SUMMARY
Investors have taken the latest tariff threats in their stride. We believe they may be underestimating the likelihood of – and potential harm from – trade strife.
KEY TAKEAWAYS:
While peak tariff shock may be behind us, we believe peak impact is yet to come
The recently passed US tax law may boost capital expenditure in time
We are watching second quarter earnings closely, especially in the financial sector
Current equity pricing doesn’t properly reflect downside risks, in our view
Bolstered by the recent passing of his tax bill, President Trump refocused on his trade war last week.
The US administration sent targeted tariff threat letters to countries that together supply just over a third of US imports.
If the rates mentioned stick, the average effective US tariff would rise from 3% in January to around 20%.
However, markets have brushed aside this renewed bout of tough talk.
While negotiations with other major trading partners like Europe, Mexico, and China are still ongoing until the new August 1 deadline, investors are no longer envisaging a dramatic rise in tariff rates as they were in April.
We believe markets are underestimating the likelihood of these tariffs coming into force and how big they may be if they do. In turn, they are likely underestimating the potential impact on corporate margins and prices.
As we have argued before, while the market may be past peak tariff shock, we are still a long way from peak tariff impact.
In our view, short-term factors like seasonality, market momentum, and a low bar for earnings have kept investor sentiment buoyant.
Nevertheless, we remain tactically neutral on equities in core allocations, believing current market pricing doesn’t properly reflect downside risks.
With implied volatility still relatively low, tactical hedging may also make sense as a risk management tool for qualified clients.
US capital expenditure’s potential upside
Several provisions in the recently passed tax legislation may boost US corporate investment over the medium-term.
The combination of tariff pressure and incentives such as permanent full expensing of equipment, research & development, and factory building may lead to onshoring of industrial production in the coming years.
That said, these provisions are intended to be permanent. Consequently, firms may not feel the urgency to initiate new projects that they would if the provisions were time limited.
In the near-term, we remain skeptical that earnings expectations will increase on the back of this bill.
That is despite the positive reception by investors, with markets hitting fresh all-time highs.
After all, companies must navigate larger macro issues, such as restrictive monetary policy and tariff whiplash. These factors may neutralize some of this pro-business domestic policy, particularly for projects that require borrowing or imported materials.
At the sector level, we see cross-cutting impacts from the tax legislation. Among beneficiaries, US defense contractors will see another $150bn in incremental government spending, focused on bolstering missile defense, artillery, and shipbuilding capacity.
Citi Research1 estimates that permanent depreciation alone boosts US telecom fair value by 7%.
Secondary beneficiaries from higher US capex also include machinery and industrial robotics names. However, it may take several quarters for a pickup in new orders to materialize.
We will be tracking new capex announcements during the second quarter’s earnings season, especially the time horizon for such investments.
Not all sectors were winners from the tax legislation. Clean energy and electric vehicle firms lose significant Biden-era subsidies beginning September 30.
Cuts to social programs such as food assistance and Medicaid are broadly negative for staples food producers and smaller health care providers, respectively.
While we see the potential to invest thematically for a rise in capex in 2026, our portfolios currently remain anchored to areas of the market where investments are already underway, particularly AI infrastructure.
What we’re watching in banks’ earnings season
Equity investor focus is turning to second quarterly earnings season. Twenty-three S&P 500 financials names are reporting in the week of July 14.
US banks have rallied nearly 10% since mid-June, boosted by successful 2025 regulatory stress tests that enable higher payouts to shareholders in the year ahead.
Big banks should deliver another strong quarter for trading revenues amid a rollercoaster for markets, while somewhat reduced macro uncertainty and improving loan growth bodes well for net interest income.
The outlook for dealmaking activity in the second half of 2025 will be a key focus for analysts. There may be important knock-on effects for asset managers whose performance has lagged the banks so far year-to-date.
Second quarterly results come at a critical moment as bank valuations approach post-Global Financial Crisis highs.
US banks currently trade at 1.6 times book value, near to their peak level since 2010, although there remains significant dispersion within the sector.
Bank bulls would argue that this time is truly different, with regulatory tailwinds, yield curve normalization, and an uptick in M&A activity justifying structurally higher multiples.
Importantly for global portfolios, financials have been a key component of momentum trades leading the market higher since April.
With momentum taking a bit of a pause as laggards catch up, second quarter earnings will be key as we assess market internals.
