Global equity markets continued to march higher recently on the back of the de-escalation of the trade war. We discuss recent developments in this ongoing saga. We also return to a question that was on our minds well before the trade war began: the sustainability of U.S. outperformance.

De-escalation of trade war has been significant

A de-escalation in trade tensions has emerged over the past month. The U.S. and China took meaningful steps over the past week with both countries agreeing to meaningfully reduce tariffs on one another's goods for the next three months, carving out time for a more comprehensive trade deal to potentially be negotiated. The U.K. and the U.S. agreed to a limited bilateral trade deal. Some sectors will remain subject to duties, but others will be spared entirely, indicating that the U.S. administration may be approaching things more strategically than it once appeared. Both deals leave the baseline 10% global tariff rate imposed on "Liberation Day" in place, which is broadly in-line with what investors expected earlier this year. On the one hand, the reduction in tariffs to a more manageable level reduces near-term risks to global growth. On the other hand, the effective U.S. tariff rate is still at its highest levels since the 1930s and risks creating some stagflationary headwinds, particularly in the U.S., with growth that may slow and prices that may rise. There have been few signs of tariff-induced pricing pressures thus far, but they are expected to emerge over the next few months.

Can U.S. exceptionalism prevail?

The U.S. stock market has recovered all the losses experienced in early April. As a result, the stock market is at about the same place it was when the year began. At that point, we were contemplating whether the long-term trend of U.S. stock market outperformance could continue. Its remarkable outperformance over the past decade has been driven by a combination of strong earnings growth and a valuation rerating over the years, which means that investors have been gradually willing to pay more for a dollar of earnings than they did in the past. This valuation “premium” can be justified to some extent by the U.S. stock market’s strong track record of consistently generating attractive earnings growth, elevated profit margins, and high returns on capital. But the willingness of investors to push the valuation premium higher over the past decade has left U.S. stocks rather expensive. While we are confident in the ability of U.S. stocks to continue to generate strong earnings growth in the years ahead, we are less convinced that the valuation multiple can move higher in a similar fashion to what we have witnessed over the past decade. This suggests the returns from U.S. stocks in the years to come may be a bit less impressive.

Less concerned, less enthusiastic about the investing environment

As mentioned above, recent developments on the trade front have lowered some of the risks to the economic outlook. But the risks have not completely disappeared. After all, tariffs may still result in slower growth and a rise in inflationary pressures. But, overall, we are less concerned about the near-term outlook than we were a month ago. The challenge from an investment perspective is that this view is already reflected in stock prices.

Opportunities to invest tend to arise during periods of market dislocations, when prices reflect investor concerns, elevated uncertainty, and higher risks. That was the kind of period we observed last month, but it proved to be relatively short lived. There inevitably will be other surprises in the future that may result in periods of more prolonged market weakness that may provide us more opportunity to potentially take advantage, either through rebalancing across our client portfolios or through more specific and targeted investments. We’ll be watching, waiting, and ready to act.

Should you have any questions, please feel free to reach out.