Tech and tariffs trigger higher volatility
Global equities remain close to all-time highs, but investors’ optimism is being tested. The first big surprise of the year came when a Chinese artificial intelligence (AI) company revealed that it had created a Large Language Model comparable to US rivals, but at far lower cost. This has led investors to question their assumptions about demand for semiconductors and datacentres. Given the extreme concentration in the US stock market, with Nvidia alone accounting for 7% of the S&P500 at the start of the year, the development sparked a broad sell-off. Since then, markets have also had to contend with President Trump’s announcement of tariffs on Canada, Mexico and China. It was always likely that Trump would impose some tariffs, or they would have quickly become an empty threat. However, investors had hoped they would be introduced in a less disruptive manner.
The risk of tariffs becomes real
Mexico, Canada and China together accounted for 42% of US imports over the last 12 months.* It is still possible that the proposed tariffs are an aggressive negotiating tactic and will be scaled back or delayed as Trump secures other concessions. As things stand, however, they are an unwelcome surprise: they are much broader in scope than the tariffs set during Trump’s first term and will be implemented far more quickly. Corporate margins could come under pressure as companies absorb higher input costs or rejig supply chains. To the extent that higher costs are passed on to consumers, they will add to inflationary pressure in the US, making further interest rate cuts less likely. They could also slow growth, moving the US economy in a “stagflationary” direction.
What does China’s AI success mean?
While there are still questions about how DeepSeek has been developed and at what cost, it has shown that AI can be trained more efficiently and at lower cost than previously thought. This is a risk for companies in the AI infrastructure supply chain, including energy and industrial companies that supply datacentres as well as chip designers and manufacturers. Share prices of many of these companies remain below recent highs while investors assess the implications. They have taken some comfort from the economic theory of “Jevons Paradox,” which suggests that more efficient technologies lower costs for consumers and spur demand. In the case of AI, this could mean that lower cost models ultimately lead to higher demand for chips and other infrastructure. On this basis, the biggest risk for investors may be sluggish uptake of AI by companies and consumers, rather than new models.
Positioning
The strong performance of equities in recent months leaves us slightly overweight the asset class. We remain broadly comfortable with this position but have trimmed our exposure given the high degree of uncertainty about US policy and the potential for higher volatility. We currently have a neutral stance on fixed income. We have recently cut our exposure to inflation-linked bonds, which are now pricing in the risk of higher inflation. As in 2024, we will take advantage of volatility in fixed income markets as interest rate and inflation expectations evolve. We remain underweight alternatives, which look relatively less attractive in today’s interest rate environment. Having said this, we still like commodities and gold, both of which can help protect portfolios against geopolitical uncertainty and other supply side shocks.
Key
🟢 Positive
🔵 Positive/Neutral
⚪ Neutral
🟠 Negative/Neutral
🔴 Negative
Outlook
| Economics | US growth remains robust. The consumer is in good shape and labour markets are cooling rather than collapsing, whilst business sentiment is improving.The outlook for Europe and EM is more challenging. Europe’s manufacturing sector faces headwinds, whilst China is struggling to reignite domestic demand.Headline inflation is close to target, but core inflation is likely to remain above central bank targets. Risk is to the upside for the UK, Europe and US.Market expectations for interest rates are close to fair for 2025, with this year potentially marking the end of this easing cycle. |
| Valuations | US mega cap equities remain expensive based on traditional metrics, but fundamentals are strong. Most other regions look fair value vs history, but expensive vs cash and bonds.High concentration of equity indices (alongside high valuations) remains a concern.Earnings growth estimates remain positive and negative revisions have slowed. Earnings strength is expected to broaden out beyond US mega caps this year.Credit spreads – the difference in yields relative to government bonds – have largely retraced August’s widening and remain expensive relative to history. |
| Sentiment | Sentiment towards equities has cooled whilst market breadth has widened.The continued strength of US mega-caps over 2024 increased the divergence vs non-US markets, although US stocks have fallen from highs recently.Non-US markets were mostly weak over 2024 whilst tariff uncertainty is weighing on sentiment this year.Volatility (based on US stocks) remains below long-term averages. |
| Risks | A resurgence in inflation, which would warrant continued hawkish central bank policy.Labour market weakness could challenge the developed market growth outlook. Potential spillover effects from slowing growth in China on the global economy.Escalation in geopolitical tensions, e.g. Middle East, Russia/Ukraine, US/China.Mounting levels of government debt, particularly in the US, pose a longer-term risk.Tariffs under a Trump presidency could pose further challenges to global growth.Political instability. |
Asset Classes
| Asset classes | Current positioning | Current views |
| Equities | 🔵 | Benign growth coupled with falling interest rates should be positive for equities, whilst Trump’s pro-growth agenda should be positive for US firms in the near-term. Earnings remain reasonable, particularly for the US and Japan. US mega cap valuations are expensive vs history (albeit with strong fundamentals) whilst other regions and smaller US companies are fair value. Sentiment has cooled slightly from ‘overbought’ levels, which is generally a healthy sign. |
| Bonds | ⚪ | Although central banks are cutting interest rates, government bond yields look attractive relative to the last decade. We believe inflation risks are to the upside, but the market is now pricing this in; hence, we have taken some profit on inflation-linked exposure. After a run of strong performance, we also reduced our emerging market debt exposure. Credit spreads look tight (expensive), so we prefer more defensive positioning such as asset backed securities and short duration high-quality credit. |
