Volatility and tariffs: navigating the new market landscape

With the announcement of trade tariffs from the United States on April 2nd, we’ve seen some volatile days in financial markets, with measures of equity volatility reaching levels not seen for some time. There’s still a lot of uncertainty, but we wanted to update you on the current thinking within our investment team.

We continue to believe that higher tariffs will slow down global growth. In the short term, they’re likely to raise prices, but that may not translate into sustainably higher inflation. Slower growth will likely impact corporate earnings.

We believe that over time we’ll see some negotiations over tariffs between the US and its major trading partners. So far, however, President Trump appears willing to see the US economy, and equity market, weaken to try to achieve his long-term goals. The longer we see higher tariffs in place, the greater the impact on growth.

Even with successful negotiations, we think higher tariffs between the US and its trading partners will be a feature of economic life going forward.

We could see some positive news on trade outside the US. We’ve already seen some signs of thawing relations between – for instance – the EU and India, and China, Japan and South Korea. The US represents around 11% of global trade. It’s certainly very relevant, but it’s not the only game in town.

With the risk of a recession rising, we’d expect to see monetary authorities react. We’ve already seen investors increase the number of rate cuts expected for 2025.

Equity market volatility has been dramatic – most recently on April 6th, when rumours of a delay on US tariffs prompted a sharp rise in US equity markets.

Trying to time the markets is difficult at the best of times – at the moment, we think it’s even more challenging than usual.

How did our portfolios perform so far? 

In absolute terms, we’ve seen most of our portfolios decline as equity markets have sold off. That’s always painful, but periods of market volatility are a fact of life in investing. We always think in terms of long-term returns, rather than focusing on relatively short time periods, and we encourage our clients to follow the same approach.

That said, most of our portfolios are ahead of their internal benchmarks year-to-date (through April 7th), helped by our decision to reduce equity exposure in early March.

In the UK, our 100% equity portfolio has performed around 1.5% better on a gross basis than a global equity ETF (VWRL LN) year-to-date through April 7th.

How does it impact our portfolios? Let’s take a moment to reflect on how we evaluate our performance. There are several key factors we take into account.

First, are the portfolios behaving as we would have expected? Are the portfolios we think of as lower risk actually behaving that way? Here the answer seems to be yes: lower risk portfolios have generally held up better year-to-date than those with more equity exposure. That seems obvious but it isn’t guaranteed. If we look back to 2022, many fixed income portfolios in the market with longer duration government bonds suffered more than higher equity portfolios.

Second, we also look at the absolute returns. Ultimately clients invest with us to grow their wealth over the long term and that should be our focus. Market volatility can be unsettling, and while we’re always mindful of that, we’re also cautious not to place too much weight on short-term movements.

Third, we think about how the portfolios are behaving relative to their internal benchmarks. We don’t talk about these a lot, partly because we construct them ourselves, but they’re helpful tools to assess the investment decisions that we’ve made. On those metrics, the portfolios are holding up.

We do compare ourselves against peers – alternative portfolios that our clients could have invested in – but we don’t think it’s very effective to make those comparisons over very short time periods. We typically focus on three-year relative rankings, and our one-year and three-year rankings remain strong.

Our market view and portfolio positioning

As usual, there’s no crystal ball, especially in such a volatile environment. That said, we aim to start with a base case scenario, and then think about what the alternatives could look like.

Our current base case goes something like this: trade policy is likely to remain a source of uncertainty for some time, and that will cause equity markets in particular to remain quite choppy. US–China trade relations look particularly difficult at present. Nonetheless, we’d expect to see bilateral trade negotiations between the US and its partners ramp up over the coming months, and that would improve sentiment. 

Rumours and newsflow will move markets in the short term, as we’ve already seen. In the end, we’d expect tariffs to settle above where they were at the end of last year, but below the current US rates announced on April 2nd.

We think that higher tariffs represent a tax on growth, and so we’d expect to see global growth slow from current levels. That would have a knock-on effect on corporate earnings. That’s why the timing of when tariffs begin to ease – or when clarity on trade policy emerges – is important. The longer we live with these high tariffs, and potentially further reciprocal tariffs against the US, the greater the hit to growth. Investors will likely seize on any signs of progress on these negotiations, but it’s still likely to be a slow process.

