Barometer: Equities set for further falls as tariffs bite

Asset allocation: moving underweight equities as tariffs bite

Trump’s Liberation Day has already taken a heavy toll on global financial assets – and this might only be the beginning of what could prove a more volatile phase for financial markets. The longer-term consequences of a full blown trade war include slower economic growth, particularly in the US and lower corporate earnings. There will be winners as well as losers, but overall we believe this uncertain environment warrants caution – the risks that concern us haven’t been adequately reflected in asset prices.

As we have much lower expectations for corporate earnings than consensus forecasts and as our appetite for risk is muted, we downgrade equities to underweight, and upgrade cash. We remain neutral on bonds while we wait for more signs on the likely depth of economic weakness. 

For now, our global business activity indicator is still neutral, although we have revised down our forecasts for the US economy. The average effective tariff on foreign imports into the US is now at 13.6% (see Fig. 2), and we believe this will amount to a 1.7 percentage point increase in inflation and an equal drag on GDP growth. Taking into consideration offsetting factors such as the substitution of an imported product for a domestically manufactured alternative, we revise US growth lower to just 1.3% for 2025. Equally discouraging, the recovery next year is going to be tepid, meaning the world’s biggest economy is on course for an unprecedented two full years of well below-trend growth. And making matters potentially worse, there is limited room for authorities to support growth – the government is constrained by already hefty borrowing, while the US Federal Reserve is constrained by inflationary pressures.

This is the key difference between the US and Europe, where we see more scope for both fiscal and monetary easing.

The outlook for China has clearly deteriorated following the imposition of harsh US import tariffs, but economic momentum across the country remains solid, consumption is booming, and the government remains committed to supporting growth, which it can do by deploying both fiscal and monetary stimulus.

Our liquidity indicators also show a more supportive environment in China and Europe than in the US. Nonetheless, we see more rate cuts in each of these key regions, even if the Fed’s easing may prove slower than that of its peers, which can afford to be more proactive.

Overall, the global rate cutting cycle remains intact. Of the 30 major central banks, 21 are easing, seven are neutral, and two are tightening.

Valuation metrics support our cautious stance on equities. Despite some big swings this month, global stocks remain expensive, according to our model, as does the US market. The latter trades on price/earnings ratio of around 20 times, far from our estimate of a recessionary trough multiple in current circumstances at 16.5 times.

We have downgraded our US earnings expectations to reflect our caution on the economy – on a top-down view, we now expect just 2% earnings growth this year versus the consensus of bottom-up analysts at around 10%.

Global bonds also score negatively on valuation, supporting our decision not to increase allocations at this point. However, we see value in US inflation-protected government debt (TIPS), which scores as “very cheap” following recent underperformance.

The dollar remains expensive, particularly relative to emerging market currencies, although the valuation gap has closed somewhat. Indeed, our technical indicators show that the US currency is now modestly oversold, leaving the door open for a short-term bounce despite longer-term headwinds.

More broadly, sentiment towards riskier asset classes is historically depressed for both retail and institutional investors – as signalled, by the AAII bull-bear spread¹ in the second and first percentile, respectively. However, discretionary investors’ positioning remains near neutral, which suggests it is too soon to see sentiment as a contrarian signal to invest.

Equities regions and sectors:

Emerging markets stocks are proving to be surprisingly resilient amid heightened market volatility and deteriorating investor sentiment.

The asset class has gained more than 3 per cent in local currency terms since January, in stark contrast to developed market stocks which lost over 3 per cent.

We believe this reflects some important fundamental trends.

China, in particular, has demonstrated that it stands ready to use both fiscal and monetary policy levers to support economic growth and offset negative demand shocks from US tariffs.

At any rate, China’s exports to the US are no longer a significant contributor to growth at just 3% of GDP. What is more, Chinese companies’ growing market share in the new tech sector – such as industrial robots, battery and renewable energy – makes its equity market more resilient. Chinese stocks are also supported by attractive valuations. For these reasons, we maintain our overweight stance in Chinese stocks.

We are also overweight across the rest of emerging markets equities, due to their attractive valuations, developing economies’ stronger growth profiles and the prospect for a long-term decline in the dollar. The growth gap between advanced and developed economies is likely to widen further this year and next from 2024 in favour of emerging markets; we think the dollar has entered a period of structural weakness against EM currencies after deviating 20 per cent from its fair value, according to our model.

Elsewhere, we remain overweight Swiss equities. We are attracted to the market’s defensive characteristics and cheap valuations.  Switzerland is home to a number of companies in non-cyclical sectors, such as healthcare and staples, which provide a buffer against market fluctuations and the uncertain environment.

