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Quarterly investment Insights | March quarter 2025

In summary

Global equity markets incurred a major selloff in the first quarter of 2025 after reaching all-time highs in mid-February. After cheering the expected pro-growth policies of the Trump administration, market sentiment shifted abruptly negative as investors reacted to the vastly more hostile US trade policies and the lack of clarity on when growth-oriented policies would be implemented.

Backward-looking corporate and economic data continued to provide a supportive picture of the global economy, but “soft” data encompassing forward expectations and sentiment have shown a marked deterioration. While financial market volatility is uncomfortable, it does produce investment opportunities that can add value to active investors’ portfolios.

In this edition of Investor Insights, we delve into some of the key developments across global markets and highlight emerging opportunities:

• Australian inflation continues to moderate, with encouraging trends in stickier sub-categories. In recognition of this progress, the Reserve Bank of Australia (RBA) has commenced its cash rate easing cycle, with current market expectations suggesting a potentially over-optimistic projection of five cuts.
• The Trump administration has aggressively targeted countries with tariffs where the US has a significant trade deficit. Given the US trade surplus with Australia, the domestic economy may be less vulnerable to these targeted tariffs.
• To understand President Trump’s economic strategy, it is important to consider the Mar-a-Lago Accord and analyse the ‘seven steps of maximum pressure’ for insights into how the Trump administration may implement these policies.
• Recent drawdowns in US equities have led to a moderation in valuations, potentially offering a margin of safety and future opportunities should trade tensions ease.
• Indian equities present an attractive investment proposition, supported by a recent market correction, strong underlying fundamentals, and structural growth drivers.

Uncertainty drives volatility and weakening investor sentiment

Market volatility is being driven by economic uncertainty, as volatile trade policies raised US inflation expectations and increased concerns about a broader economic slowdown, contributing to recent equity market declines. In response to US tariffs, several countries have initiated trade talks with the White House in what seems to be the beginning of a de-escalation of trade tensions.

The most likely base case for the global economy under these conditions is a ‘Steady Decline.’ This scenario involves the broad implementation of reciprocal US tariffs, with some potential for renegotiation. This is expected to lead to slower growth, particularly in the US, with a risk of a mild recession. Inflation is projected to rise temporarily due to tariffs. Central banks, viewing this inflation as transitory, may implement modest rate cuts to stimulate growth.

This scenario is primarily US-centric, as the direct impact of tariffs on Australian domestic inflation and economic growth is anticipated to be less significant.

Australian inflation continues to ease

Australian inflation measures have continued to trend lower. The important fourth quarter 2024 trimmed mean CPI came in at a slightly lower than expected +0.5% quarter-on-quarter and +3.2% year-on-year. Subsequent monthly CPI data releases have also provided an improved inflation outlook.

Key inflation subcomponents which have previously remained sticky are pleasingly showing signs of gradual moderation. These include rents, insurance and new home construction prices, suggesting inflation is set to decline further over the coming year. The recent data prints have increased the RBA Board’s confidence that CPI will return close to its 2.5% target in the second half of 2026.

Chart 1 shows the RBA’s CPI forecasts (released in February) suggesting core inflation would level out at 2.7% year-on-year. This was, of course, before recent tariff announcements.

 

Tariffs are a difficult shock for central banks as they act both to slow growth and raise unemployment, but at the same time raise prices, presenting conflicting policy signals for most central banks’ dual objectives. Usually, central banks view price rises as a one-off price level shift rather than inflation (ongoing price increases at a higher rate), and concern for growth and unemployment ultimately dominate thinking and policy movements.

The current inflation trends provide a supportive backdrop for interest rates, the domestic economy and Australian bonds.

The RBA begins monetary policy easing

The RBA Board reduced the cash rate to 4.1% in February, as their confidence grew in inflation returning to the midpoint of the target range in the second half of 2026, as forecast. A further interest rate cut at the mid-May Board meeting is likely if the first quarter 2025 CPI confirms the ongoing moderation in inflation.

President Trump’s significant tariff announcements in early April, associated retaliatory actions by China and Europe, and related sharp weakness in equity markets have led to a significant repricing of interest rate expectations. This reflects the markets’ views that the RBA will need to provide additional support to the economy.

