This week’s blog is written by portfolio manager CJ Cowan
Despite rising tariffs and ongoing political uncertainty, global equity markets remain near record levels. In his latest portfolio manager blog, CJ Cowan explores why markets are holding up so well, what’s driving investor optimism, and whether this resilience is built on solid ground - or something more fragile.
Over recent weeks, a flurry of trade deals has been agreed between the US and its trading partners to lower tariff rates. The UK got in first, and more recently Japan and the EU have joined the party. Just as it looked like everything was simmering down, we woke up on the morning of 1 August to find that, following yet another tariff deadline, rates had been increased on countries from Taiwan to Switzerland (although the truce with Mexico has been extended for another 90 days).
While the situation isn’t as bad as it looked on 2 April, it’s still worse than expected at the start of the year. According to research by Pimco, the average effective tariff rate on US imports has increased from ~3% in January to ~14% by mid-July, and it’s likely to move higher still. Meanwhile, the baseline rate for countries with significant goods trade surpluses with the US has been ratcheted up from 10% to 15%.
Given the biggest financial market story of the year is playing out worse than expected, why are equity markets at or near all-time highs - and should we be nervous that a crash is coming?
To tackle the second part of the question first, it turns out markets spend rather a lot of the time around their all-time highs. Once you consider that markets generally go up as economies and corporate earnings grow, this shouldn’t come as a huge surprise. Still, it fills many of us with a sense of impending doom when we read these sorts of headlines in the paper.
If we look at the history of US large-cap stocks going back to 1928 (as far as is available on the Bloomberg terminal) we see that in 38% of months the index has been within 5% of its all-time high. If you consider total return, rather than just price, this increases to 51% of the time.
Of course, there have been some bad decades: in the 1930s, the equity market spent precisely zero months within 5% of its all-time high due to the bear market that followed the Wall Street Crash of 1929. Stock prices took until 1932 to trough, eventually falling nearly 90%, and the market didn’t fully recover until 25 years later.
You can say what you want about an AI bubble, but the innovation and earnings growth delivered by these companies has been hugely impressive. Supernormal earnings growth rates can’t go on forever, but the bedrock of the market rally is founded in economic activity rather than pure financial market speculation. This should give us some comfort that it’s not 1929 all over again - even if pockets of the market do look rich - but it is not a reason to be complacent.
All that is a slightly long-winded way of saying that the market being at all-time highs shouldn’t automatically make us nervous because it is very common.
You hear a lot that the current situation is unusually uncertain, so surely markets shouldn’t be at these lofty heights?
It is always tempting to say things are more uncertain today than before. However, in saying this, we are usually falling for hindsight bias and forgetting that we were equally clueless about the future during those supposedly more certain times of the past. There’s always something going on in the world shaking things up - now is no different, even if it feels like this happening more than normal.
Many of the worst-case projections shortly after Liberation Day did not account for changing business behaviours in response to tariffs. In reality, every action provokes a reaction, and companies do as much as they can to mitigate the impact of any kind of disruption. Tariffs are no different, and while there will be further short-term upheaval and some inevitable casualties, companies will work out how best to operate under the new trade order.
Meanwhile, the goalposts have been moved so many times that investors have developed tariff fatigue and are paying less attention to Trump’s tweets, meaning the market sensitivity to new news has subsided as well. There’s still a long way to go, and it is highly likely global growth will slow further, but it looks like crisis has been averted.
When you buy shares in a company, you are buying a share of the company’s net profits. A plethora of other factors drive market prices in the short term, but earnings are what you should really care about as a long-term investor.
63% of the S&P 500 have reported so far during second-quarter earnings season and more than 80% have beaten forecasts, delivering aggregate earnings growth of 10%. The depreciation of the US dollar has helped: Société Générale’s equity strategists note that a 10% drop in USD adds 4% to earnings per share, while a 10% tariff rate subtracts 3%, meaning the two effects have largely offset one another so far.
Of course, the weaker dollar has been a headache for international investors in the US, but, in local currency terms, there is only one or two percent between the returns of US, European and UK equity markets so far this year.
Now the ‘Big Beautiful Bill’ has passed Congress, this could pave the way for growth tailwinds in the US as we move into year-end. The bill represents a further fiscal expansion, even after generously accounting for tariff revenues. It is difficult to have a recession when you are running a 6% budget deficit, so continued earnings growth in the US would not be a surprise.
Those are just a few reasons to help explain the positive performance of global equity markets and why this could continue. However, every story has two sides, and there are plenty of other reasons to be somewhat cautious as well. In particular, we can’t discount the risk that the apparent calm in markets emboldens the president to shake things up again. Still, in our view, staying modestly long the market while keeping hedges in place is the most sensible approach given the current backdrop.
CJ is a portfolio manager of the Quilter Investors Cirilium and Monthly Income Portfolios. CJ joined Quilter Investors in August 2018 from Aberdeen Standard Investments where he worked in the global macro team, managing global government bond and global aggregate portfolios.
CJ is a CFA charterholder and has also completed the Chartered Alternative Investment Analyst qualification. CJ has a degree in economics from the University of Bristol and an MPHil in Economic and Social History from Brasenose College, University of Oxford.
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