After a barrage of U.S. trade announcements in March and April, the past few weeks have been calmer - and there are now early signs of the trade war de-escalating. This de-escalation has taken some of the more extreme measures off the table, but also left the bulk of tariffs on most U.S. trade partners intact: over three quarters of U.S. imports are still facing a minimum of 10% tariffs, with the average U.S. tariff rate at above 13% - the highest since the 1930s.
In this week's economic update, we discuss the most recent tariff developments and the bounce back of global equity markets on the back of these de-escalations. We also return to a question that was on our minds well before the trade war began: the sustainability of U.S. outperformance.
Economic Update
De-escalation of trade war has been impactful.
A significant 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. This breathing room creates the necessary time for a more comprehensive trade deal to potentially be negotiated.
Meanwhile, 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 1930’s 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. We’ll continue to monitor this situation.
Can U.S. exceptionalism prevail?
The U.S. stock market has recovered all the losses experienced in early April. (Looking back at predictions for how the market could recover from a correction given an artificial trigger, this recent recovery seems to align with those projections). As a result, the stock market is at about the same place it was when the year began.
At that point in early 2025, 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 re-rating 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.
Summary
As discussed, 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. Overall, we are less concerned overall about the near-term outlook than we were a month ago. This view is widely shared, as we’re already seeing this sentiment 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 over the past little while, however relatively short lived. As we have discussed before, the latest period of risk, uncertainty and volatility was not a surprise, and we had time to plan and prepare our portfolios to weather those choppier waters. Further, these times can often create equity opportunities for those able to invest more into the markets. There inevitably will be other economic factors or influences in the future that may result in similar periods of more prolonged market weakness. We’ll continue to be proactive in our assessments and be ready to act should opportunities become available.
Step by step: Trade talks lead to tariff de-escalation but hurdles remain
We are surprised that we aren’t more surprised. There are now early signs of the trade war de-escalating: new tariffs on auto parts for early May were diluted (critically for parts from Canada and Mexico that are compliant with the CUSMA/USMCA being exempted), larger country-by-country reciprocal tariffs remain on hold, and the most disruptive 100%+ tariffs on bilateral trade between China and the U.S. were sharply reduced earlier than anticipated.
In the most recent report from RBC Economists, Claire Fan and Nathan Janzen explore the tariff developments, the outlook for Canada and our inflation rate, as well as how these developments might impact growth. You can read the full analysis by clicking here.
As always, we are available to connect with you personally. Please don’t hesitate to contact us at 519-822-2024 or elineskyschuett@rbc.com.