The path forward: Opportunity amid uncertainty

15 May, 2025
By Linda Bakhshian

Second-quarter 2025 recap 

The second quarter commenced with heightened volatility in equity markets but demonstrated a swift recovery, overcoming trade concerns, geopolitical tensions in the Middle East, and associated energy market disruptions. This resilience propelled the markets to new all-time highs. The S&P 500^® Index posted an impressive gain of 10.6% during the quarter, rebounding sharply by 24.5% from its April lows following the April 2 tariff announcements, which had triggered a 19% correction from February's peak.

US large-cap growth stocks led the second-quarter rally, delivering a robust return of 18%, a sharp reversal from the prior quarter's performance. In contrast, US large-cap value stocks lagged significantly, recording a more modest gain of 4%. Sector performance within the S&P 500 Index exhibited notable dispersion. Information technology emerged as the top-performing sector, surging by 23% as the artificial intelligence (AI) infrastructure buildout continues full speed despite concerns earlier in the year from DeepSeek, while the energy sector underperformed, declining by 9% on weaker oil prices.

Outside the US, equity markets also generally rose. In both US dollar (USD) and local currency terms, returns during the fourth quarter were mostly positive. A decline in the value of the USD meant that from the perspective of US investors, the returns of foreign markets were generally better. In USD terms, the strongest performers were Australia, Germany, Japan, and Spain, which all rose more than 15% over the three months. France, Singapore, and Switzerland produced negative returns in local currency terms, but positive returns when measured in USD. 

Keep calm and carry on?

The global political and economic landscape shifted meaningfully in early April following the chaotic rollout of the "Liberation Day" tariff policies, adding complexity to markets already contending with geopolitical tensions, index concentration, and narrow leadership. Despite these crosscurrents, the US economy demonstrated resilience in the second quarter, as corporates reported better-than-expected earnings and profit margins, while consumers remained a key pillar of strength.

Historically, trade agreements have required lengthy negotiations culminating in detailed, binding documents; however, recent trade frameworks are unconventional, leaving plenty of room for interpretation (or legal challenges) while global equity markets remain susceptible to headline risks. Recent negotiations with Japan, the EU, and a few other countries, in our opinion, have left markets complacent of risks still embedded in higher tariffs, namely the knock-on inflationary effect. This uncertainty is compounded by the US administration's continued imposition of tariffs on key goods such as aluminum, steel, and pharmaceuticals. Additionally, if the US aspires to build out AI and related energy infrastructure faster, this will add further inflationary challenges. Although the economic impact of tariffs has not yet been fully reflected in US data, concerns linger that uncertainty among businesses and consumers could slow economic growth.

So far, second-quarter earnings reports have been better than investor expectations. Last quarter’s management commentary and guidance were very cautious given the timing of tariff announcements. It is clear that companies are still planning for difficult quarters ahead; however, so far, they have been able to retain margins through a combination of pricing, cost cutting, productivity initiatives, and sourcing shifts.

AI-related companies continued to play an important role in the overall rise of the equity markets, and banks also generally benefited from the easing of financial conditions and higher trading volume during the quarter. By contrast, some firms in the consumer discretionary and materials sectors were negatively affected by investor concerns about the potential impact of tariffs and depreciation of the USD. If we can weather the tariff issues, we expect a broadening of economic growth, which would be positive for earnings and help tighten the valuation discount between the equaland capitalization-weighted S&P 500 indices.

As we move into the second half of 2025, the confluence of macroeconomic, monetary, fiscal, trade, and geopolitical dynamics continues to be a significant driver of market volatility. Heightened policy uncertainty is amplifying the variability of potential growth outcomes. While recent trade developments have offered temporary support to equity markets, we anticipate that the current sluggish economic growth will persist until we have a clearer picture of tariff impact, potentially exerting downward pressure on the economy. This backdrop may fuel investor expectations for bigger US Federal Reserve (Fed) rate cuts – expectations that, in our view, could ultimately prove overly optimistic. In this context, we remain vigilant in monitoring key indicators, especially labor market conditions, consumer real spending power, and commentary from company managements. Consumer behavior is being closely observed for signs of strain stemming from tariff impacts, while corporate profitability is under scrutiny for evidence of slowing growth or the financial burden of tariffs. The question: Who will ultimately bear the cost? These factors are particularly critical as equity valuations remain elevated, leaving little margin for error should economic conditions deteriorate further.

Nonetheless, structural positives such as the administration's deregulation initiatives and tax reforms are expected to yield long-term benefits, albeit with a lag. Measures such as reduced tax rates for small businesses and lower regulatory compliance costs are designed to lower operating expenses, supporting capital investment and fostering sustained economic growth over the cycle. Moreover, the recently enacted One Big Beautiful Bill Act includes two key stimulative provisions: the permanent extension of individual tax cuts from 2017, averting a $4.5 trillion tax increase on the consumer, and the introduction of 100% expensing for corporate investments in such things as capital equipment, manufacturing and research & development, which is expected to catalyze a robust capital expenditure cycle, enhance productivity, and drive long-term GDP growth. 

