Trump’s “liberation day” has shaken markets across the globe with immediate impact on asset prices. Commentators are reeling from the details and grappling with the implications. The most important question for investors is how to respond?
Before doing anything, remember that we tend to react instinctively when surprised. This is commonly known as the “fight or flight” response. In investing surrendering to these impulses is at best cathartic and at worst devesting to your long-term success. Instead, we recognise that the future is unknowable and consequently force ourselves to consider a range of possible outcomes.
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As we do this, the first thing we observe is that the imposition of tariffs is likely to have a discrete, rather than continuous, impact on inflation but represents an ongoing tax on company profits and/or consumers. Increased taxes tend to slow the economy and reduce the fundamental value of companies. Consequently, it is unsurprising that equity prices and the value of the US dollar are falling while government bond prices are rising.
But before we jump on the bandwagon of falling stock prices, remember that politics is inherently short term while investing is always a long-term endeavour. Most of the value of an established business reflects expected profits from the far future. A realistic estimate of the impact of the tariffs will therefore be limited by the policy horizon of the current administration and are likely milder than instinct would suggest. Where fair values remain stable, large price falls can facilitate the acquisition of high-quality assets at low prices and investors should be looking for these opportunities.
While these shrewd purchases can deliver strong returns over the long term, markets tend to be driven by sentiment over the short term and so it is important to be prepared for further falls, especially if this event sparks a series of reciprocal tariffs. Further falls in asset prices may provide even better opportunities and so we should avoid being too aggressive in the early phases of a decline, and leverage this opportunity to seek even cheaper prices for better returns in the long-term.
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For most of us, the best option is to unleash the power of rebalancing. Simply returning the exposure of your portfolio to where it was a few weeks ago avoids the cognitive challenges caused by making good decisions in panicked markets and enables us to purchase the most affected holdings more cheaply, while reducing exposure to assets that have provided protection.
Amid the geopolitical and market turmoil, this approach may appear a little boring, but the great secret of investing is that it should not be exciting. The best journey towards our goals is that which contains the least drama. While this may appear an unobtainable goal in the current market environment, a focus on the long term and a commitment to research over reaction can turn event the most challenging environment into fertile ground for long term success.
Dan Kemp is chief investment and research officer at Morningstar
This story was written by our sister title, Portfolio Adviser
