Meanwhile, growth stocks are much more expensive versus the broad market than they were in 2016. At the same time, defensive stocks—represented by the MSCI USA Minimum Volatility Index—are trading at relatively inexpensive valuations versus the broad market.
Macroeconomic conditions have also changed, with the US facing higher inflation than in 2016 and a fiscal deficit that has widened dramatically to 6.7%.
In our view, current market and macro conditions warrant caution from investors and set the stage for potential bouts of market volatility, especially given the risks on the horizon.
Risk 1: Trump’s Policy Agenda Spells Uncertainty
Trump’s pro-business credentials mask many policy uncertainties. In his initial executive orders, Trump moved to deregulate the energy industry, and he has reiterated promises to cut corporate taxes. Then, in February, he decided to impose tariffs on China, Canada and Mexico. Measures like these seek to sharpen the competitive edge of US businesses.
But policy details will take time to formulate, and their effects on US and global companies won’t be clear overnight. Tariffs, for example, aim to make imports to the US less competitive. In reality, the effect of tariffs will differ across sectors, industries and companies.
For example, goods manufacturers have more of their revenue exposed to potential tariffs than services companies, according to our analysis of MSCI World constituents. In the technology sector, semiconductors and hardware companies are much more vulnerable to tariffs than software firms.
As markets struggle to digest the impact of tariffs on individual companies, we expect volatility to increase. This could create opportunities in companies that are mistakenly branded as victims of tariffs (Display). Select companies that have moved to optimize supply chains in recent years could surmount tariff risk and deliver positive surprises in earnings and returns.
