What now – Navigating a tricky situation

Key takeaways

• This morning, the U.S. and China announced a 90-day pause on most tariffs imposed recently. The U.S. reduced its tariffs to 30% (20% related to fentanyl and a 10% reciprocal tariff), while China lowered its rate to 10%.
• The sharp market rally today reflects the unexpectedly positive tariff news. Many investors were not positioned for this outcome, leading to a significant market surge. 
• Currently, we are maintaining our balanced approach with a slight defensive tilt but remain open-minded due to the complex market backdrop.
• In today’s note, we evaluate the risk/reward after the market’s surge amid a tricky environment for investors.

Big picture

In February, we adopted a more defensive stance by downgrading equities and upgrading cash as the market hovered near record highs. We further downgraded our view in late April after the initial rebound, as our analysis indicated a less favorable risk/reward outlook. The unexpected positive tariff news and subsequent market gains have rendered our April shift less effective.

The S&P 500 is now toward the higher end of our estimated range near 5800. It is plausible that we now move above that estimated range given we have better news than we and much of Wall Street expected on the tariff front. 

Positive factors

• Today's market activity reflects a partial unwinding of defensive positions and signals that we may have moved past peak uncertainty related to tariffs. 
• On the margin, whatever one was pricing in for recession risks on Friday should be somewhat lower than before. This is part of the market lift today.
• Taking off a worst-case scenario and seeing some de-escalation in tariffs between the U.S. and China suggests a sharp deterioration in the jobs market is less likely. As consumers hold the key for the U.S. economy, this is a positive.
• Earnings may have less downside than we expected on the back of lower tariffs.
• The S&P 500 is now back above its 200-day moving average, a widely followed technical level, which is a positive development. This is occurring at a time when Wall Street is arguably still more defensively positioned, which could cause further buying.

Negative factors

• Markets react to data relative to expectations. Investors have shifted from pricing in significant bad news at the April lows to pricing in substantial good news today.
• Although today's news is better than expected, markets are already up ~20% from the April 7 intraday low of 4835.
• While the weekend's developments on tariffs may support market sentiment, it is important to recognize that average tariff levels are still expected to remain above 10%—a sharp increase from last year's 2.4%.
• Additionally, while we have a pause and a negotiation period, we do not have clarity on the tariff outcome. At any moment, there can be a change in the tariff discussion.
• With today's move, the S&P 500's forward P/E is back to 20.9x versus 22.3x at the February peak, and well above 5- and 10-year averages. Given some uncertainty around tariffs and the emergence of China's DeepSeek and other AI competitors, a peak P/E arguably is not warranted.
• Forward earnings estimates across market caps continue to deteriorate.

Bottom line

In recent publications, we have advocated for a balanced approach with a slight defensive tilt. We continue to recommend dollar-cost averaging into the market rather than taking an aggressive stance. 

With hindsight, and given the positive China surprise, we would have been better off more recently advising investors to be more aggressively buying the dip, even while correctly advising against selling as the markets were panicking in early April.

That said, the future is always unknowable. We invest with prudence and a weight-of-the-evidence approach, even while sometimes prudence does not pay off. 

Still, given the strong market bounce that has already played out and as we hover closer to peak valuations and a backdrop that is now embedding a large degree of good news, we don’t see this as an ideal time to shift to an offensive stance.

The present market environment remains complex. Markets are never black and white. We will keep an open mind and continue to reassess our views as the backdrop evolves.