Should Investors Underweight Equities in Light of Recent Market Volatility?

No, investors should hold equity allocations in line with their policy portfolio weights. Trade policy uncertainty has forced many investors to reassess the trajectory of global economic growth, sending ripples through markets, and prompting US equities to enter a “correction” on March 13. ¹ Still, there are strong arguments for holding equity allocations steady. For instance, the trajectory of trade policy remains uncertain, cutting equity exposure during market turmoil often results in underperformance, and countervailing forces—such as increased expectations for US tax cuts, fiscal spending in Europe, or greater artificial intelligence (AI) advancements—could shift sentiment and support equity performance.

The flurry of US tariff announcements, combined with retaliatory measures from other countries, has heightened concerns about slower economic growth. If all measures are implemented, the US effective annual tariff rate across all imported goods could exceed 15% in 2025, marking the highest level in 80 years and a significant increase from the 3% rate in 2024. The Trump Administration is likely seeking concessions from its trade partners and probably sees itself as negotiating from a position of strength. This is likely because the US economy is the largest in the world and trade makes up a structurally smaller share of its economy compared to its key trading partners, making it less vulnerable to the economic impact of tariffs.

US equities have been hit hardest by the Trump Administration’s policies. As of March 16, 2025, the asset class is 8.6% lower than its February peak, compared to a 0.1% decline for global ex US equities over the same period. ² This disparity is partly driven by concerns over economic growth, which have weighed on corporate earnings growth forecasts. US equities have a higher exposure to growth-sensitive sectors, such as information technology, and a greater concentration of companies with global supply chains and customer bases. As a result, the consensus estimate for 2025 US earnings growth has been revised down by 2.6 percentage points (ppts) since the start of the year, to 11.9%. In contrast, the comparable global ex US estimate has been revised down by only 1 ppt, to 8.5%.

Recent US equity underperformance is also linked to its valuations. At the start of the year, US equities were trading at 22.5x consensus 2025 earnings expectations, compared to 13.3x for global ex US equities. This represented a 70% valuation premium, significantly above the 20-year average of 25%. As of yesterday, this premium has narrowed to 60%, driven by a recalibration of investor expectations. Concerns have grown that the administration’s focus on tariffs, rather than tax cuts, suggests a less pro-growth agenda than initially anticipated. At the same time, the narrowing valuation premium also reflects optimism around potential fiscal spending initiatives in Europe and China, which are being spurred in part by US trade policy actions.

This recalibration of expectations highlights the broader unpredictability of politically driven market movements. Trade policy decisions are likely directed by President Trump himself, making the situation less about traditional market analysis and more about interpreting the intentions of a single individual. While Trump may be less sensitive to equity and economic data than in his last term, if conditions worsen, the administration might soften its stance and accept smaller concessions from trading partners. Alternatively, tariffed countries might offer concessions that pave the way for settlements, or tensions could escalate. This unpredictability makes timing an equity underweight highly risky.

Historical data point to a similar conclusion. Over the 30 years ended in 2024, global equities experienced a median intra-year price decline of approximately 12%. Despite these pullbacks, the median annual return for global equities over the same period was 15%. This pattern was visible in 2024 as well, when equities fell 8% before finishing the year with an 18% return. In other words, market pullbacks are more commonplace than unusual. Unfortunately, behavioral biases—such as the instinct to avoid losses—often drive investors to reduce equity exposure during periods of volatility. But this approach often backfires, locking in losses and limiting participation in the recoveries that typically follow.

Looking ahead, several factors could support equity performance. One key driver is progress on US tax reform legislation. So far, progress has been limited as Congressional Republicans are working to balance tax cuts with priorities like increased border security and concerns over reducing social safety net programs. Combined with the administration’s deregulation efforts, these measures could stimulate the US economy that, absent tariffs, was already in a solid position. In Europe, fiscal stimulus presents another potential catalyst. Last week, likely incoming German Chancellor Friedrich Merz announced a €500 billion infrastructure fund and proposed loosening Germany’s constitutionally enshrined “debt brake” to support military spending. If approved by the Bundestag this week, which seems likely, this fiscal package could mark one of the most significant policy shifts in Germany and Europe.

AI may also reclaim its position as the dominant market narrative. Just weeks ago, the focus was on the Chinese model DeepSeek and the substantial capital investments planned by major technology firms in AI for 2025. At the time, FactSet reported that nearly half of S&P 500 companies mentioned AI in their fourth quarter earnings calls, marking the highest level since tracking began ten years ago. While AI adoption has been at least as rapid as the adoption of computers and the internet, its integration into corporate workflows remains in its early stages. ³ Greater advancements in underlying technologies and their applications to improve corporate profitability appear likely and could reshape investment forecasts.

Rather than reducing equity exposure, we recommend investors follow their typical rebalancing practices and hold modest tilts within their public equity sleeve to cheaper segments of the market, such as value and small-cap equities in developed markets. Recent performance patterns also serve as a strong reminder of the importance of diversification—across asset classes, geographies, and sources of value-add. On the latter, making large bets against policy allocations to equities can overshadow all other sources of value-add, including those connected to managers and any other tactical deviations. In volatile markets, thoughtful decisions—not rash actions—are what separate the top-performing investors from everyone else.

Kevin Rosenbaum, Head of Global Capital Markets Research

Footnotes

1. An equity market correction is a decline of 10% or more in price levels from recent highs.
2. All performance data are derived from MSCI indexes in US dollar terms.
3. Alexander Bick, Adam Blandin, and David J. Deming, “The Rapid Adoption of Generative AI,” National Bureau of Economic Research, September 2024.