| Alternatives | 🟠 | Select alternatives continue to offer diversification in a potentially volatile environment, albeit with a higher hurdle given yields available on bonds and cash. We favour assets with the ability to deliver less correlated returns to traditional markets and those which hedge against risk scenarios, such as gold and other commodities. |
| Cash | ⚪ | Although some central banks have started reducing interest rates, they remain attractive relative to recent history. Additionally, cash allows us to take advantage of tactical opportunities in potentially volatile markets. |
Equities
| Asset | Current positioning | Current views |
| Equities | 🔵 | Benign growth coupled with falling interest rates should be good for equities, whilst Trump’s pro-growth agenda should be positive for US firms in the near-term. Earnings remain reasonable, particularly for the US and Japan. US mega cap valuations are expensive vs history (albeit with strong fundamentals) whilst other regions and smaller US companies are fair value. Sentiment has cooled from ‘overbought’ levels and market breadth has widened, which is generally a healthy sign. |
| US | ⚪ | Domestic growth remains robust, and the election result is supportive, as corporate tax cuts and deregulation will be beneficial for many firms (particularly domestic firms). Inflation has fallen closer to target, but the imposition of tariffs and deportations poses a risk. Valuations still look expensive, but this is concentrated in the mega caps and these companies typically have stronger fundamentals. |
| Europe | 🟠 | Consumer confidence has fallen, whilst manufacturing remains weak. Political risk is elevated and rising, whilst proposed tariffs under a Trump presidency are a risk for exporters. Given the risks, favour targeted exposure rather than broad market. |
| Japan | 🔵 | Japanese earnings are robust, beating expectations and delivering growth, whilst valuations are now below historical averages. Japanese equities have also seen more positive earnings revisions than other regions. Sharp yen moves have created market volatility, however monetary policy is expected to normalise slowly alongside signs of sustained inflation and wage growth. Corporate governance reforms are accelerating and remain supportive. |
| Asia/ Emerging markets | ⚪ | In China, weak domestic consumption and troubles in the property sector have led to a deterioration in economic data. Stimulus measures are likely not yet sufficient to reignite domestic consumption. Tariffs under a Trump presidency could also cause further headwinds to the Chinese economy. However, sentiment is at lows and valuations are cheap. Elsewhere, growth prospects look more robust, whilst valuations are reasonable. |
| UK | 🔵 | An improvement in business and consumer confidence has been stalled by the budget, and the outlook for growth remains challenging. Headline inflation has returned to target, but stronger demand may add to inflation. This is likely to prevent the Bank of England from cutting interest rates much further. Valuations are cheap, unlike most other developed markets. |
Bonds
| Asset | Current positioning | Current views |
| Bonds | ⚪ | Although central banks are cutting interest rates, government bond yields look attractive relative to the last decade. We believe inflation risks are to the upside, but the market is now pricing this in; hence, we have taken some profit on inflation-linked exposure. After a run of strong performance, we also reduced our emerging market debt exposure. Credit spreads look tight (expensive), so we prefer more defensive positioning such as asset backed securities and short duration high-quality credit. |
| Government bonds | 🔵 | Yields remain attractive relative to the last decade and have increased since September. Market expectations for interest rate cuts are currently close to fair for the UK and US although look slightly excessive for Europe. Uncertainty around US government borrowing and central bank independence poses a risk to longer-dated US bonds. |
| Credit | 🟠 | Absolute yields continue to look attractive, but spreads are less supportive at current levels. We prefer shorter-duration and higher-quality (investment grade) corporate credit, as well as higher quality asset backed securities where we feel relative valuations are attractive given the strength of the consumer. |
| Inflation-linked | 🟠 | Many developed market real yields remain in positive territory; however, market inflation expectations have moved higher. Whilst we expect inflation to exceed central bank targets, this is now priced into bond markets and so we have reduced exposure to inflation linked bonds further. |
| Emerging markets | ⚪ | Emerging market growth prospects look relatively robust compared to developed markets, although tariffs are a risk. While developed market central banks are cutting interest rates (generally a positive for emerging markets), this is already priced into markets. Given their recent strong run, valuations now look elevated vs history. |
Alternatives and cash
| Asset | Current positioning | Current views |
| Alternatives | 🟠 | Select alternatives continue to offer diversification in a potentially volatile environment, albeit with a higher hurdle given yields available on bonds and cash. We favour assets with the ability to deliver less correlated returns to traditional markets and those which hedge against risk scenarios, such as gold and other commodities. |
| Absolute Return | 🔴 | Select opportunities in equity long/short and trend following strategies given diversification characteristics. However, government bonds are now looking more attractively valued and may provide a better source of portfolio diversification over the medium term. |
| Liquid private real assets | ⚪ | Long-dated revenue streams and income characteristics remain attractive in select parts of the market. We see good opportunities in renewables, infrastructure, specialist property and exposure to private companies. Valuations are more attractive following recent market volatility. Falling rates are supportive for the sector. |
| Commodities | 🔵 | Broad commodities can hedge against further disruption to energy markets, although areas of the asset class are sensitive to slowing economic growth, particularly in China. Increasing demand from infrastructure spend and energy independence goals could support metal prices against a backdrop of tight supply. |
| Gold | 🟢 | Gold should act as a hedge against growth or inflation shocks, as well as a further escalation in geopolitical tensions. Central bank buying is a long-term support, as is weakness in China’s property market, but strong performance over the last year may result in temporary pullbacks. |
Terms
Spread: the difference in yield between a non-government and government fixed income security.
Duration: approximate percentage change in the price of a bond for a 1% change in yield.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
