The market seems to think that the biggest risks have been taken off the table. Yet, the tariffs and trade issues that triggered extreme volatility in April have yet to be resolved. President Trump’s authority to unilaterally levy tariffs has been repeatedly challenged in the courts, and his use of executive orders to impose tariffs is still under judicial review.
Until there’s a resolution, the trade questions that previously weighed down markets remain a risk too big to ignore. Add to that slowing growth, a weak labor market, challenges to the Fed’s independence and continued geopolitical tensions, and we believe there are enough unknowns to warrant caution.
So where’s all the confidence coming from? Since April 8, sentiment has been shaped by upward earnings revisions, strong second-quarter results, the benefits of a weaker dollar for US companies and expectations of more tax breaks for US large-caps. In our view, the ensuing sugar rush may have prompted investors to project overly positive outcomes for the riskiest stocks, which may not be justified in the long term.
US Mega-Caps Diverge Despite Technology Surge
Risk-on sentiment has fueled US technology stocks, which surged by more than 50% since their April 8 lows. At the same time, the performance of the Magnificent Seven (Mag Seven) mega-caps has diverged, as investors have rewarded companies that are spending more on AI and are paying closer attention to their exposure to trade wars—and valuations. As their share price patterns continue to diverge, we think selectivity among the US mega-caps is paramount.
Beyond the Mag Seven, we think recent trends are creating opportunities in other market segments.
One sector that we believe warrants a second look is healthcare, which has underperformed of late but could be a source of stable growth in the coming years. Healthcare stocks typically rank high in quality metrics, and healthcare has seen some of the highest earnings growth rates of any sector over the past 20 years. AI could also be a new catalyst for growth in healthcare, with a wave of new applications in development that aim to improve patient outcomes.
Dividend growers and dividend-yield stocks could also be well positioned, especially against a backdrop of monetary easing. When rates come down, investors typically look for alternative sources of yield, which can drive demand for income-oriented equities. In our view, investors should cast a global net for income stocks, given that many US firms opt for share buybacks instead, owing to their greater tax efficiency.
Given myriad uncertainties, we believe defensive equities also deserve attention. Stocks that lose less in market downturns have less ground to regain when the market recovers. That means they’re better positioned to compound off higher returns in subsequent rallies. Over time, this smoother return pattern can deliver resilient returns, which helps keep investors in the market during bouts of turbulence.
Deglobalization Doesn’t Have to Mean Destabilization
As companies reshore supply chains amid trade tensions, a new era of deglobalization has begun. There are many benefits to an integrated global economy marked by free trade and low trade barriers. But deglobalization, too, can create opportunities for active investors.
Regional market correlations tell an interesting story. From the mid-1990s through the early 2000s, correlations moved sharply higher, coinciding with peak globalization. That means markets in the US, Europe, Japan and emerging markets tended to move together with less variability in returns by region. But in recent years, regional market correlations have begun to fall (Display). If deglobalization continues unabated, correlations could revert closer to their long-term averages.
