Whipsawing

Tariff tensions deescalated in early May before intensifying again later in the month. In between, the US Court of International Trade (UCIT) ruled that President Trump had exceeded his authority in imposing certain tariffs. This whipsawing has only heightened market nerves. Our Chief Investment Office explains further.

May began with a semblance of optimism as the US and China agreed to a temporary reduction in tariffs, offering a brief respite to markets. The US lowered tariffs on Chinese goods from 145% to 30%, while China reduced tariffs on US imports from 125% to 10%, effective until mid-August. This partial ceasefire helped push markets close to record highs.

However, the optimism was short-lived. In mid-May, President Trump accused China of violating the Geneva trade agreement, leading to the revocation of Chinese student visas and the imposition of new export controls, including restrictions on AI chips. In response, China vowed to take stronger measures to protect its interests, reigniting fears of a full-scale trade war and dampening investor sentiment.

The whipsawing was not limited to US-China relations. Just two days after declaring that tariffs on all European goods would increase to 50% from 1 June, Trump announced the imposition would be delayed until 9 July. Markets rallied strongly in the aftermath, reversing the declines seen in prior sessions.

Complicating matters is the slow progress of the US reconciliation bill. The House of Representatives passed Trump’s "One Big Beautiful Bill" in late May, but it now faces a difficult journey through the Senate. The bill is a double-edged sword: failure to pass it would likely lead to a near-term deterioration in US growth, as the proposed tax cuts and fiscal spending are needed to offset the expected slowdown from tariffs. On the other hand, it threatens to raise fiscal deficits over the long term. The Committee for a Responsible Federal Budget estimates the bill could add roughly $3.3 trillion to the debt through 2034 – or $5.2 trillion if temporary provisions are made permanent. While the UCIT decision may benefit global growth in the long run, it could prove problematic in the near term, with more than $200 billion in tariff revenue removed from US coffers.

These substantial deficit projections have triggered strong reactions in the bond market, including a credit rating downgrade from Moody’s and a rise in long-term Treasury yields to levels that have recently proven troublesome for equities.

There remain other avenues for the Trump administration to enact tariffs if desired and we expect the reconciliation bill to pass eventually. However, it is the protracted and erratic policy approach that has left investors and businesses treading water, struggling for direction. This cumbersome process may ultimately prove as damaging as the decisions themselves.

Equity markets have managed to muddle through the disruption so far, with S&P 500 aggregate earnings growth remaining strong over Q1 at approximately 13.5% year-over-year (y/y). However, the gains were uneven. The “Magnificent 7” reported actual earnings growth of 27.7% y/y, compared to less than 10% y/y for the remaining 493 companies. Moreover, the period likely did not reflect the negative impact of tariffs; if anything, it may have included business activity brought forward to pre-empt them.

Looking beyond S&P 500 constituents, the broader health of corporate America declined in Q1. Data from the Bureau of Economic Analysis shows US corporate profits fell by 3.6% – the largest drop since Q4 2020. While profits remain in a positive year-over-year trend, providing a cushion for future shocks, consumer confidence is already weak. Companies are expected to pass one-off price increases to consumers in the coming period, so we are closely monitoring profit margins and earnings in the quarters ahead.

Equity market sentiment has been bearish and positioning light

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More broadly, the uncertainty and “America First” policy approach has increased nervousness among holders of US assets. The Bank of America Global Fund Manager Survey for May 2025 revealed a net 38% underweight in US stocks – the most in two years – while asset managers held the largest underweight to the US dollar since 2006. Compounding matters, Section 899 of the reconciliation bill, if passed, would allow the US to increase taxes on entities from so-called “discriminatory foreign countries.” In other words, a potential ‘revenge tax’ on foreign holdings of US assets – something that could trigger further capital flight.

Despite the unease, markets could still move higher. US equities are positive year-to-date, though still below their February highs. Indeed, based on expectations of monetary easing, surplus liquidity, and a pro-business agenda from Trump, US equities were one of our highest conviction calls at the start of 2025. Given the current bearish sentiment, clarity on tariffs and easing from the Federal Reserve could again spur a sharp reversal in market sentiment.

What This Means for Our Diversified Portfolios

Given the prevailing uncertainty, we find it difficult to justify upgrading risk. Instead, we continue to view market rallies as a possible opportunity to trim broad equity exposure and reallocate to segments where we hold greater conviction. These include US technology-related companies, as well as European and Japanese equities.

We believe our mild underweight to risk assets and US equities at the aggregate level provides portfolios with adequate downside protection in the event of a market pullback. At the same time, our nuanced positioning within the global equity allocation allows us to participate in rallies in a risk-adjusted manner.

Elsewhere within risk assets, we maintain a mild underweight to Australian equities and broad-cap US shares, given rich valuations and a modest earnings outlook. High-yield and emerging market equities are also held at a mild underweight.

Within defensive assets, on a duration-adjusted basis, we prefer the long end of the curve as a means of risk mitigation. We also maintain a mild overweight to cash. Any increase in risk assets is likely to be accompanied by a similar lengthening of portfolio duration.