Equity investors seeking clarity should be careful what they wish for

Reuters

4 hours ago

LONDON, June 23 (Reuters) - Financial markets famously hate uncertainty, but getting answers to many of the open questions currently hanging over markets may end up offering investors little comfort.
Several recent global developments, including President Donald Trump's April 2 tariff announcement and subsequent 90-day pause as well as the breakout of the Israel-Iran war, have sparked some of the highest levels of uncertainty in decades.
If recent U.S. stock market performance is anything to go by, investors seem convinced that everything will work out just fine.
Investors will likely get more clarity on several of these issues in the coming weeks, but they may find that this optimism is unwarranted.
On July 9, the 90-day pause on Trump's Liberation Day 'reciprocal tariffs' will end, and unless the delay is extended or multiple trade deals are struck, U.S. import tariffs will essentially double from the 10% level today.
So far, only the UK has managed to agree on a trade deal, and, even here, there is little clarity about the future of tariffs on UK steel exports. Negotiations with the European Union and Japan have stalled, and the EU has prepared a range of potential retaliatory measures.
At the same time, the U.S. Commerce Department is preparing to present its findings on investigations into semiconductors, pharmaceuticals, copper, aircraft, jet engines and a host of other goods, opens new tab. It is widely expected that once these findings are presented, the U.S. government will act quickly to impose additional tariffs or import restrictions.
Meanwhile, the Senate is expected to vote on the Trump administration's budget bill in July. The Congressional Budget Office has estimated, opens new tab that in its current form, this bill will add $3.3 trillion in extra debt over the coming decade.
Investor confidence in the dollar and the safety of U.S. Treasuries has been shaken recently, partly due to the country's deteriorating fiscal outlook, so this deficit-expanding budget will only add fuel to the fire.
And now, the war between Israel and Iran has been thrown into the mix, with the U.S. attacking Iranian nuclear sites on Sunday. Oil prices have increased by roughly 10% since the war broke out, though the price as of June 20 was still in line with the 2024 average. After the U.S. attacks, we could see Iranian retaliation against oil fields in the Middle East or the all-important Strait of Hormuz, which could drive oil prices much higher.
With all these moving parts, it is easy to lose sight of what matters right now and what doesn't. While many actions, such as the extension of the 2017 tax cuts in the budget bill, will take years to unfold, the rise in tariff levels could have an immediate impact.
The tariffs currently in place (e.g., base tariffs and tariffs on steel, aluminium and autos) could add 0.9 percentage points to U.S. inflation over the next 12 months, as importers are forced to pass tariff costs on to consumers. If there are no additional trade deals struck and tariffs revert to the higher levels announced on Liberation Day, another 0.7 percentage points could be added. And that doesn't even include potential tariffs on pharmaceuticals, semiconductors, and other goods.
The inflation impact from the budget bill will likely be much smaller at roughly 0.1 percentage points over the next 12 months, and an oil price spike to $80 per barrel is apt to have roughly the same impact. Only if oil prices spike to about $100 and remain in that region for the next six months would we have to be seriously worried about an inflation shock from the war in the Middle East.
Of course, if all these developments, including a 20% oil price spike, come to pass, U.S. inflation could rise from current levels by up to two percentage points in the next twelve months, dwarfing the likely impact on the UK and euro zone.
Despite these concerning figures, U.S. equity investors seem nonplussed. U.S. stock markets, perhaps banking on another TACO moment, have rallied 15% above the level justified by macroeconomic fundamentals, based on my estimates.
Over the last 10 years, a deviation of this size was followed by an average decline of 7% in the S&P 500 in the subsequent three months. The gap between performance and fundamentals is smaller in the euro zone and UK, suggesting any mean reversion would be less extreme there.
Now, it's possible that everything – from the trade war to the real war – will end well. And stock markets have an uncanny ability to ignore adversity for a long time.
However, if much of this uncertainty is resolved negatively, resulting in either higher U.S. inflation or lower growth, U.S. equities' surprising resilience is likely to be challenged.
(The views expressed here are those of Joachim Klement, an investment strategist at Panmure Liberum, the UK's largest independent investment bank).
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