Australian markets are now pricing nearly 130 basis points of cash rate reductions over the next year (chart 2) and around a 50% chance that the Board will cut the official cash rate by 50bps at the May Board Meeting, after having made no change in April.

If current very high and broad tariff settings are maintained, then global economic growth will be slower, and the US economy will likely slow meaningfully and possibly enter a recession. Australian economic conditions will weaken, and unemployment will likely rise, in which case interest rate reductions of the size currently priced seem reasonable.

In the event the US does negotiate and lower tariffs on many countries, then less significant economic damage would likely occur. In this case, Australian cash rates are still expected to fall as inflation moderates, but likely by another two to three cuts this year, not the five currently priced.

Australia is less vulnerable to tariffs

The Trump administration has aggressively employed tariffs as a negotiating tactic. The average US import tariffs are projected to reach multi-decade highs should the US implement and maintain even just some of its threatened tariffs.

Nations with which the US maintains a substantial trade deficit have been primary targets.

Australia is among the few major economies with which the US enjoys a trade surplus (chart 3), meaning Australia imports more from the US than it exports.

This has resulted in the minimum 10% tariff applied to all US trade partners being applied to Australian goods. This is far less than the tariffs being applied to Mexico, Southeast Asian countries and, most of all, China.

While less susceptible to targeted US tariffs, Australia is not immune to negative repercussions from tariffs on other global trading partners.  

Protectionist policies seem well entrenched within the White House, and we see elevated tariffs as impeding global economic growth. US consumers are likely to be significantly affected, and we anticipate a reduction in their discretionary spending in the near term. It is worth considering that many of the tariff rates applied to various nations will likely be subject to ongoing negotiations, suggesting the potential for some rates to decrease in the coming months.

The Mar-a-Lago Accord: de-valuing the US dollar

Speculation surrounds the potential implementation of the Mar-a-Lago Accord by the Trump administration.

The Accord proposes devaluing the US dollar to stimulate exports, reduce trade deficits, and revitalise domestic manufacturing, aiming to enhance US competitiveness and address perceived economic imbalances from overvaluation.

Key mechanisms include:

• Tariff threats
• US debt restructuring
• Sovereign wealth fund intervention to manipulate currency
• Coercion via defense agreements
• Substantial federal budget cuts
• Federal Reserve rate reduction pressure
• A Tobin tax, where currency transactions using the US dollar are taxed with the aim of reducing speculative flows that tend to strengthen the US dollar.

The Accord offers a conceptual framework for understanding certain Trump administration policy approaches. Chart 4 shows that so far, the policies are having the desired effect.

Trump’s seven steps of maximum pressure

The current trade and geopolitical environments are challenging, especially when the rhetoric may seem irrational.

The aggressive nature of President Trump’s economic and political actions should be analysed within the context of his typical negotiation tactics.

BCA Research has outlined a seven-stage model for interpreting these tactics. Given the recent aggressive tariff announcements and the early stage of his Presidency, we are likely in the initial phases of this framework.

Investor pessimism is pronounced, with “Liberation Day” tariffs potentially signalling peak trade tensions.

We expect the US to re-engage in trade negotiations and eventually ‘Make a Deal’.

A re-rating of US equity markets

The US equity markets have borne the brunt of the global equity market sell-off since reaching record highs in mid-February (chart 5 – top). The considerable uncertainty and inconsistent implementation of tariffs have prompted financial markets to reassess expectations, anticipating an economic growth slowdown, heightened inflationary pressures, and a decline in US company profitability. These concerns have culminated in a substantial fall in equity markets

Technology mega caps have been particularly hard hit with the Nasdaq 100 Index retreating by 21% (chart 5 – bottom) at its lowest point, thereby entering a bear market. While this selloff has been uncomfortable for investors, it has not been as deep as the drawdown experienced in 2022.

Markets have staged a rebound from their recent lows, as the peak in pessimism surrounding tariffs has diminished, and the US has rolled back some tariffs while numerous nations have entered negotiations.

