Poise, not noise

Fight, fight, fight 

The US administration’s prevailing philosophy is to restore the American greatness concept. That implies a confrontation towards those that are perceived to be preventing this greatness from manifesting – foreign governments and institutions, immigrants, and those that have pursued a progressive policy agenda domestically. For markets, the most important manifestation of this confrontational approach has been trade policy and the attempt to reshape the global trading system in America’s favour. By now we are familiar with the unorthodox and unpredictable way the agenda is being pursued, and how this creates volatility in investor sentiment and market prices. For the near future, the US will keep fighting for better outcomes on trade, will back a budget that widens the Federal deficit, and pursue defunding research in areas such as social equality, health and climate risk that do not align with the MAGA agenda. The risks of self-inflicted economic damage are clear.

Challenge! – The agenda is being met with challenges – in the markets, in the courts, by elements of corporate America and show business, and by the rest of the world. Despite claiming trillions of dollars in pledged investment, the US has not managed to secure any meaningful trade deals even with the threat of the Liberation Day tariffs being resurrected. Indeed, President Donald Trump has backed away from the threat of recession-guaranteeing levels of tariffs on China and the European Union without having been able to claim victory in securing preferential access to those markets or realistic plans for a wave of foreign investment into US manufacturing. In the end, Trump claiming he has sealed a good deal might be enough to tone things down. That would be a positive catalyst for markets. However, the risk is that inconclusive confrontation persists.

Sentiment

 Markets have tended to rally on Trump’s retreats, as they did briefly this week following the court ruling that the executive use of emergency economic power to impose tariffs was illegal. They fell back again once that decision was appealed. I have no doubt this pattern will be repeated, but the result is no clearer. How will we know when America is great again? It is unrealistic to assume that the Administration will settle for less than the blanket 10% tariff, with other specific sectoral and China focussed taxes. A confrontational approach by the Administration is likely to be the modus operandi, at least until the mid-term Congressional elections in 2026. As such, investor sentiment is likely to be volatile and markets are likely to be directionless.

Domestic versus foreign 

There are likely to be differences in sentiment towards investing in the US between domestic and foreign investors. Antagonism towards the rest of the world is core to the agenda – note the provision in the budget that would allow for additional taxes on various income streams earned by foreign individuals or companies deemed to come from countries classed as having unfair or discriminatory taxes against the US. The antagonism surely feeds into asset allocation decisions regarding US assets, as the US loses empathy internationally. The policy approach creates uncertainty around US economic fundamentals such as growth, corporate profits, inflation, interest rates, and the dollar. On balance it tilts investors to more of a home country bias. The dollar is down over 9% on a trade-weighted basis versus other major currencies so far this year. Stock markets in those countries that are the source of important levels of savings (some of which go to the US to fund its borrowing needs) have outperformed the US markets.

Fundamentals will determine returns in the end

I have said before that it is hard to argue that foreign investors totally disinvest from the US dollar. Any suggestion of large moves would be incredibly destabilising to global markets and the world economy. Moreover, there are good reasons to stay invested in the US given likely future returns a return to more orthodox politics at some point. But modest changes to portfolio allocations are possible and are happening or being discussed in investment committees around the world. Beyond the policy noise and swings in sentiment, it is the fundamental outlook and the risks that will determine the outcome of such deliberations. As we are seeing a self-inflicted macro shock unfold, one would expect performance from equities to be constrained relative to the last couple of years.

The macro shock is a potential slowdown in global trade, centred around flows to the US, with the knock-on effects to broader activity through uncertainty, supply chain disruptions and an import price-rise induced hit to real incomes. It is not clear what the magnitude will be. A macro shock, on balance, favours bonds over equities. However, for bond investors there are also inflation and fiscal risks. And if you are a non-US investor, there are concerns about further dollar weakness and, unspecified but potential, other risks to cash-flow derived from investing in US financial assets should the level of confrontation get turned up further.

