Market volatility reignited by auto tariffs

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US stocks fell on Wednesday, as anxiety over trade returned ahead of an announcement on auto tariffs from President Donald Trump. The S&P 500 fell 1.1% and the tech-heavy Nasdaq fell 2%, reflecting the market's unease, with the Magnificent 7 heading toward its worst quarter since 2022.

Despite entering correction territory earlier this month, the S&P 500 has rebounded by around 3.5% in the past two weeks, aided by reports of President Trump's tempered tariff approach, which had helped to maintain market calm this week.

Additionally, market sentiment may have improved owing to progress in easing hostilities between Russia and Ukraine, as they reached separate agreements with the US to pause maritime attacks and develop strategies to implement a ban on strikes against energy facilities.

However, stocks fell leading up to Trump's press conference, as Federal Reserve Bank of St. Louis President Alberto Musalem cautioned that inflation might continue to exceed the central bank's 2% target owing to tariff changes, and EU trade commissioner Maroš Šefčovič warned that the anticipated US tariffs could be as high as 20%, affecting all member states equally.

During Wednesday's press conference, President Trump said he would impose a 25% tariff on all imported passenger vehicles, light trucks, and key auto parts, effective 2 April. An accompanying factsheet claims the 25% tariff will eventually be applied to the non-US content of USMCA-compliant auto production, once a process is established to do so. Shares in the big three US automakers fell 4-8% in after-hours trade on Wednesday, while Japanese and South Korean automakers fell 2-4% on Thursday. S&P futures are indicating a 0.1% rise when the US market reopens on Thursday.

What do we think?
While recent media reports have suggested the upcoming reciprocal tariff announcement on 2 April, dubbed “Liberation Day” by Trump, may not be as severe as initially feared, we think market volatility could pick up again following the latest automotive sector tariff headlines. Trump claimed the latest tariffs would foster growth in the automotive industry by encouraging companies to establish more factories in the US. While some domestic plants may have space to modestly lift capacity, this is limited in scope against the context of the roughly 16mn new vehicles sold in the US annually. Building and bringing new auto production facilities online in the US takes close to three years, limiting the medium-term ability of the US domestic supply chain to ramp up production.

We think the proposed tariffs as announced would deliver a big hit to the auto industry, stoking higher costs, higher prices, and a sharp decline in US sales. The tariffs could also disrupt supply chains, deter investments, and significantly raise consumer prices. They may also ignite trade disputes with Europe, Japan, and South Korea. In terms of the broader impact, although the US auto sector, excluding Tesla, accounts for only 0.25% of the US market, the bigger question is what these very aggressive automotive tariffs signal for next week’s announcement on both reciprocal and ex-auto sector tariffs. We believe bilateral deals can be reached to mitigate the breadth and scale of the coming tariffs on 2 April, with EU trade commissioner Maroš Šefčovič meeting US trade officials, India expressing openness to cutting tariffs on US imports, and Vietnam proposing preferential tariff cuts. However, investors will also need to consider the risk of a sharper response from US trade partners affected by this action. We advise investors to prepare for a wide range of selective tariffs and retaliatory measures that could increase market swings.

The geopolitical tensions between Russia and Ukraine, while showing signs of easing, remain a factor weighing on market sentiment. The ambiguity in the maritime ceasefire terms suggests geopolitical risks are likely to linger, with Russia demanding conditions for the Black Sea agreements to take effect, while Ukraine insists the truce should proceed without sanctions relief. Our base case remains that a full ceasefire is unlikely to be reached imminently.

US consumer confidence slid further amid a poor economic outlook, marking the lowest level in over four years. Households are concerned about higher prices and a downbeat economic outlook, as indicated by the Conference Board survey and the University of Michigan's sentiment reading. Additionally, credit card issuer Synchrony reported that US consumers are curbing spending, with higher delinquencies in auto loans, credit cards, and home credit lines suggesting financial strains. Although our economic forecast does not call for a recession, poor sentiment amid elevated uncertainty is likely to weigh on market performance in the near term.

In light of the current market volatility and uncertainty surrounding trade policies, investors may find opportunities in equity exposure. Our analysis suggests that buying the S&P 500 after a 10% drawdown can potentially yield higher returns compared to waiting for larger declines. Historical performance, while not a guarantee of future results, indicates that waiting for more significant drawdowns risks missing out on rapid market recoveries. Our back-testing analysis of the S&P 500 since 1990 supports this strategy, showing that increasing equity exposure after a 10% correction has historically delivered the highest return and Sharpe ratio, which measures the risk-adjusted returns of a portfolio, compared to those waiting for a 15% or 20% drop. Although losses can be substantial at a -10% entry, they have typically been offset by periods of swift equity rebounds.

The threat of further tariff escalation remains a key concern, but our economic forecasts do not call for a recession in the US. In our base case, a wide range of selective tariffs and counteractions are likely to lead to slower economic growth compared to last year, but they should not prevent the US economy from expanding by around 2%—its historical trend rate—this year.

How do we invest?
Our core message remains to stay invested in stocks. We expect a period of further stock market volatility in April. In the coming weeks, we would view levels in the S&P 500 starting at a peak-to-trough drawdown of -10% as a potential buying opportunity. Investors should ensure portfolios are well diversified with assets such as quality bonds, gold, and alternatives to effectively navigate current challenges.

Navigate political risks. Tariff-related uncertainty and trade policy shifts reinforce the need for portfolio diversification and risk management. In equities, capital preservation strategies can help manage downside risks. We continue to favor high-quality fixed income like investment grade corporate bonds, which may provide a hedge against trade risks.

More to go in stocks. In our base case, we expect US equities to end the year meaningfully higher than current levels. US policy uncertainty could lead to short-term volatility, but we believe that continued structural AI tailwinds and solid earnings growth should drive markets higher once policy uncertainty peaks. Our “Six ways to invest in Europe” theme focuses on a selection of stocks exposed to positive European drivers (like pro-growth reforms in Germany or rising security investments), while also seeking to minimize exposure to tariff risks. Our stock selection has higher allocations to the industrials, materials, real estate, and utilities sectors compared to MSCI Europe. Read more in our 17 March report: "Six ways to invest in Europe – What do US tariffs mean for European equities."

Seize the AI opportunity. AI fundamentals remain intact, in our view. Although economic and policy uncertainty are likely to contribute to near-term volatility, we continue to see broad-based long-term investment opportunities across the value chain, particularly in AI infrastructure names with strong pricing power and in megacap platform beneficiaries. Near-term volatility should present an opportunity to build strategic, long-term AI exposure.