Taking stock

Equity investors moved fast. Markets reacted swiftly to the imposition of import tariffs by the U.S. government, with prices swinging wildly and volatility briefly rising to levels rarely seen outside of a major crisis. At the time of writing, markets have calmed, regaining almost all of the losses that followed the initial tariff announcements on April 2.

Suddenly a cloudier outlook for profits, but we still expect modest growth this year

Our research team has of course been recalibrating our earnings forecasts following the tariff news and revision to our overall economic assumptions for the U.S. and the rest of the world. We now expect around 7% profit growth worldwide this year, down from 13% before the April 2 tariff announcement and subsequent revisions (Exhibit 1). It is very difficult to quantify the direct impact of the tariffs until we know how companies will react. Will they absorb the costs? Pass them on to their customers? Find alternative manufacturing locations and suppliers? This is the key question that we now need to answer.

Still, we have revised our numbers and identified the risks and sensitivities, which is critical for investment decision-making in an uncertain environment. We have also assumed a broader impact on economic growth for 2025, which is of course relevant for a much wider range of companies.

Regionally our U.S. corporate profit estimates dropped slightly, with a 6% reduction in 2025 profit forecasts during the past month, but we still see 5% growth for the full year. The starting point is strong, many secular growth drivers seem relatively insulated from tariffs, and stock buybacks remain healthy. Emerging market profit estimates were the least impacted.

After 15 years of underperformance, international and emerging markets now offer competition to U.S. equities

In our bottom-up research process, overall U.S. stock valuation looks neither cheap nor expensive. We still see faster earnings growth from U.S. companies over the next five years than we expect on average in either Europe or Asia. But this is offset by higher valuations and lower dividends, so the expected returns look very similar. Europe offers similar aggregate returns to the U.S., but a lower valuation, lower tariff sensitivity and perhaps improved fiscal support.

Our investors were broadly more positive when we met in April as compared with our January meeting. In January our “bull-bear” ratio was 25% positive/75% cautious across our team; in April it had shifted to 60%/40%. Interestingly, too, the view from Europe (especially) and Asia is now more constructive than the view from the U.S. We do see good value in selective emerging markets, notably Korea, Indonesia and Taiwan. Overall, our expected returns lean toward value factors, with energy and banks offering the highest expected returns (Exhibit 2).

The outlook for technology returns has improved after recent underperformance, and the group ranks in the middle of the pack, with software more attractive than hardware. In our quantitative work, the spread between high- and low-priced stocks around the world still ranks in the 78th percentile vs. the last 30 years of history, despite strong relative returns from value in Europe and Asia over the past four years.

In the ongoing AI debate, bulls and bears both find support

Before the tariff news the most notable feature of global markets this year was the sharp underperformance of the technology sector, especially in the U.S. This is important both because the sector is so large (accounting for more than a third of S&P 500 market capitalization) and because technology stocks have been such a dominant driver of returns since the global financial crisis.

Over the past decade, for example, S&P 500 technology stocks have gained an annual 20% a year, almost twice the returns of the second-best group (the financials). This has driven much of the outperformance of U.S. stocks and attracted huge amounts of foreign capital to the U.S. market. According to Federal Reserve data, foreign ownership of U.S. stocks has almost doubled to 18% since 2006. Exceptional returns from the technology sector surely explains much of this enthusiasm.

Is that trend now exhausted, and are all the benefits of artificial intelligence (AI) now discounted? Times may be changing within the sector. Many of our New York-based investors do see better growth opportunities elsewhere in the equity market these days. They have been reducing exposure to the beneficiaries of AI capital spending (where momentum is strong but questions persist over the eventual returns). At the same time they have been focusing on software, where valuations are significantly lower after several years of weak returns (Exhibit 3).

On the so-called “Magnificent 7,” we would make two observations: First, these stocks are a little less exceptional these days from a fundamental viewpoint. After the group delivered stunning 70% profits growth over the past two years (compared to essentially no aggregate growth at all for the other 493 stocks in the S&P 500), we see less exceptional 15% profit gains in 2025. The businesses are more mature, and heavy AI investment is slowing growth, at least for now.

More importantly, we think it is wrong to think of this group as just one opportunity. These companies are in fact very different fundamentally and will have very different return streams. As always, our real focus is on the stock level opportunity and finding the winners. Several of the Magnificent 7 still feature in many U.S. and global portfolios.

Exhibit 4 shows the views of our team members. Many favor quality stocks in the financial and industrial sectors while avoiding high priced defensive stocks.

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