No trends 

There is little direction in markets amid a sense that investors are not doing much in terms of portfolio reallocations. Total returns from US equity indices are flat year-to-date with the S&P and Nasdaq beating the small cap universe. Returns have been strong over the last month, but market levels are still well below the highs reached in February. Globally, US indices have underperformed, along with equity markets in the greater China region, while European markets have done significantly better. If trade-war rhetoric is to continue and the crux of any newly imposed trade friction is centred on US-China flows, then it is hard to see why the relative equity market performance would reverse significantly.

Of course, Europe could still get hit hard by Trump, as threatened last week. The macro backdrop for European stocks is not helpful to begin with, although the European Central Bank can still cut interest rates. In addition, there are potential tailwinds for European growth looking forward, but the reality of German fiscal spending is not present yet. Europe retains a huge valuation advantage over the US. Earnings growth expectations for the next year have been coming down for both regions, but the pace of downward revisions has slowed. And there is the technology argument. Nvidia reported $44bn of revenue in the first quarter, well above analysts’ expectations. The artificial intelligence theme remains alive and kicking, and it is a hard theme to avoid exposure to in a global equity portfolio. The outperformance of European equity markets relative to the US has been impressive and unusual so far this year. But however sympathetic one is to Europe, and antipathetic to the current US Administration, expecting such a level of outperformance to continue would be optimistic.

It is the politicians, not the CEOs 

It is not corporate America that is causing the uncertainty, it is political America. US markets are expensive but have demonstrated strong earnings, forecasts for which are still in double digits for this year and next. Markets are supported by domestic investors where sentiment does not seem to be as bad (there will be some sympathy with the MAGA agenda). There is no recession, there is plenty of liquidity in money market accounts and technology is moving quickly. Some element of US exceptionalism remains in the stock market. Balance and diversification are the key for foreign investors. A lower desired level of exposure to the US market given valuation and the other macro risks may be the result but it does not mean the US is a no-go.

Fixed income trendless

Global bond returns have been mostly positive. Income returns on a US aggregate index have been around 1.5% out of a total return of 2.24%, year-to-date. For a similar European index, returns have been dominated by income (0.9% out of 1.0%). For all the concerns about inflation and fiscal sustainability, benchmark yields remain in well defined ranges. However, there has been curve steepening in the US, the UK and Japan given concerns about future supply related to higher levels of government borrowing. These concerns are mostly overdone with debt management agencies recognising the need to focus future issuance at the shorter-maturity end of yield curves. The 5% yield on US Treasury bonds that was seen soon after the recent Moody’s downgrade to the US credit rating is likely to have marked a good buying opportunity. History suggests that is a good entry point of one wants to invest in long-dated Treasury bonds (a debate for another time).

The key risk to Treasuries is that higher coupons on newly issued debt are going to be needed to attract additional buying as deficits get bigger. This pushes up market yields and pushes down prices on existing bonds, leading to negative price returns in bond portfolios. For foreign investors in US bonds there is also a fear that the real value of their holdings could be eroded by higher US inflation and an even weaker dollar. Despite the unorthodox streak running through Washington, there has been no suggestion that they are going to monetise the debt and inflation away the problem of fiscal sustainability. US Treasury Secretary, Scott Bessent, for one, recognises that the inflation of 2021-2023 was driven to some extent by the Fed’s balance sheet policies super-charging quantitative easing. That is not a policy choice today. However, it is safer to stay in short-duration fixed income strategies given the volatility of yields at the long end of the curve. Short-duration credit in investment grade and high yield remains a sweet spot in this uncertain world.

Risks are higher. Risk premiums are higher. Further episodes of intense market volatility (with the Pavlovian responses from the commentariat) are likely. The world is changing but market capitalism is not dead; it is just the mechanisms are being shook-up. That creates uncertainty. But fundamentals are still solid for global markets and the level of confrontation from the US Administration will recede eventually. As such, long-term returns from balanced, diversified portfolios with a solid exposure to income flows from credit, and earnings growth from technology, should continue to see wealth grow.

Performance data/data sources: LSEG Workspace DataStream, ICE Data Services, Bloomberg, AXA IM, as of 29 May 2025, unless otherwise stated). Past performance should not be seen as a guide to future returns.