Fresh stock market records despite tariff turmoil

The sharp equity market declines following Trump's tariff announcements in April, which he framed as an act of "liberation", have now been almost entirely recouped. In many countries, even new all-time highs or at least new highs for the current year were reached in recent weeks.

• On the one hand, the markets have come to believe that only a fraction of Trump's announcements will actually be implemented and that the effects are likely to be rather limited.

• On the other hand, capital is now flowing (back) out of the US in increasing amounts, and net-net hardly any fresh capital is flowing into the US financial markets, in sharp contrast to recent years.

This, in turn, is putting pressure on the US dollar, and a weaker dollar has usually been supportive for equities and bonds in Emerging Markets in the past. This seems to be the case this time around as well, but of course that does not mean that this tailwind will necessarily continue, even if the dollar continues to weaken (which seems likely).

Economic impact has been manageable so far

Both the US economy and the economies in China and Europe have so far been largely unaffected by the tariff caprices (although plenty of one-time effects and distortions call for caution when assessing the data). However, most analysts assume that negative effects and economic slowdowns will emerge to some extent in the course of the year, especially as no trade deals have been materialised so far with the USA's most important trading partners. However, they do not foresee a global recession or a severe downturn, and the financial markets are certainly not pricing in anything of the sort.

China: Fairly decent growth, but...

China, undisputedly the main target of Trump's tariff attacks, has so far surprised with slightly higher GDP growth, but beneath the surface, the familiar problems of the past years are all too evident:

• The real estate sector continues to act as a drag, and

• in some areas of manufacturing, overcapacities are obvious.

• The latest inflation data from China underscore the problems in the manufacturing sector. They showed a sharp decline (deflation) in producer prices and only a very slight increase in consumer prices.

• In spite of claims to the contrary by a number of observers, private consumption in China keeps growing. However, it is growing at a slower pace than Beijing would like and, above all, slower than would be needed to offset the possible loss of foreign demand (primarily from the US, but possibly also from Europe).

Nevertheless, real GDP growth of 4.5–5% is likely for 2025. However, that figure on its own says little about the quality of this growth – but this applies to all countries, not just China.

Are Local currency bonds poised for a comeback?

After being largely shunned by foreign investors in recent years, Emerging Market local currency bonds are showing signs of a comeback. This applies not only to their performance this year, but also to capital flows, which have shown significant net inflows in recent months for the first time in a long time. Of course, this could just be a flash in the pan and a short-lived trend.

However, there are a number of reasons and indications to believe that local currency bonds could perform well in the coming quarters and possibly years, especially against the US Dollar and US dollar-denominated bonds. First, many Emerging Market currencies are fundamentally cheap. Second, the weakening dollar is providing central banks in Emerging Markets with leeway to cut interest rates. And if there is a significant global economic slowdown, this would support bond markets in general. However, it is important to note that even in a positive market environment, careful selection of currencies and issuers remains essential.

Stock market rally with question marks

Emerging Market equities would then see upside potential from interest rate cuts on the one hand but headwinds from disappointments in earnings on the other. Earnings growth in Emerging Markets has recently been driven primarily by companies in the technology, media, and telecommunications sectors, while most other sectors have seen little or no earnings growth. On the positive side, however, there are signs that profit margins have bottomed and could be on the verge of an upward trend.

Less demand from the US?

In this context, it remains to be seen how severe any decline in demand for goods and services in the US will be, not only as a result of tariff increases, but also of potentially slower growth in government spending than under the Biden administration. Opinions differ widely on the latter, namely regarding the impact of Trump's recently passed tax and spending bill (the One Big Beautiful Bill Act, or OBBBA). Some analysts see further high deficits (which would boost growth), while others foresee declining budget deficits (which would slow economic growth). If global growth slows more sharply, this will weigh on the profits of most companies, not only in industrialised countries but also in emerging markets and would imply headwinds for the stock markets. On the positive side, however, interest rate cuts could then have a supportive effect.