the new era that the world has found itself in, with geopolitical alliances shifting, the US at its most isolationist for more than 80 years, and protectionism and nationalism on the rise. The change is profound.
At the same time, though, quality businesses have a long history of weathering political and economic adversity and can be remarkably adaptable to change. Investment in national economies will also be crucial in the coming years with the goal of driving better growth and resilience.
Structural trends include the need for investment in digitalisation and automation, research and development, healthcare, upgraded infrastructure and industrial facilities, and improved energy efficiency and security. Portfolio companies are well placed to meet these needs.
Though times are changing, there is also much about the current phase of stock market upheaval that is familiar. As panic sets in, time horizons shorten and share prices become mesmerizing.
The last week has been reminiscent of the first phase of the Covid sell-off, with across-the-board selling as investors shoot first and ask questions later. More than ever, remaining calm and objective and focusing on the fundamentals of business analysis is crucial.
We find our own analysis – as well as the conversations we have with companies, analysts and experts – particularly grounding through such periods.
US import tariffs – the bottom-up view
We divide the portfolio into three broad categories:
No US imports: Companies that generate little or no revenue from the US, and companies that are selling services rather than ‘stuff’. Digital and data analytical companies, for instance, such as RELX, Experian, LSEG and Sage fall into this category, as do domestically exposed names such as Howden Joinery and Integrafin.
Limited US imports: Examples include specialist distributors, engineering firms, and healthcare companies (although most pharmaceutical products are, for now at least, exempt from tariffs). In general, these companies do not import a great deal into the US – they tend to have a predominantly local-to-local sourcing and manufacturing footprint. Specialist distributors Bunzl and Diploma, for instance, source more than 80% and 90% of their US sales domestically. Where tariffs have an inflationary impact on input costs, pricing will be used to help offset the impact.
More significant US imports: The holdings with the more significant US imports are the luxury goods holdings, Games Workshop and Diageo. These companies make up around 10% of the portfolio. We visited Games Workshop in Nottingham last week, and management is relaxed about tariffs. The company imports the products it sells in the US from Nottingham. Gross margins on the products are more than 70%, which means that – at the UK’s 10% tariff rate – it will need to raise prices by 3% to protect profitability.
Diageo is potentially exposed to import tariffs via the Tequila, Canadian Whisky and Scotch it imports into the US from Mexico, Canada and the UK. It also imports a small volume of products from the EU. With the Canadian and Mexican USMCA exemptions being retained last week, the new tariffs will only impact Diageo’s imports from the UK and EU – a welcome relief. As with Games Workshop, the high gross margin structure (60% for Diageo) will help pass these tariff costs on. Analysts expect a small (c.3%) impact on company earnings as a result of these new tariffs on the UK and EU.
The economic impact
Leading indicators for the US economy have fallen sharply over the past few weeks, as tariff uncertainty has risen. US consumer sentiment has dipped as worries about higher inflation and a slowing economy grow.
For businesses, the issue is as much the willy-nilly implementation of the tariff framework as the absolute amount being levied, with everything still open to negotiation and liable to change.
The temptation for CEOs is therefore to press pause for now on major investment and hiring decisions until a clearer picture emerges. This situation is somewhat reminiscent of the first few days of the pandemic lockdown, when the world collectively held its breath and waited for the next steps to unfold.
Hugh Yarrow is portfolio manager of the Evenlode Income fund. The views expressed above should not be taken as investment advice.