President Donald Trump’s announcement of tariffs against Mexico, Canada, and China has raised the spectre of a global trade war, unsettling equity markets as investors assess the implications for global growth and inflation expectations. Combined with sharp government spending cuts by the new U.S. administration, markets face twin headwinds: tariffs and fiscal tightening in the world’s biggest economy.

It remains uncertain whether tariffs are a short-term negotiating tactic or if they will lead to retaliation and escalation. The scope and duration of U.S. budget cuts are also unknown. However, both factors present significant economic risks, particularly for Australian equities.

Trade wars don’t happen in isolation. While the U.S. is targeting China, the economic fallout will spread globally, including here in Australia. As China is our largest trading partner, any slowdown in its economy due to rising costs or disrupted supply chains could directly impact Australian exports.

The resources sector is particularly vulnerable to a Chinese slowdown. But the impact extends beyond resources; reduced demand from China could ripple through the nation's economy, affecting employment, corporate profits, and government tax revenues.

The other heavyweight sector on the ASX, financials, is also exposed to these headwinds. Banks may face higher funding costs, crimping margins, and slowing demand for credit in a softening economy. Weaker domestic growth could spark an uptick in bad debts at a time when bank provisions are at cyclical lows.

Cyclicals and consumer-facing businesses, such as retailers and building materials, would also be impacted by any downturn in the economic cycle. Companies that are sensitive to interest rates are likely to be more volatile in this environment as central banks, and markets, wrestle with the competing signals from slower growth and potentially higher inflation.

But parts of the market should prove resilient. Healthcare stands out as a potential safe haven, as demand for their services remains steady regardless of economic conditions. Defensives more generally, such as healthcare and infrastructure, are likely to outperform in volatile markets and provide portfolio stability.

Strategic sectors aligned with national priorities, such as renewable energy and critical minerals, may also be insulated if government policy remains supportive.  

Companies generating U.S. dollar revenues, should benefit from a stronger U.S. dollar. However, the picture is more complex for those with operations in China, Mexico or Canada. Given China’s position as the world’s factory, and Mexico’s role as a manufacturing hub for goods destined for the U.S., there will be ongoing impacts for many businesses if tariffs are sustained or a trade war eventuates.

Looking ahead, a shift from cyclicals into defensives could help mitigate risks, while investors should prepare to take advantage of potential market dislocations.

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