MC Explainer: Why Stock Markets Are Crashing. Understanding Trump's Tariff Policy and Impact. What Investors Should Do.

President Trump has signalled a dramatic shift in US trade policy, targeting what he sees as unfair trade imbalances. His administration has proposed a 50% cut in the US trade deficit, which stood at $1.2 trillion in 2024. The key measures and objectives include:

Higher Tariffs: Raising import duties on a range of goods, particularly from China, Mexico, and even traditional allies like Canada and the EU.

Reshoring Manufacturing: Encouraging US companies to produce domestically by eliminating tariffs on U.S.-made goods. Manufacturing accounts only for 10% of US GDP currently.

Devaluing the Dollar: Aiming to weaken the dollar to make American exports more competitive.

Discouraging Financial Investment: Shifting focus from Wall Street to Main Street, discouraging stock market investments in favour of real-world infrastructure and job creation.

Stock Market Impact: Why Are Investors Panicking?

The financial markets have reacted negatively for several reasons:

Earnings Pressure on U.S. Tech Giants

The so-called "Magnificent 7" stocks (Apple, Microsoft, Google, Amazon, Nvidia, Tesla, and Meta) account for 37% of the S&P 500. There are at least three concerns here. One, companies like Apple have significant manufacturing outside of US. China accounts for 50% of iPhone manufacturing. High tariffs will make these costlier when imported into America. This additional cost will have to be passed on to consumers or they will need to take a hit on their earnings.

Two, almost all the US tech companies operate in global markets with EU being one of their main markets. While services are not part of Trump’s tariff hikes, Europe’s strategy to counter US will be to hit their services business, primarily technology and financial services. For instance, EU is already contemplating a one billion dollar fine on X for spreading disinformation. In a trade war situation, these companies will be at the receiving end of the economic war initiated by Trump.

Third, the inflationary pressures created by the tariff hikes might keep interest rates high which is bad for valuation of tech companies.

Fourth, if global trade slows due to higher tariffs, these companies—heavily reliant on international markets—could see their earnings decline. Possibility of US recession will also hit them.

Weaker US Dollar Strategy

Usually, uncertainty tends to make investors flee back from the rest of the world to the US dollar. This time it is indeed different because devaluing the dollar is part of Trump’s overall strategy, to attract foreign investments into the US.

The serious intention to cut the trade deficit also signals a weak dollar. Central banks and asset managers would look for options to diversify their assets, reduce dollar exposure.  Investors are reassessing their holdings, leading to capital outflows from US financial markets.

Global Slowdown
If major economies retaliate with their own tariffs, global trade could slow. Economists suggest the tariff hikes will make businesses wary of investing because of lack of clarity on pay-offs from manufacturing from different global locations. Investments account for about 10% of global GDP. A 10% reduction will shave-off 1% from global GDP. US economy too faces a threat of slowdown, some analysts say. Apart from growth, it will impact sentiment.

Bond Market Instability

While there are likely to be fewer foreign buyers for US debt, US treasuries are a safe haven for local US investors. Risk-aversion is causing investors to flock to treasuries away from equities. This has brought down treasury yields, and also drained liquidity from stock markets.

Impact on India: A Double-Edged Sword

While U.S. protectionism disrupts global markets, India stands to benefit in some ways, though not without risks.

Why India Could Gain:

Redirection of Capital Flows: Foreign investors held $31.3 trillion of assets in US financial securities as of June 2024. Of this, $17 trillion is in US equities and 12.5 trillion in Long-term Debt Securities. Some of these assets will look to realign given a weakening dollar is now a reality, and Wall Street is not particularly Trump’s priority. India’s structural growth story will find takers. While tariff and associated risk to global growth is estimated to shave-off 60 basis points from India’s GDP, the impact is much less than other countries as because of domestic growth drivers.

Rupee Appreciation: If the U.S. dollar weakens too much, and the rupee appreciates, foreign investors math around India returns will change. A 3-4% depreciation in the rupee created a higher hurdle rate of returns for India. If this equation is reversed, high valuation will be acceptable for the foreign investor to that extent.

Export Advantage in Key Sectors: Indian economy stands insulated on a relative basis as the country’s trade surplus with the US for 2024 was -- $45 billion as opposed to most other countries like China, Korea, Vietnam, Taiwan or others which are highly reliant on exports to the US. India has also seen the lowest tariff increases compared with these countries. The relative change in tariffs make India more competitive in areas like textiles, apparels, footwear and electronic manufacturing and so on. This has a flip side, hold on.

Cheaper Imports Because of Weaker Dollar: India’s merchandise imports amounted to $897 billion for 2024. A weaker dollar (and a stronger rupee) will make our imports cheaper, which will be blessing.

Manufacturing Boost: With Western firms reluctant to invest in China due to geopolitical tensions, India could attract manufacturing investments, aligning with its PLI (Production Linked Incentive) scheme, which has already pulled in $20 billion in committed investments. But, this will still need to be evaluated in the new global context where most countries may want to put measures in place to prioritise local investments. American companies too will reevaluate manufacturing not between China Vs India, but US Vs India.

Potential Risks for India:

Continued Foreign Selling: The Indian stock market has already seen foreign institutional investors (FIIs) withdraw $3 billion in March alone, reflecting short-term nervousness. Foreign Institutional stake in Indian equities has come down from 32% at the peak to 17% thereabouts currently. A bulk of the FPI money that flows into India comes through Emerging Market Funds which will likely see outflows because there are serious economic headwinds across major Emerging Markets. With a 15% weightage in EM indices, India will see proportionate selling when this happens.

Competitive Pressures: The main threat to India are not direct impact of tariff but the second and third order impacts in terms of how other countries respond the Trump tariff. One, a significant part of global capacities are committed to the US, since it is the biggest consuming market.

China runs a total merchandise trade deficit of $992 billion, of which with US alone it is $360 billion. If these capacities get redirected (dumped) to other markets, it will flood the world with cheaper goods, which will be a threat to local industries. This is where government intervention may be required. But it will be a hard path to tread.

Two, countries may also engage in competitive devaluing of their currency to make themselves more competitive. It’s hard to predict how these will play out for our industries.

How Should Investors Navigate This?

Focus on Domestic-Oriented Stocks: Companies reliant on domestic demand, such as banks, FMCG, and infrastructure firms, may be safer bets. However, investors need to be conscious about valuations.

US Tech: US tech is a bad place to be in. They will be prime losers both from Trump policy as well as retaliation from Europe. Valuations are not supportive. High interest rates, which are likely, are bad for high growth stocks.

Indian Pharma: Rallied yesterday as the sector was untouched by Trump tariff. However, this is not a done deal. It ain’t over till it ain’t over. And stocks aren’t cheap.

Large-cap Value: Large-caps offer value with Nifty at 17x P/e. Midcaps and small-caps continue to remain overvalued. However, large-caps may continue to see selling by foreign investors in the short-term because of possible redemptions from EM funds. While they offer value, as long as FII continue to sell, they will continue to head lower or simply remain range-bound.

Nibble, Not Go Headlong: Markets are likely to fall. Indian markets cannot be insulated from a global turmoil. If all financial markets trade in the negative, which they are likely to, India cannot buck the trend. The divergence will evolve over time.  Investors could nibble but not go head long. Fear on the Street isn’t going away in a day as this seems to be only the beginning of a protracted economic war which will take time to unravel. Markets will continue to be volatile and provide opportunities for investors to buy. Keep FOMO aside.

Stay Diversified: With the U.S. dollar under pressure, gold will continue to see further upside. The key is to stay diversified, for the new world economic order is yet to emerge. Stay diversified across equities, gold and fixed-income.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.