US Markets Learn a Lesson in Uncertainty
Parallels to post-Brexit Britain and how valuations look today
At the end of January I wrote that US markets were priced to perfection – and yet:
…at the helm of all this is Trump. You can argue that the bark is worse than the bite, that they’ll be a lot of chest-thumping on tariffs and borders without a lot of action. It will be the NAFTA renegotiations all over again.
I’d argue that we just don’t know – and that that uncertainty is not fully reflected in valuations right now. Markets seem to be placing a lot more weight on actions that could be good for growth as opposed to ones that could be bad.
Well, sentiment shifts quickly. Fast forward six weeks and all talk of low regulation and lower taxes has been overwhelmed by concerns on how tariffs will impact the US economy, and how a slash-and-burn approach to government spending could crater consumer confidence, while removing a major source of stimulus over the last decade. And although Trump has bottled following through on the most punitive tariffs, and cuts to government spending remaining a rounding error on the total budget, the uncertainty of itself has had a chilling effect.
Consumer confidence is weakening quickly, and the stock market is tumbling, if not in free fall quite yet. Worldwide reciprocal tariffs are set to be imposed from April 2 and both Trump and the Treasury Secretary, Scott Bessent, have made comments around accepting some economic pain.
And it’s this final point in particular – the justification of economic damage for the sake of a greater good – that reminds me of the UK’s own recent experience of policy uncertainty and what this might mean for the US.
In June 2016 the UK voted to leave the European Union but without a clear plan for doing so. What ensued was several years of political upheaval in which various forms of trading relationship were floated. We all heard a lot about the impact of tariffs and regulatory barriers, but few of us fully understood the intricacies of customs unions or rules of origin. Certainly not me, or the politicians battling over it.
In the end it took three and a half years following the referendum vote for the UK to officially leave the EU in January 2020, and it was only a few months before then that the terms on which it would leave became clear.
Yet although the terms of the UK’s trading relationship with the EU didn’t materially change until January 2021 (after a transition period post withdrawal ended), the impact on business investment over the previous four years of uncertainty was stark. After plummeting during the financial crisis, UK business investment rebounded between 2010 and 2016. But after 2016 it went sideways, and today it is barely above 2016 levels (noting that Covid has a major impact, but this applied globally).
There was no actual change in the UK’s relationship with the EU until January 2020, but the referendum in 2016 – and the uncertainty over what that meant - had an immediate and real impact on business decisions. Time and again the refrain from UK business was, we can adjust to whatever the outcome, but we can’t plan and make decisions until we know what that outcome is.
And what I think we’re seeing in the US now has parallels with this Brexit experience in the UK. It’s not the economic policy in and of itself, it’s the uncertainty over what the end outcome might be, and the sense that economics will be subsumed to a wider political purpose. For true Brexiteers, any economic damage was a fair price to pay for the prize of leaving the EU. For the true tariff, and the true government is evil believers in the US today – and Trump seems one of them – economic damage is a fair price to pay for the prize of US self-reliance and a smaller federal government.
Now, before I get too carried away, the US is not the UK. It’s a $25 trillion economy in which trade accounted for 25% of GDP in 2023, versus a $2.7 trillion one in which trade accounted for 64% of GDP. As we prefaced many pieces of advice when I was at the Treasury, “the UK is a mid-sized open economy that can’t do XYZ and is more exposed to XYZ and so on…” The US is a mega-sized economy that has long benefitted from a massive domestic market, has the world’s reserve currency, and even pre-Trump could basically do what it wants.
It was only last week that TSMC said it was planning an additional $100 billion investment into the US. It was only a month ago that tech giants were announcing plans to spend over $300 billion in AI-driven capex investment this year. The US stock market has still unequivocally trounced other major global markets over the last decade.
But that stock market outperformance takes me nicely back to where I started this post. The US may have some exceptional qualities, but US asset prices have undoubtedly reflected this. The US has been priced for perfection – how much is it still true after the last few days?
Well, the S&P 500 has come back down to earth, and the forward P/E ratio now sits at just above 20. That’s less dizzying than the 25+ levels hit at the end of February but hardly cheap…
Meanwhile, credit spreads remain close to lows seen before the financial crisis…
And the ‘equity risk premium’ – comparing the earnings yield on the S&P 500 to the 10-year Treasury yield – is back above zero but hardly at historical averages…
The overall picture is that valuations don’t look too different to 12 months ago and don’t look that cheap. Yet confidence in the US, its economic policy, and its global credibility, has fundamentally changed. All of which is to say I think this correction could have further to run.