US equities sell-off will create opportunities

Tariffs, funding freezes, and government spending cuts have caused investors to reassess the outlook. The chances of stagflation have grown, but policy will stabilise, and opportunities will appear, both domestically and globally.

US equities slide

Since the S&P 500 posted an all-time high on the 19 February, it has declined by over 10 per cent, marking a technical correction. The widely watched 200-day moving average has also been breached. US equities that had climbed strongly following the presidential election of Donald Trump have swiftly reversed course as investors re-evaluate US policy.

Part of the reversal in US equities seems to be a case of complacency. The market initially focused on the positives of the Trump platform and preferred not to dwell on the potential downsides. Investors hoped that Trump would take a pragmatic approach and use the threat of tariffs as a negotiating tactic without following through.

By mid-February, it emerged that no immediate agreement with Mexico and Canada was likely, further steel and aluminium tariffs would be implemented, and trade partners India and Europe could be added to the list of tariff counterparties. In March, some of the tariffs on Mexico and Canada came into effect, with the majority postponed until April, while the blanket tariff on China was doubled to 20 per cent. All three countries have promised retaliatory measures. In addition, the Trump administration is considering protectionist policies on copper, lumber, and timber.

These developments indicate the US is taking a hawkish stance towards its trade deficit with other countries. The implications of these measures are higher input costs and lower margins for US businesses and higher prices for consumers. Trump and Treasury Secretary Bessent have also both indicated they are willing to accept temporary financial market pain to push through their agenda.

Challenges to growth

The uncertain policy environment has made it more difficult for businesses and consumers to plan investment and spending. While these challenges are not yet showing up clearly in hard economic data - US GDP growth is tracking above 2 per cent and unemployment remains at historically low levels - it is affecting soft data. Recent consumer confidence readings have dipped sharply and even the Republican-leaning NFIB small business survey, which tends to be more optimistic during Grand Old Party (GOP)-led governments, has weakened.

The market also continues to re-evaluate the potential implications of Trump’s other policies. Immigration controls have been interpreted as likely to lead to a lower influx of cheap labour and consequently higher wages. Department of Government Efficiency (DOGE)-related spending cuts have seen tens of thousands of government employees laid off and that number could ultimately stretch to hundreds of thousands, affecting the spending power of many households, at least in the short term. The combination of tariffs, immigration control, and government job cuts are leading to lower growth forecasts.

Despite that outlook, monetary policy levers may not be able to flex as much as usual. Inflation remains above target, and the US administration’s policies are expected to put upward pressure on prices. If this is the case, it means that despite weaker growth, the US Federal Reserve may be forced to keep monetary policy more restrictive than they would ordinarily like. Our macro team has placed a 50 per cent probability on a stagflation scenario (higher than target inflation with below trend growth) for the US this year.

Short-term pain, but potential long-term gain

The more pessimistic outlook is feeding through to financial markets. US Treasury yields are falling - not because inflation is coming under control, but because of growth fears. In equities, US stocks have sold off as investors incorporate the revised economic path and the AI theme loses some of its lustre. Previously, artificial intelligence (AI) was powering US equities higher, but this impetus has evaporated in recent weeks as the advent of Chinese rival DeepSeek’s R1 model causes a rethinking of the prospects for the Magnificent Seven stocks.

Although technical signals in US equities suggest stocks are oversold and that we could see some short term rebound given the magnitude and speed of the recent declines, the fundamental outlook is uncertain as the lack of policy clarity will affect the environment for corporate decision making.

However, we know the Trump administration has an end game - a better trade balance with its partners and onshoring manufacturing operations. In that light, once the policy backdrop becomes more stable, we could see a continuation or even acceleration of large scale and prolonged capital investment that reorients the economy towards a stronger domestic manufacturing base. As the environment settles, we could also see renewed focus on tax cuts and deregulation.

Outside of the US, we see opportunities in other markets. Europe, which is starting from a point of low expectations, has posted solid corporate results; the region’s earnings revisions have risen quickly, decoupling from the flatter US earnings trajectory. The valuation gap between the US and Europe has reduced as European markets benefit from a re-allocation from the US, although the gap remains wide historically. Europe is the strongest regional performer this year and this may continue.

Our latest Analyst Survey of our bottom-up equity analysts around the world shows corporate sentiment improving markedly in Europe while slowing in the US. Ukraine peace talks are already leading to a drop in European gas prices, reducing the price of a key input for businesses. In Germany, the recent election results could signify a watershed moment; a relaxation of the debt brake and potentially hundreds of billions of euros in infrastructure and defence spending over the coming years.

Similarly to Europe, our equity analysts highlight China for improving corporate sentiment. DeepSeek has accelerated the AI race in China and, combined with signs of a more supportive policy environment for technology and potential fiscal stimulus, could sow the seeds of an enduring bull market.

Investors should bear in mind that the S&P 500 is back to where it was six months ago, and valuations, which were stretched, are moderating. While we expect more volatility ahead, there are opportunities. A US economy transitioning to more domestically driven manufacturing and trading at more reasonable valuations could offer a rich pool of investment ideas for stock pickers. In the meantime, there are opportunities for investors at a global level. Europe and China both have the potential for ongoing market recoveries, while Japan remains an attractive investment destination as it continues to enjoy reflation and structural reform.

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