What a difference a few weeks, or even days, makes. In a major pivot, the U.S. administration went from announcing sweeping tariffs across many of its trading partners to then invoking a three-month pause for all countries. The exception is China, where tariffs have since risen to 145%. Previously announced tariffs impacting the auto sector, steel and aluminium remain in place, while new exemptions for some electronics have been granted. The shift in approach has led to some respite from the stock market volatility experienced recently, but uncertainty remains elevated. Moreover, the “risk-off” backdrop that traditionally accompanies a period of market uncertainty has turned into a “U.S.-off” environment. The term, coined recently by an interest rate strategist at RBC, refers to the simultaneous weakness seen in U.S. stocks, U.S. government bonds, and the U.S. dollar. We explain below.

The U.S. stock market has struggled this year relative to other markets. The weakness has been observable across small, midsize, and “large cap” stocks. Many sectors, except a few traditionally defensive ones, have been weak. While global stocks have had challenges too, U.S. stocks have underperformed many other developed markets. We attribute this underperformance to elevated valuations. The U.S. stock market entered this year at a forward Price-to-Earnings multiple of well over 20 times, compared to its historical average of closer to 16 times. Investors had come to expect strong earnings growth from U.S. stock market growth companies and were particularly enthralled with the earnings potential tied to generative artificial intelligence. This left investors with very high expectations for future growth, which has now come into question. It is not surprising that technology-related pockets of the U.S. market have been among the weakest year-to-date.

Weakness in stock markets is normal during periods of economic uncertainty. More surprising has been the behaviour in the U.S. government bond market in recent weeks. Bond yields tend to fall (and bond prices rise) when investors are seeking the relative safety and comfort offered by bonds, and in particular government bonds. At the time of the U.S. government’s policy pivot, however, longer-term U.S. government bond yields rose (prices fell) relatively sharply. There was more selling pressure than buying pressure. Some of the selling pressure may have been attributable to deleveraging in the institutional and hedge fund community and selling by foreign investors, including central banks. Bond yields have moved lower more recently, suggesting that this may have been a temporary anomaly.

The U.S. dollar has also often been a beneficiary during periods of economic and market stress. In the most recent environment, however, the USD has weakened, with other major currencies such as the Canadian dollar, Euro, Japanese Yen, Swiss Franc, and Pound Sterling sitting at year-to-date and, in some cases, multi-year highs relative to the U.S. dollar. The U.S. dollar weakness this year reflects investor concerns and questions that have surfaced on several fronts, including the trajectory of U.S. economic growth, potential for global investors to rotate out of U.S. assets, unpredictable and erratic government policy, and the sustainability of the U.S. fiscal position (that is, high U.S. federal government deficit and debt levels).

The U.S. continues to play a key role in our investment portfolios because of the depth of the opportunity set presented by its stock and bond markets. Nevertheless, we are open to the possibility that longer-term trends may be changing, and other markets, sectors, and currencies could be important drivers of future portfolio performance. We will continue to assess opportunities for our clients and their portfolios.

If you have any questions, please do not hesitate to contact us.

 

Drew M. Pallett LL.B. 

Senior Portfolio Manager and Investment Advisor 

RBC Dominion Securities

Email: drew.pallett@rbc.com