Shares cling onto the wall of worry

Stock markets continue to climb a wall of worry. Wherever you look, markets are at or close to all-time highs. The S&P 500 is within 100 points of its recent record level. Here in the UK, in Europe and in Japan markets have never been higher.

It’s not as if there is nothing to worry about. Rising tensions in the Middle East. The fourth anniversary of a seemingly intractable war in Ukraine. Closer to home, a by-election in Greater Manchester that Prime Minister Keir Starmer could do without. And that’s before the US Supreme Court waded into President Trump’s ongoing trade war with the rest of the world.

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Tariffs in focus once again

The Supreme Court’s bombshell on Friday took the form of a 6-3 ruling that the President’s Liberation Day tariffs last April were unlawful. The country’s top judges ruled that he exceeded his authority when he invoked the International Emergency Economic Powers Act to impose tariffs on dozens of America’s trading partners.

The White House was quick to respond. A 10% flat rate tariff using another law - the 1974 Trade Act - was almost as quickly replaced by a higher 15% levy. It is due to come into effect tomorrow.

The new tariffs are bad news for some countries - including the UK - because they are higher than the rates negotiated in the wake of Liberation Day last year. For others - including China - they represent an improvement in trade terms. To add complexity to the mix, the tariffs can only be applied for 150 days.

That creates a whole new level of uncertainty around trade. Something that markets may struggle to price in effectively. In the short term the impact has been muted because key markets are closed. China’s lunar New Year holiday spills over from last week until today. And Japan is closed for the Emperor’s birthday.

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Europe-bound

The tariff uncertainty comes against a backdrop of already shifting investment flows out of the US towards other markets around the world that are perceived to be better value than the tech-dominated US benchmarks.

European stocks are headed for their highest ever monthly inflows in February after two weeks of record sales. Europe is being seen as one of the best ways to hedge against US tech stock risks due to its lower overall valuations and weighting towards old economy sectors like financials and mining.

The Stoxx Europe 600 index trades on a valuation only about two-thirds that of the US benchmark. That has started to look good value against an improving economic backdrop, with Germany in particular on a roll as a government funded spending spree looks to boost industrial and, especially, defence capabilities.

Earnings remain key

A key question for investors exploring the rotation out of the US is whether Europe can match the S&P 500 when it comes to earnings growth. As fourth quarter results season draws to a close, the US looks like delivering low double digits profits growth yet again, much higher than investors can enjoy in Europe.

Buoyant earnings are helping the US bull market broaden out from the Magnificent Seven leadership. The equal weighted S&P 500 index has in fact outperformed the Mag 7 by 12% over the past three months. Key to the future of the headline index will be whether the big tech stocks can remain within their sideways moving trading band. If they fall out of the bottom of that channel, it will be hard for the rest of the market to keep the bull on track.

A key test of that will be this week’s fourth quarter results announcement from Nvidia, the biggest and most important of the AI stocks that have driven the market higher. The consensus is for another strong quarter of growth. More important will be guidance on the current quarter.

But politics is in the spotlight too

While not strictly a market moving event, this week’s by-election in Greater Manchester could have an impact this week. Rising anticipation of lower interest rates in the UK in the first half of this year has boosted both bonds and shares. Any revival of political risks on Thursday - if Labour loses out to threats from both left and right - Green and Reform - has the potential to undermine the calm that has reined in markets over the past year or so.

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