Are investors under-reacting to a changing United States?
There is a well-known phenomenon in finance that markets tend to under-react to news, good or bad. The news breaks, perhaps economic or company-specific, and prices react straight away, either up or down. However, that initial reaction is often an under-reaction, and as investors digest the news, they continue to react over quite long periods of time, often producing large moves later than expected. In this way, over periods of up to a year, trends emerge which can be profitable to follow. The under-reaction of investors is observed across markets and regions, be it in foreign exchange, bonds, commodities, or stocks. The phenomenon is the same whether prices move up or down.
Have we under-reacted, then, to the changing role of the United States? The Trump administration is resetting how the US deals with political opponents domestically, as well as its attitude to the world more generally. The US is more than prepared to throw its economic and military weight around, threatening former friends as well as enemies. At the same time, equity markets are reaching new highs, commodity prices are increasing, and interest rates are falling. Are markets under-reacting again, or have they got it right? On the surface at least, there appears to be a contradiction between the geopolitical uncertainty we hear so much about and the apparent lack of reaction from most investors. So, what action, if any, should investors take?
Over the last year we have perhaps become accustomed to the US using its economic heft to impose punitive tariffs, which were introduced in April 2025. Many countries have had to scuttle to Washington to obtain tariff relief in exchange for promises to buy American fossil fuels, US agricultural products, or to invest in US industry. The US’s closest friends and neighbours were worst hit – Canada was forced to give up its local digital services tax and open its domestic market to US imports, while Mexico had to give in to American demands on border and domestic security and impose tariffs on Chinese imports. All this was done to extract very limited concessions from the US. Trump’s America holds all the cards in these relationships and gets a kick out of playing them.
Militarily, the Trump administration has just carried out the most daring covert operation for years, swooping in and seizing Venezuelan President Nicolás Maduro from his heavily guarded presidential compound. Venezuela is powerless to respond to this action, and no other country took meaningful action in its support. The Trump administration had previously seemed to be against involvement overseas, but the success of this operation may change that. At the time of writing, Trump is turning his attention to Iran, a country that the US and Israel bombed for 12 days last year without meaningful Iranian retaliation.
At home, Trump is sanctioning law firms perceived as hostile, has challenged left-leaning universities, and has closed parts of the federal government. Depending upon your political viewpoint, this is either a challenge to the democratic system or a purge of the corrupt establishment. Crony capitalism, normally associated with totalitarian regimes, is creeping into the US system, where proximity to the presidential inner circle and political alignment are necessary to secure preferential business deals.
The picture painted above is bleak, but the US remains a democracy and constitutional checks and balances remain in place. President Trump has abided by the decisions of the Supreme Court, and he remains open to pressure from Congress. For instance, the threat of legal action against Federal Reserve Chairman Powell was quickly knocked back by a combination of outcry from donors and hostility from Congress. The attempt to prosecute James Comey and fire Lisa Cook was also slapped down by the courts.
It is unfair to say that financial markets have not reacted to Trump. The price of gold, an alternative to the US dollar, rose when the Trump administration threatened to prosecute Federal Reserve Chairman Powell, and it continues to climb. Equity markets did not react to the abduction of Maduro because Venezuela does not have an investable equity market, but that is not to say there was no reaction. Bonds issued by the Venezuelan government rallied strongly on the hope of the end of US sanctions.
Generally, financial markets are reasonably good at pricing steady cashflows, but they appear to be far less effective at pricing abstract threats to those cashflows. In asset pricing theory, the value of a financial asset is the sum of future cashflows, discounted at an appropriate discount rate. It is the role of financial markets to estimate those future cashflows and put a price on investments. One of the reasons they appear not to be reacting to Trump could be that future cashflows have not changed, but that instead the discount rate is imperceptibly adjusting as markets assess whether Trump represents a threat or an opportunity. Another reason why financial markets have not reacted more forcefully to President Trump’s undemocratic tendencies is that his tax cuts and deregulation serve to increase corporate cashflows, thereby boosting the value of equities and bonds.
The US mega-caps are a good example of this – does Trump’s short term combative foreign policy pose a threat to their businesses through increased uncertainty or do tax breaks, reduced regulation and a supportive government, willing to support them at home or abroad, increase opportunities in the long term? Financial markets are unpacking this continuously and the answer seems to be positive.
While it is true that markets do under-react to news, and to news of President Trump, that is not to say they have ignored him. Yes, he has shaken things up, upset democratic norms and challenged some of the checks and balances of the rules-based order, but he has also been pro-business and pro-capitalism, which are net positives for a long-term investment portfolio. Perhaps more than with any other US president, there is greater idiosyncratic risk around Trump. We have seen considerable risk in long-dated government bonds for some time, especially in the UK, however Trump’s idiosyncrasies make long-dated US government debt a risky place to be too. Despite this, the US market remains, after all, the deepest, most liquid and most dynamic financial market in the world, containing the world’s largest, most strategically important and best-run companies. Whatever you might think of Trump and the state of the world, avoid the US at your peril.
Please be aware that the value of investments may go up or down and you may receive back less than you invested originally. Past performance is not a guide to the future.
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