Tariffs and trade: three investment takeaways in the conflict’s opening round

Less than two weeks after taking office, the Trump administration raised the stakes on February 1 by announcing plans to levy 25% import tariffs on goods from Mexico and Canada, with Canadian energy products and Chinese goods facing more modest 10% tariffs. As America’s three largest trade partners responded, initial talks between the United States and Mexico resulted in a one-month pause in their tariffs as those two countries entered negotiations in hopes of reaching a longer-term compromise. Hours later, Canada announced a similar 30-day pause pending further talks with U.S. negotiators.

The initial knee-jerk reaction from global markets had a risk-off tone as investors bid up prices of currencies such as the U.S. dollar, the Japanese yen, and global sovereign bonds. On the other hand, more speculative segments of the markets such as cryptocurrencies experienced more intense selling pressures.

From our perspective, investors may wish to resist the urge to overreact to incremental developments in a highly fluid situation. As demonstrated by the announcements of negotiated pauses in tariffs involving the United States, Mexico, and Canada, deals may emerge as quickly as tariffs are implemented, potentially causing markets to whipsaw unpredictably.

Here are three takeaways that we urge investors to consider beyond tariffs.

1 The global economy looks solid—The global economy began 2025 on an improving trend, with readings on manufacturing activity looking especially strong. It remains to be seen whether these readings may have been somewhat inflated by expectations of tariffs and anticipatory inventory stocking, which may have fueled heightened manufacturing activity. However, we've seen an uptick in business surveys of corporate purchasing managers and Institute of Supply Management reports.

2 U.S. earnings are strong—Three weeks into earnings season, initial fourth-quarter reports from S&P 500 Index companies have been coming in strong. As of January 31, fourth-quarter earnings were expected to rise 13.2% compared with the year-ago period—the strongest growth since the fourth quarter of 2021.

3 Keep an eye on equity valuations—In our view, the biggest current market risk relates to valuations, as we believe that current market levels have priced in a lot of good news. The trailing price-to-earnings ratio of the S&P 500 as of January 31 reached over 27x—an elevated level that's historically rare.¹ In fixed income, the high-yield bond spread fell to 256 basis points (bps) on January 24—near a 20-year low of 233 bps.² Such a tight high-yield spread suggests limited value in lower-quality bonds.

Given these circumstances, what options do investors have to seek to protect portfolios, should escalating tariffs incrementally weaken U.S. economic growth? Two issues are important to consider, in our view:

1 Currency shifts—Historically, the U.S. dollar has tended to strengthen when the United States imposes tariffs. A strong U.S. dollar may help to mitigate the higher costs resulting from tariffs, as the United States can buy foreign goods at cheaper foreign currency rates. The dollar is also considered a risk-off currency, meaning that its performance often improves as investors become more risk averse and shift to higher-quality currencies such as the dollar.

2 Favorable math for high-quality bonds—As a result of a recent rise in yields, high-quality bonds currently offer the best income potential in over 20 years. The yield of the Bloomberg U.S. Aggregate Bond Index reached 4.86%,¹ offering attractive income opportunities, in our view. If tariffs create a more substantial economic slowdown, we believe that the U.S. Federal Reserve will likely need to cut interest rates. In our view, locking in higher-quality bond income potential is likely to be beneficial in this type of environment as investors can get paid to wait out the tariff-related volatility.

Looking ahead—quality is paramount

Overall, in the wake of the latest tariff developments, our broad market views for 2025 remain unchanged across global equities, as we continue to focus more on stocks’ quality value attributes rather than the growth factor. To us, this is a way to manage valuation risk and add exposure to high-quality cyclical sectors that may potentially benefit from a modest economic re-acceleration. As for fixed income, we continue to prefer a mild credit bias, as high-yield spreads look expensive to us. We prefer U.S. investment-grade corporate bonds, mortgage-backed securities, and municipal bonds. If valuations change over the course of the year, we'll be on the hunt for other opportunities.

1 FactSet, as of 1/31/25. 2 FactSet, as of 1/24/25.