A Distinctly Discriminating Turmoil

Michael Grant

Key Points:

• In recent months, a macro shift has accelerated as the new US administration communicates to markets that there could be short-term economic pain, with tariffs part of a broader strategy focusing on Main Street over Wall Street.
• We do not believe a US bear market is unfolding, at least not now, because the economic risk is one of slowdown, not recession. Instead, we are witnessing what happens when assets become over-valued, over-owned, and over-hyped.
• Trump believes the US economy has become too dependent upon government support, and the positive supply-side impact of restricting the latter is a complicated story. In any case, changes to fiscal policies and regulation should be more impactful than those related to trade and immigration.
• With investor concentration in the US mega-caps, small reallocations can have big effects on the margin. This is unfolding across equity classes. There is a fundamental vulnerability for US dollar-denominated assets in a world of deglobalization.
• The dispersion of equity performance in terms of individual stocks is elevated everywhere and signals the opportunity for active management. Capital is not being withdrawn; it is being reallocated. The turmoil within equities is discriminate.

Commentary around financial markets can confuse catalysts with causes. Many point to Trump’s tariff wars as one source of the recent turmoil across US equities. It seems clear that many underestimated the commitment of the resurgent Trump presidency to radical change. How else to explain why the consensus outlook for 2025 has not survived the first quarter?

The more genuine mistake has been to underestimate Trump’s willingness to overlook the turbulence that the pursuit of his agenda would entail. In his own words, “Markets are going to go up and they’re going to go down but, you know what, we have to rebuild our country.” Investors are discovering there is no “Trump put” under equities.

The distribution of the latest turmoil reveals the essential problem: the overvaluation of, over-optimism about, and over-exposure to America’s largest-cap growth stocks. The collapse of the momentum factor in March—one of the fastest unwinds in 40 years¹—highlights the danger of overstaying the party, or “dancing as long as the music plays.”²

This positioning crisis across the investment industry has symmetrical logic. The counterpart of everyone’s overweight to US growth equities has been a corresponding underweight outside of America and to cyclical value in particular. The comparative resilience of equities in Europe, Canada, and Mexico—the targets of Trump’s tariffs—is telling.

Again, the catalysts are less important than the underlying diagnosis. The obsession with Trump generates the impression that his pronouncements are the most significant influence. In our view, it is an accident of history that Trump’s second presidency coincided with the moment when America’s growth equity assets had attained unsustainable levels.

That said, Trumpism is the shock therapy for Europe’s political establishment, succeeding where even the invasion of Ukraine failed. His direct engagement with Russia has forced Europe to confront the consequences of its decline: irrelevance on every world stage. One of several expressions³ of this panic is the discriminating resilience of European equities.

Trump’s initiatives are succeeding where 50 years of mainstream policy recommendations have failed: they are producing a degree of rebalancing of international demand. Demand in parts of Europe must revive from a position of stagnation. The pace and timing of this rebalancing will be decisive for the cyclical value industries that dominate non-US markets.

Tariffs, the growth scare, and the bursting of the AI bubble—all have coalesced to produce signs of hesitation in US consumer demand. Here, there are parallels with the Silicon Valley Bank liquidity crisis in spring 2023, when economic fears intensified but abated quickly. Today as then, labor markets appear firm, consumer balance sheets remain pristine, and real wage growth is positive.

We view the coming changes in trade and immigration as less impactful for the US economy than those related to regulation and fiscal policies. The latter are positive supply-side shocks. The consequence of limiting fiscal activity is a complicated story, with some short-term pain that we interpret as slowdown, not recession.

Fortuitously, the message of market behavior is that US recession risk is low for now. Bond yields have only declined moderately, credits spreads have not moved decisively, commodity prices are resilient, and cyclical sectors have not underperformed. The implication is a severe correction of equity values, not a bear market.

Although today’s headlines diminish our confidence, we continue to see expansion as the most likely path ahead because the key drivers of recession are not yet in place. Sentiment matters, but fundamentals matter more. Higher uncertainty is not the same as the certainty of recession. Of course, all of this bears monitoring.

Volatility in a Very Broad Range

Entering 2025, we anticipated two scenarios for US equities: volatility or a bear market. By March, equities stood at the threshold of a bear market. However, it is too early for this because the US economy is confronting a slowdown, not a recession. This favors the scenario of volatility rather than outright bear—for now.

The US equity sell-off has been held at the important support of ~5500 for the S&P 500 Index. This zone may be retested, if only because further tariff salvos are coming, and many investors will sell into any revival. At worst, we see downside to 5300, which is consistent with the interpretation of “correction with high volatility.” A wide trading range for US benchmarks should be assumed; our portfolio is hedged accordingly.

Once this phase of the shakeout is complete, US equities could return to their 2025 year highs by summer on the assumption of stabilization in the economic data. We expect the Federal Reserve to deliver a reduction in the federal funds rate of at least 50 basis points in the May-to-August period. In other words, we anticipate a setting of three steps forward and two steps back for US equities in Q2.

What happens after will be strongly influenced by the correctness of our structural perspective, which we described last autumn as the “Invincibility Syndrome.”⁴ While a degree of investors’ over-optimism has been removed, the obstacle of over-ownership is unresolved. Investors are likely to reduce risk into any revival, which implies recovery cannot be V-shaped.

The riposte to the Invincibility Syndrome and its implications for prolonged disturbance is this: has the world that produced the decade-plus outperformance of US growth equities really changed that much? After all, the attributes of these businesses are substantial in terms of profitability and security. Could this not simply be a temporary setback rather than a more strategic turning point?

Dogmatism about the future is rarely a productive investing quality. And yet, two arguments stand tall over the question of sustained American financial supremacy. First, asset valuations matter, at least when they are extreme and especially when they are backed by considerations of sentiment and positioning. The comparison with the year 2000 can be qualified, but not entirely dismissed.

Second, the exceptionalism of US financial markets was enabled by America’s ability to attract capital for competitive returns and security from all parts of the world. Today, few doubt the narrative of a more fragmented world economy with greater restrictions on trade and investment. Disruption implies that capital can go home, which the latest investor flows highlight has begun.

In this version of the new global order, it is hard to believe that financial flows will not be affected in some fashion. While the US economy is less vulnerable to Trump’s policies than those of its major trading partners, the unintended and indirect effects upon flows of portfolio capital may be more disruptive than many can imagine today.

This is why the first quarter might be judged as an overture for what is to come.