Trump ‘woke the rest of the world up’ to leveraging economic firepower against trade partners, says Morgan Stanley CIO

Morgan Stanley’s CIO Lisa Shalett argues that a post-2025 shift in U.S. trade policy has created a multipolar global economy in which other countries can leverage monetary easing, increased fiscal/defense spending and redirected Chinese export capacity to capture ‘imported disinflation.’ Key datapoints: China’s exports rose 6.6% year-on-year in December (valued at $357 billion) while shipments to the U.S. plunged 30% in December (the ninth consecutive down month); NATO members have increased defense spending targets from 2% to 5% of GDP. With major central banks easing in 2025 and concentration of strategic inputs (e.g., Canada ~90% uranium processing; China ~90% rare earths), Shalett recommends a more globally balanced, multi-year portfolio tilt to capture these structural shifts.

Analysis

Market structure: Fiscal-driven rearmament and bilateral trade realignment favor defense primes (LMT, RTX, NOC), upstream commodity/minerals (MP, CCJ, Lynas equivalents) and industrials that service capex. U.S. consumer discretionary and low-margin importers (mass retailers relying on cheap China supply) are at risk of margin compression if supplier networks reprice; expect 3–7% EBITDA pressure in vulnerable retail cohorts over 12–18 months. FX and rates: incremental global fiscal deficits + easier EM monetary policy should keep real yields lower in EM and compress carry into USD — downside risk to dollar ~5–12% over 6–12 months if trend persists.

Risks: Tail events include sharp China export restrictions or a tit-for-tat embargo that spikes input prices (rare earths, semis) and disrupts manufacturing; low-probability but >10% P(12 months) with high impact. Time horizons: immediate (days–weeks) for FX and export flow data; short-term (1–6 months) for earnings/margin revisions and capex orders; long-term (1–3 years) for structural supply-chain reshoring and commodity tightness. Hidden dependencies: many “western” miners still depend on Chinese processing/refining — expect execution risk and delays of 6–24 months.

Trade implications: Favor 6–18 month exposure to defense and upstream commodities via equities and call-spreads; reduce exposure to import-dependent retail and low-margin consumer names. Use pair trades to isolate the theme (materials/defense long vs retail/consumer discretionary short) and express macro via FX (buy CAD/AUD vs USD on weaker dollar threshold of -5% from current). Options: buy 9–12 month call spreads on LMT/RTX (0.30–0.40 delta long leg) and 6–12 month calls on MP/CCJ to cap capital and target 30–60% upside.

Contrarian angles: Consensus assumes China will perpetually export disinflation — but if Beijing elects to flood global markets to preserve export volumes, metal prices may fall short-term; conversely, if China tightens rare-earth shipments, prices could spike >50% in 6–12 months. Historical parallels to Cold War rearmament show front-loaded capex with later productivity gains; expect 12–36 month volatility and uneven winners. Monitor monthly Chinese Customs export mix and NATO defence budget ratifications as immediate decision triggers.

Key Decisions for Investors

• Establish a 2–3% portfolio position long in defense primes: split between LMT and RTX (1% each) and NOC (0.5%) with 9–12 month call spreads (buy 0.30–0.40 delta calls, sell ~20% OTM calls) to target 20–35% return, stop-loss 12%.
• Allocate 1.5–2% long to upstream critical materials: MP Materials (MP) 1.0% and Cameco (CCJ) 0.5%; use 6–12 month LEAP calls on MP (delta ~0.40) and outright equity for CCJ; take profits at 40–60% and cut at 15% loss.
• Initiate pair trade: long 1.5% materials/industrial ETF (XME or select basket) vs short 1.5% U.S. small-cap retail ETF (XRT) to isolate margin squeeze; rebalance monthly and widen stops to 15% given higher volatility.
• FX/Fixed income tactical: if USD weakens >5% from today within 3 months, increase EM commodity FX exposure (CAD/AUD) by 1–2% and reduce 2–5y US Treasury exposure by 1% to protect against rising global yields; reverse if USD re-strengthens above that threshold.
• Monitor triggers (required actions): watch Chinese Customs export data monthly and NATO member defense spend confirmations quarterly — take profits or tighten stops on defense/material longs if Chinese rare-earth exports rise >20% YoY for two consecutive months or if NATO spending ratification stalls for more than one quarter.