Six Impossible Things Before Breakfast?

What You Need to Know

The unwinding of “Trump trades,” a spike in volatility and the outperformance of European versus US equities have sparked debate about whether this is a tactical shift or the beginnings of a longer bearish trajectory for markets.

We think that the market shift is tactical, not strategic, in the sense that it mainly represents the unwinding of an unusual degree of consensus, e.g. with respect to the US versus Europe and the growth/mega-cap trade. The unprecedented size of the flows going into this investment view implies there may be more rebalancing to come. However, we do not believe that this marks the end of strategic US exceptionalism, which is driven by deeply ingrained forces.

Investors have perhaps been complacent about volatility and need to position for it to be persistent, given high valuations, market concentration and a highly uncertain policy environment. In addition, the tactical earnings outlook in the US is meaningfully lower. Nevertheless, we think it remains appropriate to have a positive view on equity returns for the year.

The view that this shift is a tactical rebalancing is still consistent with recognizing the momentous scale of the geopolitical repositioning we are witnessing.

Additional Contributors: Robertas Stancikas, Harjaspreet Mand and Maureen Hughes

The unwinding of the “Trump Trade” in recent weeks has set investors racing to question how much of this move is a tactical blip versus a move that requires a strategic shift in the narrative. While the Trump trade is no single specific, well-defined thing, the confluence of equities being down, US equities underperforming European equities, crypto falling, the Mag Seven underperforming and US financials trailing all point to a shift against the trades investors assumed would do well with Trump as president. (We don’t include the dollar underperforming in this list, because it was never entirely clear to us whether Trump’s proposed menu of policies was good or bad for the currency).

While the market’s repricing in recent weeks feels shocking and has included significant deleveraging, it is, we assert, a rotation rather than a true freaking-out about risk assets. This rotation is in part predicated on the view that the growth outlook has genuinely shifted for Europe relative to the US but mainly reflects the scale and quasi-unanimous nature of the pro-US, anti-Europe sentiment that existed at the start of the year. This feeling was manifested in the unprecedented scale of the flows out of Europe and into the US over the last 12 months. Yes, gold has risen over the last month’s market selloff, but the pace of return is the same as it has been since the election (moreover, this is in tandem with the dollar falling, so gold has retreated in EUR and GBP terms). Indeed, the $5.5 billion outflow from crypto ETFs and a more than $11 billion inflow into gold ETFs since the first week of February is a concise example of the tactical unwinding of a Trump trade. We also note there is no sign of destruction in sentiment toward credit, where spreads started the year tight; a proper de-risking would show up in these markets. This is not to make light of the degree of pain that appears to be felt, e.g., by levered returns when trends, such as the ones we have seen, unwind.

The “flooding-of-the-zone” approach to policy formation has no doubt shifted the political and geopolitical narrative in a fundamental way. But what about the investment narrative? In this note, in the interests of being focused, we attempt to address this question from a few specific points of view. The rapid release of so many policy announcements, the potential for some of them to change at short notice (e.g. tariffs) and the unconventional (at the very least) nature of policy implementation leaves investors in a similar position to the Queen in Alice, who every day had to try and believe six impossible things before breakfast. We do think that this shift in policy effectively brings forward a series of structural changes that define a new investment regime, which changes long-term expectations from the norms of recent decades but is not necessarily bearish.

The bottom line tactically is that we expect global equities to deliver a positive return over the course of 2025 but with much higher volatility. The flow of policy announcements as well as tariff and counter-tariff announcements is set to continue, which could be a painful period for markets. The equity market was probably too hopeful that deregulation would swamp the negative impact of tariffs and other policies. While there are potential market-friendly regulatory announcements that could still well transpire, there are also potential market-negative ones, such as immigration policy, that are presumably still to come. Strategically, we still believe in US exceptionalism, but tactically the relative advantages the US had are weaker than they were before.

Geopolitics and Recency Bias

While geopolitical realignment hasn’t dominated discussions with investors, in the US at least, it is arguably the most significant of the shifts that have taken place in recent weeks. The problem for investors is that markets do a very poor job at pricing geopolitical issues, as is the case with other low probability but potentially calamitous events.

One of the themes that runs through our strategic allocation research is the idea that investors need to be aware of recency bias. Different levels of this bias need to be peeled away, like layers of an onion. There is the recency bias of the last two years of a US-momentum tech-led trade as well as of the post-1982 period of quiescent inflation, a growing pool of global labor, strong growth and even stronger profits. Then there is the recency bias of the last 80 years of a post-war US-led order. Bluntly, we think all these must be stripped away. One can at least attempt to scale and price the first two, but what about the latter? It is, we argue, impossible to do so, so it would be wrong to introduce it as an extra risk premium in deriving an equity forecast. Any such reduction in the long-term outlook for equity returns could be wrong for years, and in any case something that cannot be scaled correctly. Nevertheless, it does matter, especially for those tasked with making long-term allocations.