What often matters in investing is often the difference between the ‘known unknowns’ and ‘unknown unknowns’ – a situation that is particularly applicable today. Donald Trump’s tariffs are now more or less known, with an average level of 15%. Six months ago, this would have seemed crazily high: now it is interpreted as a positive outcome and has helped markets reach new highs. But markets could soon discover the as-yet unknown impact of tariffs on inflation, growth, margins and, ultimately, earnings. In Q3, will we see a pricing of these unknowns?
Markets look through tariffs
Since the start of the year, we have seen strong performance across risky assets, from equities to credit, even though US equity leadership appears to have faltered. Consequently, any geographic diversification away from US equities has proven to be a wise strategy. Amid market gains, coupled with strong momentum, what could weaken risky assets’ strong run?
One of the risks investors and policymakers will likely face in Q3 is the consequences of trade tariffs. July’s US Producer Price Index seems to have triggered alarm bells: expected at 2.5% on a 12-month variation basis, prices actually reached 3.3%, driven up by imports. Markets are likely to discover that the global economy is not immune to trade tariffs.
While tariffs should have a greater impact on inflation, world trade and earnings growth in the coming months, the question investors face is whether they should react to it. This is a fair question, since equity-market performance tends to correlate with future earnings growth. As shown in Figure 1, the correlation between earnings and price progression involves a six-to-nine month lag, which means that forward-looking markets dismiss what appears to be temporary within this time frame.
This raises an important point: if the impact of tariffs is a one-off event affecting earnings by year-end, markets could look through them. Any subsequent market setback could then lead to another round of ‘buy-the-dip’ trading, cushioning the depth of any market decline.
FIG 1. Global equities: the correlation between returns and earnings1
Structural trends meet valuation risk
The impacts of tariffs impacts would occur in a market environment where a strong narrative –- the rise of AI –- meets valuation risk. The AI and tech themes remain dominant, and despite the sector's lack of performance in 2025 to date, trend strategies have not yet reduced their exposure as much as they have for consumer staples or utilities (see Figure 2). The tech narrative appears intact from the investor positioning perspective.
Having said that, valuations are elevated across the sector. While jitters in early August remain contained so far, these persistently high valuations could rapidly become a market headwind. Investors could end up being torn between structural narratives (the abundant liquidity and the tech and AI trend) and the temptation to take profits temporarily, creating enough tension to make portfolio rebalancing challenging.
FIG 2. Trending tech: the percentiled beta of trend strategies to equity sectors2
Our positioning across asset classes
Our investment teams do not yet see a case for bearishness. The environment remains benign: inflation outside of the US is notably lower, the global economy remains resilient, and a few more cuts are expected from G10 central banks. Balancing these elements, our teams maintain a mix of selected risk-on exposures alongside neutral positioning – depending on their asset class and opportunities identified. That said, the valuation argument is a source of concern (primarily for US stocks), and any market pullback could be used as a re-entry point.
Multi asset. The All Roads team has slightly reduced its market exposure to around 135%, with its allocation to protection and cyclical assets remaining at 60% and 40% respectively (rebased to 100%).3
Fixed income. Our Global Fixed Income team remains neutral on sovereigns and emerging market (EM) hard currency debt, holding a preference for Treasury Inflation-Protected Securities (TIPS) over nominal US Treasuries, and for investment grade over high yield (HY), which has a defensive and selective tilt. Our Asia Fixed Income team remains overweight India, commodities, insurance and EM HY sovereigns.
Convertible bonds. The team is positive on the US and neutral on Europe and China. However, given the current market complacency, it has trimmed risk in order to move closer to the benchmark. It continues to favour the themes of US deregulation and onshoring, AI and Chinese consumption.
Equities. Our Global Equities team has reduced its overweight to Europe and is beginning to reverse its US underweight, aiming to build US exposure on any market dips ahead of the next Federal Reserve meeting. In terms of sectors, it remains overweight technology, media and telecoms, and consumer discretionary. Our Swiss Equities team has de-risked by taking profits from well-performing stocks, and is overweight communication services and industrials. The Asia Equities team remains overweight China and Hong Kong, and is equal weight India.
