Schroders is taking a more cautious stance on equities, downgrading US markets in particular as markets price in a “near-perfect” macroeconomic backdrop, according to the firm’s multi-asset team.
Although there is a “low probability” of recession in the medium term, expectations of resilient growth and stable inflation leave the country “increasingly vulnerable to disappointments”, they said.
Part of this is due to tariff uncertainties, which have come down since US president Donald Trump’s ‘Liberation Day’, but the team noted that the tariff rate remains higher than it was at the start of the year and is “trending higher”, meaning there could be “sudden, more aggressive” action taken by the US government with countries that have yet to strike a deal.
Another concern is inflation, with Trump putting increasing pressure on the Federal Reserve to cut interest rates despite price rises remaining higher than the target 2%.
Fed chair Jerome Powell said in his final Jackson Hole symposium speech that US-imposed tariffs could stimulate inflation, which would suggest rates should remain elevated.
The Schroders team noted: “We remain concerned about the risk of stronger tariff pass-through, which could further exacerbate inflationary pressures.”
This, alongside “the persistence of aggressive fiscal stimulus”, suggests inflation could overshoot if not tackled correctly.
However, Trump is keen to cut rates, going as far as to fire Joe Biden-appointed Fed governor Lisa Cook, although it is yet to be determined whether the president will be allowed such authority over the independent body.
The difficulty is that labour market data remains “difficult to assess,” the Schroders team said, with the balance between labour supply and demand appearing “unsustainable”.
“In light of this backdrop, our view on equities has moved to neutral from positive, as we see the risk/reward profile for equities becoming less compelling in the near term,” they noted.
Every region now stands at ‘neutral’, including the US, which was downgraded. The team noted that negative growth shocks and higher valuations represent key risks in the region.
But the US was not the only area of the market to be downgraded. In Europe, the team dropped to ‘neutral’ as “tariff risks and a strong currency are offsetting the domestic cyclical recovery and improving earnings within the small- and mid-cap sectors”.
Meanwhile, Japanese equities were lowered to ‘neutral’ due to weaker company earnings than other regions, although they noted there are “supportive macro trends and policy incentives” coming through.
Emerging markets were also downgraded to ‘neutral’. Despite a weaker dollar and “favourable developments in certain countries”, they said there were “no clear catalysts for prices to move up in the region”.
Despite this, the team noted that they do not believe this marks “the end of the cycle” for stocks and do not expect a material fall in the short-to-medium term. Rather, the ‘neutral’ weighting represents the fact they “struggle in the short term to see the catalysts for the market to move significantly higher from here”.
Away from equities, the team has soured on government bonds, giving the asset class a ‘negative’ rating. They are particularly concerned by those with longer maturities.
“This reflects our concerns around both inflation risks and potential repricing of ‘term premium’, or the extra yield investors require to compensate for the risk of holding longer-dated bonds,” they said.
There were some positive ratings, however. The team are optimistic about the prospects of gold, which remains a “valuable diversifier” and should do well in a world where the US dollar continues to weaken, which they said could come from “portfolio rebalancing flows” as investors reassess its role in portfolios.
The team are less optimistic on commodities in general, however, giving the asset class a ‘neutral’ rating as weak global demand for base metals and a “retrenchment in copper prices” means the markets look “balanced.
For oil, the team expect lower prices to come through due to significantly higher supply in the second half of the year.
Emerging market local debt also got the thumbs up, particularly in Latin America, where countries are benefiting from supportive policy, a weaker US dollar and higher interest rates than other regions.
“While valuations in Asia are starting to look less favourable, overall we remain positive on emerging market local debt,” they said.