Trade tensions on three fronts
Three trade fights are live at once. First, the U.S. and Canada: talks broke down over the weekend and tariff rates are rising again. There are no winners in a trade war - the losers are consumers in both countries, because tariffs push inflation higher.
Second, China. Reports say the U.S. plans an extra tariff on Chinese imports over excess manufacturing capacity. That could push the combined tariff to 20%, the maximum level agreed to in May. On top of this are U.S. sanctions on Iran's economic partners. China is Iran's largest economic partner, which ties these threads together. A visit from Xi is set for next month, roughly one month out, and these moves could complicate it - though they likely will not stop it.
Expect some market swings tied to China trade relations. China is unlikely to comply unless the U.S. gives concessions elsewhere. Still, keeping the trade truce going serves both countries' best interest. Last night China's foreign ministry raised the threat of secondary sanctions, which makes the picture with Beijing more complicated.
Why markets keep shrugging off tariffs
Over the past 18 months, earnings from the AI buildout have outweighed any tariff worry in investors' minds. That is the core reason stocks hold up through trade shocks.
The AI investment equation: numerator and denominator
This week puts the U.S. AI investment equation on full display. Nvidia (NVDA) is the numerator - the earnings story, the revenue, the demand, the hard evidence of AI spending. NVDA sits at the center of the AI trade.
Jackson Hole frames the denominator. Kevin Warsh speaks there on Friday. Together the two form cash flow relative to the discount rate. Warsh's comments matter because markets have heard from him only a handful of times and are still working out how he thinks about the Fed's reaction function. The timing stands out given recent changes at the Treasury and around Scott Bessent. Watching how he handles those crosswinds will be telling.
Europe as an anti-AI diversifier
The FTSE 100 has run well lately, helped by strong regional earnings. Europe works as an anti-AI trade and a portfolio diversifier. You can hold AI and still not make it the only thing.
Europe's economy gets a lot of bad press, mostly over China's negative impact. That damage is well known by now, probably overstated, and likely already priced into the stocks. Earnings are being revised higher. Europe's earnings drivers are much broader than the industries facing direct Chinese competition:
- Financials and industrials are the biggest weights, about half the index.
- Healthcare is the third-largest sector.
- Automotive companies are only 1% of market cap.
Economic data is surprising to the upside. Europe's banks have beaten U.S. banks on both return on equity and stock returns over the past couple of years, and they trade at cheaper valuations. Banks also gain from a steepening yield curve, seen in the German bond market and UK gilts. The takeaway: do not ignore Europe.
Playing the market outside pure AI
Can you play the story outside technology, or is everything an AI play? This ranks as one of the top client questions. The AI trade now runs through equities, fixed income, and the whole economy, so many investors ask how to hedge the risk that AI fails to meet high expectations.
The classic diversification tools still work. Equities let you take part in the innovation directly. Fixed income pays you a yield while you wait for that innovation to arrive, so both complementary assets hold value.
Beneath the surface, there are ways to cut exposure:
- Equity markets are highly concentrated, so equal-weighting a portfolio spreads that out.
- Lean into value over growth.
- Expand investments globally to hedge single-country concentration. Europe is one example, with less correlation to the AI trade that dominates the U.S. and Asian markets.
Tried-and-true diversification remains a strong way to think about the broader portfolio.
