Time to look for tin hats and cockroaches

Simon Edelsten

A version of this article first appeared in the Financial Times

Followers of markets may have noticed it is tin hat time. Many are reading the headlines and banking their substantial profits from the past few years. Who can blame them?

The early weeks of the Trump presidency had given already-expensive US tech stocks a last hurrah – seen as a trade on Making America Great Again. But then came the DeepSeek torpedo. Since late January Nvidia shares have fallen 21 per cent; Tesla’s 44 per cent. The S&P 500 is down nearly 9 per cent on the FTSE 100.

It is credible that Trump anticipated his tariffs causing markets to wobble — some like to think his bruising trade deals are part of a cunning and sophisticated MAGA plan to defend US domestic companies and jobs from imports. And some try to argue that consumer and business confidence will recover once he has got his tax cuts through.

The alternative view is that Team Trump does not know what it is doing and failed to anticipate the economic effect of its policies, especially the loss of confidence. Occam’s razor says the simplest solution is usually right. There may be no plan!

Markets are complex. Commentators offer different arguments for what drives – or crashes – them. For me, these are the key reasons why investors have been reaching for their hard hats.

The first is the carry trade. This is the elephant in the room – the Big Trade. Many financial operators borrow where money is cheap (Japan) and use it elsewhere to buy promising investments. Japanese inflation has been rising, leading the yield on Japanese government bonds higher. The 10-year yield was 0.9 per cent last November. Today it is over 1.5 per cent. The yen has risen in turn. A dollar bought ¥157 at the start of the year. Now? Just ¥148.

The cost for some of buying dollars by borrowing in yen has soared. Meanwhile, what of those promising assets? Borrowing a lot in yen to buy Tesla shares no longer looks so smart. Traders are reducing position sizes.

Next are those DeepSeek reverberations. The news that China has developed a cheap, workable artificial intelligence app continues to hit a market already primed to sell expensive technology shares.

CEOs of US tech giants, who have committed to massive capital expenditure on AI, dismissed the risks, citing the Jevons paradox — even if the service becomes cheaper, demand will increase to compensate.

But is the benefit of AI so great that demand will rise substantially? And will people pay enough for that added functionality to justify the hundreds of billions being spent? The market, evidently, doubts this.

Next up: Main Street USA. It seems some US citizens are surprised that the President has done what he said he promised – specifically, firing lots of public employees. Cutting down on central government sounds great, until it includes sacking friends and slashing public services.

Alongside this, the deportation of immigrants – now underway – may again include people who many see as hard-working, tax-paying neighbours.

It is all very unsettling. A trip to the mall does not help. Soaring US egg prices may be due to avian flu, but they are fuelling wider inflation concerns. Apprehensive consumers tend to rein in spending.

Finally, tariffs. These dominate the headlines, but I think their impact can be exaggerated. Markets are struggling to predict where these will settle, but the sectors most affected – steel, cars and agriculture – are a relatively small part of global equity markets.

The first reaction of many UK investors has been to retreat to cash savings accounts, which in the UK can offer a return that marginally beats inflation.

But if I am underestimating the impact of tariffs – if they remain, if European governments have to increase borrowing, and if anti-immigration policies raise labour costs – then that cash advantage over inflation could quickly reverse.

Bonds are an alternative but these fall when inflation rises unexpectedly. And high-yielding, low-growth shares – ‘bond proxies’ – are no safer. When inflation returns, interest rates rise, and assets relied on for yield fall in value to maintain the competitiveness of the yield. So, if an asset that yielded 5 per cent suddenly has to deliver 6 per cent, expect its capital value to fall 15 per cent.

Companies with pricing power cope best with inflation over time. Even these stocks may fall when inflation first appears, as equity markets tend to follow bond markets lower initially. Over time, though, stronger companies can raise prices to accommodate higher costs. ‘Over time’ is the important phrase here – as always with equities, only invest if planning to be in the market for several years.

And so we see the return of the so-called ‘cockroach’ stocks: those best equipped to survive highly adverse conditions — the name comes from the theory that cockroaches can survive nuclear war. I am not sure this has been tested and would rather it was not.

Cockroach companies held in our funds include Japanese banks (they like rising JGB yields to some extent); UK property REITS with relatively low debt (I have recommended these for some time, and so far it has been an awful suggestion but their rents are tied to inflation); Singapore Telecom (Asian mobile broadband is essential for small companies in a region with poor fixed telecom networks); and Munich Re (the world’s reinsurance companies take the risks governments choose not to cover, such as insuring businesses against natural disasters – demand for this cover is increasing, as are the premiums charged).

These companies all have barriers to entry. This list is quite esoteric and does not fit easily into any one investment ‘style’, like ‘value’ or ‘growth’. But I am a pragmatist. One thing matters most to me today: ‘resilience’.

 

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