In contrast, we remain cautious on most other developed markets. US stocks are de-rating across the board, pushing the median price earnings multiple for the US market to 18 times their 12 month forward earnings. That said, we expect a further decline in valuations as the overall market trades at 20 times, compared with 16.5 times, a level we expect a multiple to be under recessionary conditions.

Europe and Japan may be less vulnerable to near-term economic shocks than the US, yet they are by no means shielded – consumer confidence and domestic spending are starting to lose steam. We remain neutral on both region's equity markets. 

When it comes to sectors, our allocation prefers defensive characteristics of utilities, which also benefit from a long-term increase in electricity demand. We like communication services thanks to their resilient earnings (the premium of Magnificent Seven stocks of industry leaders stands at below post-Covid average). Financials are also attractive too as they will benefit from a steeper yield curve and potential deregulation from the Trump administration. The sector exhibits healthy earnings dynamics and is not expensive.

Fixed income and currencies: backing Swiss bonds

We upgrade Swiss bonds to neutral from underweight, in part as a consequence of the Trump administration’s chaotic tariff policy. If Trump’s liberation day did anything, it was to prompt investors to liberate themselves from the dollar. The greenback slumped and is vulnerable to further losses. The flip side of this has been strength in other currencies, not least the Swiss franc. 

Switzerland’s economic resilience and the defensive nature of its economy – strong current account surplus, low inflation and prudent fiscal policy suggest its assets should do well whenever global economic conditions are volatile.  The franc appreciated 7% against the dollar. Now, though, amid growing expectations that the Swiss National Bank will respond by cutting rates back to negative territory – in effect charging people for holding francs - we believe the conditions are in place for a bond market rally but an potential steadying in the value of the Swiss franc. So our overweight in Swiss bonds is accompanied by a neutral position in the Swiss currency.  

Elsewhere, we remain neutral on US Treasuries. Tariffs and dollar weakness are likely to push up inflation while also hurting growth. Higher inflation could well tie the Fed’s hands on how far it is willing to cut rates, though it could also look through what is essentially a supply shock and focus on weakening demand in the US economy. These opposing forces keep us neutral on the US sovereign bond market.

We also remain neutral on European government debt. The European Central Bank has been easing monetary conditions in the face of dipping inflation. But a significant degree of this disinflationary trend comes about because of falling oil prices, particularly in euro terms, rather than because of weak demand. This could well limit how much further the ECB is willing to ease policy.

We remain overweight emerging market (EM) local currency debt. EM
currencies have also benefited from the weakening dollar, while these economies have also shown themselves to be resilient to US generated economic shocks. Surprisingly, that’s particularly true of open, manufacturing-based economies. This could well be down to the fact that they have the most fiscal and monetary room to mitigate negative external forces.

Within credit, we remain neutral with a preference for European
high yield and emerging market corporate debt. Both these areas of the credit market should benefit from their respective economies being more resilient compared to the US.

We also remain positive gold. Although the precious metal has had a strong run, our technical indicators show that it’s not overbought and it remains a haven against geopolitical risk.

Global markets review: swings and roundabouts

April saw some spectacular swings in global markets – after Trump first unveiled his Liberation Day tariff plans, the S&P 500 posted its biggest daily fall since the pandemic, with some USD2.5 trillion wiped off its market value. But, with Trump dialling down some of his initial plans, stocks subsequently recovered, with both the US benchmark and the global MSCI ACWI finishing the month little changed in local currency terms. Market volatility, as measured by the VIX put/call ratio - which compares bearish investor bets to bullish ones - also retraced back to average after an initial spike.

Some of the sharpest moves were seen in gold, which added nearly 6% - taking its year-to-date gains to a whopping 26% - as market volatility sent investors in search of safe havens. The price of gold hit a record high of over USD3,400 an ounce. Gold ETFs saw investment demand more than double to 552 tonnes, with appetite particularly strong from China, according to the World Gold Council.

Conversely, oil shed some 14% and commodities lost over 8% on concerns that geopolitical tension and tariff wars would crimp global growth. As a result, energy stocks were the worst performing sector in equities, down 11% in local currency terms, while relatively defensive sectors, like staples and utilities, outperformed.

Regionally, most developed markets were broadly flat in local currency terms. However, US investors with unhedged allocations to Europe or Japan would have benefited from foreign exchange moves. The dollar lost 4.6% against a basket of currencies, hitting three-year lows (see Fig. 5). Against the safe haven Swiss franc, the US currency dropped to its lowest in a decade.

Global bonds gained around 1% in local currency terms in April, with some of the best performance coming from government debt in Europe and in emerging markets. Reflecting this, investment flows into government bond funds remained firm during the month while credit saw heavy outflows.