Additionally, while trade uncertainty has created short-term concerns, the large capital expenditures from some of the biggest US companies, especially those AI-related, are providing an offset, with positive implications for both the economy and the markets, while the previously mentioned structural reforms have the potential to underpin the economy's resilience longer term. Hence, we remain focused on monitoring key indicators to assess the evolving trajectory of growth and investment opportunities.

Looking ahead, our investment teams strive to construct portfolios designed to yield positive, risk-adjusted longterm returns, paying attention to both quality and value when building their portfolios. We anticipate that markets will remain fluid, characterized by a broader spectrum of potential scenarios as investors assess the implications for corporate earnings, consumer behavior, new fiscal incentives and Fed policy.

Our conviction remains that, over the long term, equity markets are shaped more by tangible policy measures than by political rhetoric. Furthermore, sustainable earnings growth is predominantly driven by the intrinsic strengths and vulnerabilities of individual companies. While businesses, consumers, and supply chains exhibit the capacity to adapt to evolving conditions over time, uncertainty remains a critical factor that markets struggle to price effectively. In our assessment, actively managed, well-diversified equity portfolios can offer investors a strategic advantage by mitigating the risks associated with overexposure to any single market theme. 

Expert views from our network

Each quarter, we explore insights from our investment analysts and portfolio managers on the most pressing and relevant market issues. This quarter, Alexis Freyeisen, our Client Portfolio Manager specializing in international equities and emerging markets, has shared valuable perspectives that may prove insightful for asset owners who have not recently revisited their exposure to emerging markets.

“We are cautiously optimistic about the outlook for emerging markets (EM), despite the possibility of near-term volatility due to uncertainty over tariffs. There are certainly reasons for caution, including US policy unpredictability, potential further disruption from global supply chain reconfigurations, and the possibility that US interest rates may remain at high levels for longer than previously expected. However, none of these meaningfully alter the bright perspectives about growth opportunities in EMs.

“Even if the tariff rates imposed so far are somewhat above what was initially expected, the impact on EM growth may not be as negative as markets had feared a few months ago. The impact is likely to be most severe for smaller countries with export-oriented economic models. Moreover, many EMs now have a stronger macroeconomic framework than in the past and are more competitive globally.

“EM equities just needed a catalyst. A weaker USD this year has allowed central banks and policymakers in EMs to pursue policies to support the domestic economy. Looking at patterns since the end of 2005, we can observe an inverse correlation between the value of the USD and the cumulative relative return of EM equities versus the S&P 500 Index. While the weak performance of the USD this year could pause in the near term, we are observing a reassessment of the dollar taking place at large asset owners, which combined with rich valuations and trade policies favoring the rebalancing of the US current account (which, in theory, will mean a lower capital account) has the potential to put downward pressure on the American currency.” 

Notes: S&P 500 Index total return, MSCI Emerging Markets Index net total return in USD, and US Dollar Index (DXY) all from Bloomberg, details of methodology available on request; correlation of monthly changes in these two series is -0.45.

“In recent years, the earnings outlook for EM was unappealing. However, we think that the combination of a weaker USD and local policy reforms will help to create a more attractive environment for both domestic and foreign investors. In Korea, for instance, we are expecting corporations to adopt more shareholder-friendly policies such as higher dividends and more share buybacks. In China, we anticipate that the central government will continue trying to reduce excess capacity in some industries, which should improve margins for the remaining firms. And in EMs, generally, we can see local companies developing goods that will appeal to both local and global demand.

“Over the past two decades, the forward P/E multiple of EM equities has generally been lower than the forward P/E multiple for the S&P 500. In recent years, this discount has generally been around 35%. Over the past year and a half, the discount has increased slightly, and at the end of June 2025, it was approximately 43%.” 

Figure 2 shows ratio of price-to-earnings ratios for S&P 500 Index and MSCI Emerging Markets Index, based on consensus forecast earnings for the next fiscal year (FY1), all data from Bloomberg; details of methodology available on request. Data as of June 30, 2025.

“After more than a decade when the returns to EM equities were lower than the returns to US large-cap equities, it is not surprising that asset owners have been reluctant to commit money to EMs, explaining the light positioning. At the end of June 2025, EMs represented 11% of the MSCI All Country World Index by weight, but Morningstar has estimated that average US client exposure to EM equities was only 3%. In our view, conditions are now ripe for a reappraisal of EM equities, due to a weaker USD, improvement in fundamental conditions, attractive relative valuations, and renewed appetite for diversification.”