Darrell R. Spence, Chris Buchbinder and Andrew A. Cormack

April 7, 2025

If investors were looking for a reason to sell US stocks, they found it in President Donald Trump’s sweeping tariffs. Following several weeks of volatility sparked by on-again off-again tariffs, Trump’s 2 April announcement of higher-than-expected levies against virtually every US trading partner sent shockwaves through global financial markets.

After two straight years of 20%-plus returns, US stocks have declined more than 13% so far this year, underscored by a sharp drop late last week amid fears of a full-blown trade war, higher inflation and the rising risk of recession. In response, several Wall Street firms have downgraded their forecasts for US economic growth in 2025.

“The bottom line is that the tariffs, as announced, have the potential to significantly weaken the US economy, if not cause an outright recession,” said Capital Group economist Darrell Spence. “Granted, not all of the tariffs will get passed through to consumers, and it is certainly possible that some get rescinded. However, the grandeur with which this policy was announced makes it seem unlikely that a meaningful portion of it gets reversed quickly.”

US stocks have declined sharply amid shift in trade policy

Sources: Capital Group, Bloomberg Index Services Ltd., MSCI, Reuters, Standard & Poor's. Returns reflect total returns in USD. As of 4 April 2025.

Most sectors of the equity markets, both US and globally, declined sharply after the 2 April tariffs announcement. But since the start of the year, global markets have dramatically outpaced the US amid a powerful rotation into value-oriented stocks, including solid dividend payers. Bonds also have held up better, serving their traditional role as an effective counterbalance when stocks come under pressure.

The US economy has not yet shown signs of a downturn, apart from a recent decline in consumer confidence. US gross domestic product (GDP) growth rose to 2.4% in the fourth quarter, higher than previously expected. The unemployment rate remained low at 4.2% in March. And inflation has stabilised, falling into a range of 2.5% to 3% over the past few months. Market worries, however, have focused on how the tariffs could harm consumer spending, corporate earnings and GDP growth.

Equity insight: This is why downside protection matters

The sharp market selloff serves as an effective reminder that it is always a good idea to maintain a balanced portfolio with an eye toward downside protection. Even though growth-oriented US stocks enjoyed a winning streak over the past decade, market sentiment can turn around quickly, says Chris Buchbinder, equity portfolio manager.

“Coming into this year, I was already cautiously positioned,” Buchbinder explains. “There was a lot of enthusiasm over artificial intelligence and a lot of excitement over the positive effect that Trump’s policies could have on the US economy and specific industries. To a degree, I took the opposite side of that and, so far, it feels like the right positioning to me.”

Adding to more defensive areas of the market such as health care — which has not done as well over the past two years — appealed to Buchbinder, who has significantly elevated that sector in his portfolios. He expects US and global equity markets to remain choppy this year as the tariff story evolves, and he is not trying to guess how the trade war will play out. Instead, he is maintaining his defensive posture while looking for opportunities in more economically sensitive companies as expectations are reset.

“There are many potential outcomes from the Trump tariffs,” Buchbinder adds. “They range from a severe recession to a negotiated agreement where trade barriers are lowered around the world and this whole event blows over. That said, I think the potential severity of the negative outcomes is not fully priced into the market, so it makes sense to stay cautious and wait for more information.”

Playing defence has paid off so far in 2025

Source: Capital Group, MSCI, Standard & Poor's, RIMES. Returns reflect total returns in USD. As of 4 April 2025.

Fixed income insight: Seeking shelter in the storm

Bonds have done this year exactly what they are supposed to do at times of stress in the stock market. While the S&P 500 Index has declined, the Bloomberg US Aggregate Index — a broad-based gauge of the investment-grade (BBB/Baa and above) US bond market — has gained 3.7%, providing a cushion against equity market volatility in well-balanced portfolios.

Much of the positive gains were driven by a big move in US bond yields. Last week, the 10-year US Treasury note dipped below 4% for the first time since October 2024, just a few weeks before Trump’s 5 November election victory. If the US economy weakens, it is likely that interest rates could head lower in the months ahead, roughly in line with market expectations.

Since Trump’s 2 April announcement, expectations for US Federal Reserve rate cuts have moved significantly, with some market participants predicting a reduction at every Fed meeting between now and the end of the year.

Investors expect the Fed to slash interest rates this year

Sources: Capital Group, Bloomberg Index Services Ltd., U.S. Federal Reserve. Fed funds target rate reflects the upper bound of the Federal Open Markets Committee's (FOMC) target range for overnight lending among U.S. banks. As of 4 April 2025.

“The US tariffs, and the threat of retaliation, have exacerbated already elevated levels of uncertainty,” says Pramod Atluri, fixed income portfolio manager. “This increases the risk of companies retrenching and further weakening the labor market.”

“At the same time, higher import prices may present a negative real income shock to the US consumer, who has thus far remained resilient,” adds Atluri. “Although the situation is in flux, the risks of a US recession have increased and, therefore, adopting a more defensive position is warranted.”

In foreign exchange markets, the US dollar, which has fallen sharply this year, could decline further as the rest of the world reacts to the tariffs by launching more stimulative fiscal policy. This is especially the case in Germany where leaders have pledged to spend billions more on defense and infrastructure projects, even if it means abandoning previous debt limits.

“Trump’s approach to negotiations is forcing countries to make almost instantaneous decisions on defense, fiscal policy and conflict resolution,” says fixed income portfolio manager Andrew Cormack. “The consequence of this should be structurally higher European bond yields and a stronger euro versus the dollar.”

Beyond the immediate economic shock, higher US tariffs also hint at a potentially more significant policy regime shift for the global economy and financial markets. As it stands, it seems as though tariffs may not simply be a negotiating tactic, as some investors speculated.

“The US appears to be stepping away from the open world trade system that it fosters, and from which it has benefitted over the last 80 years,” says Capital Group European economist Robert Lind. “At the least, this implies greater volatility and a higher risk of economic policy mistakes. Risk premiums in financial markets should rise to reflect this new environment.”

Given the increasing level of uncertainty, the best offence, at least for the time being, may be a good defence. Given more than a decade of outsized gains in the US, investors may want to consider taking another look at their asset allocation plans with an eye toward more balanced and diversified portfolios.

Darrell Spence is an economist with 32 years of investment industry experience (as of 12/31/2024). He holds a bachelor’s degree in economics from Occidental College. He also holds the Chartered Financial Analyst® designation and is a member of the National Association for Business Economics.

Chris Buchbinder is an equity portfolio manager with 29 years of investment industry experience (as of 12/31/2024). He holds a bachelor’s degree in economics and international relations from Brown University.

Andrew A. Cormack is a fixed income portfolio manager with 20 years of investment industry experience (as of 12/31/2024). He holds a first-class honours degree in actuarial science from the London School of Economics and Political Science.