As investors navigate the landscape of 2025, Stephen Wright identifies a key risk that could lead to a significant stock market downturn—rising inflation driven by U.S. tariffs. While stock market crashes can be triggered by various unforeseen events, such as political upheaval, a pandemic, or a financial crisis, Wright argues that the inflationary consequences of trade policies are a more predictable risk to watch.
The Inflationary Impact of Tariffs
The U.S. government’s decision to impose a 25% tariff on imported steel and aluminum is an important development for investors to monitor. While this move may benefit domestic producers like Alcoa and Steel Dynamics, it could create challenges for other industries. International steel companies might see reduced demand, while manufacturers in the U.S. could face higher input costs due to the restricted supply of raw materials.
These increased production costs are likely to be passed on to consumers, resulting in higher prices. In other words, the tariffs could fuel inflation, which, if not kept in check, could trigger broader economic consequences.
Inflation and Stock Market Impacts
Currently, U.S. inflation stands at 3%, but if inflation were to increase, the stock market could experience volatility. Should inflation rise above 3%, bond yields, currently at 4.5%, may not offer investors much in real returns. This would make bonds more attractive than stocks, potentially causing a decline in equity prices.
Given that the U.S. comprises over half of the global stock market, a downturn in American stocks could have a ripple effect on markets worldwide, including in the UK. If the stock market experiences a significant correction, global markets could follow suit, leading to broad-based declines.
How Investors Should Prepare
While predicting a stock market crash is nearly impossible, investors can take proactive steps to protect their portfolios. One strategy is to identify stocks that are already priced with pessimism factored in.
An example of this is Diageo (LSE: DGE), which is currently trading at its lowest price-to-earnings (P/E) ratio in a decade. While Diageo faces risks from the tariffs—since much of its production is tied to specific geographies and not easily replicated in the U.S.—the company’s extensive distribution network remains a valuable asset. Over the long term, this infrastructure could provide Diageo with a competitive edge, helping it to weather potential inflationary pressures.
Monitoring Market Trends
Wright emphasizes the importance of staying informed about market movements, especially as inflation concerns grow. While it is impossible to forecast a market crash with certainty, keeping a close eye on factors like inflation can help investors make more informed decisions.
At present, the risk of inflation spiking in the U.S. stands as a major threat to the stability of global markets. However, Wright advises against betting on an imminent crash. Instead, he suggests that investors should look for opportunities in undervalued stocks, such as Diageo, which already appears to reflect some of these risks in its current valuation.
In conclusion, while inflation and tariffs may pose a significant threat to the stock market, careful monitoring and strategic stock selection can help mitigate the impact. Investors should stay vigilant and be prepared to capitalize on undervalued opportunities as the market evolves in 2025.
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