Three scenarios to help manage the tariff uncertainty

Key messages:

• The range of potential outcomes is broad but can be aggregated into “rollbacks”, “reordering”, or “retaliation”.
• We expect these scenarios will all weigh on economic growth but have different implications for markets.
• Our Dynamic Asset Allocation (DAA) process has been positioned to prevent the worst of the impact from a reduction in risk sentiment. We are currently reviewing these settings to respond to the potential economic outcomes.

Background

Global equities tumbled last week, after President Trump announced sweeping tariffs on what he dubbed “Liberation Day”. That included 10% tariff on all countries (in effect April 5) and reciprocal tariffs on more than 50 countries that will take effect on April 9. Global equity markets saw double digit losses over two-day periods.

Last week marked a material shift in the consensus view on the outlook. Most major banks have revised their GDP forecasts lower for the US and global economy over 2025. Several banks have also adjusted their probability of a recession materially higher.

Three scenarios to make sense of the outlook.

While uncertainty is extremely elevated right now, we have considered three broad scenarios. All of these scenarios involve some slowing in economic growth but will have different implications for markets.

Table 1: Major indices fell sharply after tariff announcements

Table 2: Three scenarios to make sense of tariffs

What is priced in markets right now?

The brutal movements in equities last week present a challenge in gauging which scenario is being priced by markets. Table 3 shows typical movements in equities in response to different economic outcomes.

Table 3: Equity market responses to different economic outcomes.

Chart 1 shows how our scenarios correspond to these different economic outcomes for the US S&P500 – and the different prices levels that would be consistent with those scenarios.

Chart 1: What the US S&P500 is pricing relative to our scenarios.

Currently US markets appear to be pricing in a growth scare – but have not fully priced a recession.

In Australia, the story is somewhat similar, although pricing is further away from a recession.

Chart 2: What the Aus ASX200 is pricing relative to our scenarios.

A key driver of outcomes is going to be the impact on earnings. Equity valuations were extended at the start of the year because a consensus view had built that earnings growth was set to reaccelerate. Right now, US and Australian valuations remain above long-term valuations. We estimate that earnings growth will need to reaccelerate further compared to last year to justify these valuations. This is possible, but will be a challenge in each of the three scenarios. The upcoming earnings reporting seasons in the US could provide some sense of the likelihood – and we think the risk is that earnings growth is guided lower leaving some further downside risk to valuations.

What to monitor as the outlook evolves.

Chart 1 and Chart 2 suggest that markets are more concerned about the US sliding into recession, than Australia entering recession. While economic data have been solid recently, the risk is that uncertainty leads businesses to postpone investment spending, reducing hiring and increase firing, and that leads consumers to retrench spending. The prospect for higher prices could also weigh on consumer spending.

To that extent, we would advise continuing to focus on sentiment indicators, labour market indicators and consumer spending indicators to gauge the economy. Our favourite indicators remain the manufacturing PMI, the change in the unemployment rate, and the US Treasury yield curve. All of these indicators have been flashing orange for some time – indicating growth was set to slow – but they do not yet confirm recession.

How have we been protecting portfolios?

We have been concerned about elevated valuations and slowing global growth for some time. By any metric, global equities were at historically stretched valuations at the start of the year. We have been communicating for some time that returns appear to have been dragged forward, leaving forward-looking returns somewhat lower relative to history. We had also been more concerned than the consensus that tariffs were not merely a negotiating tactic, and instead were likely to represent a drag on growth and a boost to inflation.

Our dynamic asset allocation (DAA) process had moved to an underweight exposure to international equities, reflecting what we thought were elevated valuations relative to the growth outlook. Within our equity exposures, we had also reduce our beta by diversifying away from large-cap growth to quality value and infrastructure. These have benefited portfolios through this market volatility.

Within fixed income, we have been concerned that tight credit spreads were not compensating investors for the risk of increases in downgrades or defaults. We had a preference for government bonds and investment grade credit, with lower sensitivity to volatility. While the rapid and large declines in global equities over the past two weeks mean that absolute returns will suffer, we can see that our DAA process has helped mitigate downside risk.

Chart 3: Our DAA settings

How will we manage portfolios going forward?

Market volatility highlights the need to stick to investment processes and philosophies. We have a clear, repeatable asset allocation process that can be adjusted in real-time as market and political information updates.

We observe that falling equity prices move valuations closer to fair value, allowing the opportunity to reduce underweights to these assets. We also are monitoring currency movements that tend to be a pressure release valve for global markets in times of turmoil. We have previously shared our views around hedge ratios for international equity investments.

Critically, we remind investors to:

• Remain focused on the longer term. History shows that remaining invested and sticking to processes delivers long-term portfolio returns.
• Continue to embrace a diversified portfolio. Portfolio diversification has been critical in managing downside volatility through Q1 2025.
• Not try to time markets. We are not able to pick the bottom in any specific market, and we believe investors will not be compensated for trying to make big position changes in this environment.

Our team at Oreana Private Wealth are available to work with you through any of these actions as markets stay volatile, to help achieve your investment needs.

Disclaimer: This presentation has been prepared by Oreana Private Wealth, a division of Oreana Financial Services(Oreana) for general information purposes only, without taking into account any potential investors’ personal objectives, financial situation or needs. This information consists of forward-looking statements which are subject to known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements to be materially different from those expressed or implied. Past performance is not a reliable indicator of future performance. Neither this document nor any of its contents may be used for any purpose without the prior consent of Oreana. Anyone reading this report must obtain and rely upon their own independent advice and inquiries.

Limitation of liability: Whilst all care has been taken in preparation of this report, to the maximum extent permitted by law, Oreana will not be liable in any way for any loss or damage suffered by you through use or reliance on this information. Oreana’s liability for negligence, breach of contract or contravention of any law, which cannot be lawfully excluded, is limited, at Oreana’s option and to the maximum extent permitted by law, to resupplying this information or any part of it to you, or to paying for the resupply of this information or any part of it to you.