What sort of policy responses could we see? In the United States the President has already started pushing for the Federal Reserve to cut rates. Fed Chair Powell’s most recent statements suggested that the central bank isn’t in a rush to cut rates, given the policy uncertainty and the potential that higher tariffs could feed into higher inflation. That said, as we see the US economy slowing down, we’d expect the Fed to ease monetary policy. 

With that scenario in mind, we want to relate it back to asset prices – particularly what we believe is currently reflected in markets such as US equities. It’s an impossible question, in that you can never know for sure what is priced in, but we aim to form a reasonable view.

Our current view is that US equities, and equity markets more broadly, are now reflecting slower growth, with perhaps relatively little earnings growth for 2025. That would be a fairly sharp slowdown. Remember that at the start of the year, equity analysts were forecasting double-digit earnings growth for the S&P 500.

Despite that, we don’t think that current valuations are pricing in a deep recession. If that’s right, then equity investors are still somewhat optimistic about a negotiated solution to the current tariff situation.

What about the alternative scenarios? If tariffs are the focal point, then we should be thinking about different tariff outcomes. The positive scenario sees global tariffs move closer to the 10% level that many investors had been looking for at the end of March. That would probably be enough to prompt a rally in equities in the short-term. 

The negative scenario, at least for now, is where the current tariff regime stays in place for an extended period of time, with the US and China in a stand-off at even higher tariff levels. In that case, we think we’ll see a recession in the US, and likely elsewhere. Earnings forecasts for global equities will fall. We’d expect to see central banks ease monetary policy to mitigate some of that. 

Opportunities and tactical changes we are considering 

There are some important tactical and strategic questions we should address. In the short term, we think the key question remains around tariffs. It’s difficult to take a strong position on any single scenario outlined above, given the policy uncertainty. So for now, we’ve stayed positioned relatively conservatively – based on our internal metrics. 

As we get greater comfort in the base case scenario, we would look to add to equities. Looking at the long-term risk profile of our portfolios, we think we have room to add more equity risk. Similarly, if the negative scenario looks more likely, we think that there’s still scope to reduce our equity exposure from here, given our view on current valuations.If we were to add to equities, there’s a question of which ones – but in the short term, we think it’s not the most important question. If we see a resolution on tariffs, we’d expect to see a global equity rally.

Longer-term, however, we could see greater differentiation. Here we come back to a “pre-tariff” debate. Do we still bet on the US equity profit machine, even with its higher valuations? Or do we think that non-US equities can continue to outperform? Most recently we had been tilting a bit away from US equities, on valuation grounds. And we continue to debate whether the US large-cap tech companies will continue to drive profit growth as they have done in recent years.

Fixed income remains an important part of a multi-asset portfolio, even more so given the rise in bond yields in recent years. It’s been reassuring to see the negative correlation between bonds and equities in recent months, allowing multi-asset portfolios to benefit from diversification.

We’ve continued to discuss the relative attractiveness of different parts of fixed income. There are a range of opinions on duration – some believe that it will outperform in a slowing economic environment. Others are concerned that tariffs will feed into inflation and limit the upside of longer-dated bonds. 

We remain concerned about rising sovereign debt levels, notably in the US. We don’t currently expect to see investors demand higher yields to hold US government debt, but it’s something we’ll continue to monitor. In general, we remain sceptical about high yield, even if spreads have widened. If we do see a recession, we’d expect default rates to rise from here. We continue to like short-dated emerging market debt, which we’ve added to in March.

Currencies have been another important topic. The US administration is keen to see the dollar weaken against its trading partners – that’s not an easy thing to engineer, but it does raise questions about our currency exposure. We have historically used currency-hedged equity ETFs in some of our portfolios. We may use more of them going forward.

And that brings us to a final strategic question. Historically, we’ve followed a market cap weighted approach to investing, and that’s seen our exposure to US financial assets increase, largely because of the rising weight of US equities in the global markets. In a world of greater policy uncertainty, we are evaluating whether we should further increase our geographic diversification across the portfolios.