US equities will continue to be volatile as trade news is absorbed into equity market revenue and earnings expectations.

Equity market valuations moderate

US equity valuations, represented by the price-to-earnings ratio (P/E), have retraced considerably as equity markets have declined.

The S&P 500 Index (representative of the market cap weighted index) has rerated from a forward P/E of over 25x down to 20x. The S&P 500 Equal Weight Index forward P/E (equally weighted average of all 500 companies) has also fallen considerably to 16.4x from over 20x.

Mega cap stocks have skewed broader US equity valuations higher, but the average US company’s valuation is closer to longer-term normalised levels.

Table 1 shows that the earnings growth estimates are positive and highlight that forward P/Es, one and two years ahead, are relatively modest when taking earnings growth into account.

Earnings uncertainty is a rising risk, though, as companies reevaluate and adapt to the current economic climate and the potential effects on future earnings. Earnings expectations are beginning to be revised lower. The full extent of the revisions is unclear, and we expect companies most directly impacted by tariffs may struggle to provide earnings guidance to investors.

The derating in equity valuations does provide an improved margin of safety for investors as US equities become more attractively valued, especially if the economic environment stabilises.

Equity market correction provides opportunity in the absence of a recession

The drawdown in US equities has seen the S&P 500 comfortably breach the 10% threshold required for a technical correction. Historically, corrections have presented attractive buying opportunities provided the US economy and corporate earnings continue to grow.

Typically, investors who purchased the S&P 500 following a correction of more than 10% achieved positive returns in 76% of cases over the next six months and 86% of cases over the following year. However, recovery is slower if the correction occurs within twelve months of a recession.

Recent US trade policy actions have increased US recession risks, though a recession is not a consensus base case.

An opportunity in Indian equities

The Indian economy possesses several fundamental strengths that underpin long-term growth, positioning India as an attractive investment destination.

These key factors include:

• Forecast strong GDP growth of between 6.3-7% in the coming years
• Supportive government policies including fiscal spending, tax reform & deregulation
• A demographic advantage where India has one of the world’s largest and youngest populations
• Rising foreign investment
• Urbanisation and formalisation of the economy, including digital transformation.
• Strong earnings growth profile of companies in the market across diverse parts of the economy

We believe the Indian equity market presents a compelling strategic portfolio allocation opportunity, as Indian companies effectively leverage these economic tailwinds to drive revenue and earnings growth.

Chart 8 illustrates the historical trend of Indian companies consistently delivering stronger and more stable earnings growth compared to their global counterparts. This outperformance is even more pronounced when compared to other emerging markets, where negative earnings growth is projected.

This superior economic and earnings growth has historically translated into higher relative valuations, with Indian equities trading at an average 21% valuation premium (represented by the price-to-earnings ratio) to the MSCI World Index over the past five years.

Chart 9 depicts the recent pullback in Indian equities, which has reached the 20% bear market threshold. Consequently, India’s valuation premium relative to the rest of the world has decreased from 32% in 2024 to 15%.

The recent market drawdown, combined with Indian equities’ lower correlation to other global equity markets, presents an attractive investment opportunity, particularly in the current investment climate.

Outlook

Global financial markets are currently navigating a period of heightened volatility as recession fears in the US intensify. This has led to a repricing across asset classes, reflecting elevated risk premiums driven by concerns over slower growth and persistent trade uncertainty. While consensus still anticipates the US avoiding recession this year, these underlying economic concerns pose a significant headwind to economic growth and corporate earnings going forward.

Despite these challenges, opportunities are emerging. A de-escalation of trade tensions and clearer trade policies could lead to market stabilisation and a potential recovery in risk assets after a significant derating. Valuations in U.S. equities have moderated significantly, while opportunities in other attractive markets such as India have also presented. Meanwhile, central banks worldwide are adopting more accommodative monetary policies to counter economic headwinds.

In an environment where unsettling headlines often dominate the narrative, investors should not overlook the positive factors that can inform strategic decision-making. Successfully navigating this environment requires a disciplined yet dynamic portfolio management approach that effectively manages risks while seizing investment opportunities to enhance returns.

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