MARKET RECAP
Global equity markets swung from steep losses to fresh highs during the quarter. In early April, President Trump imposed a baseline 10% tariff and reciprocal tariffs of up to 50% on dozens of trading partners, only to suspend most reciprocal tariffs for 90 days amid market panic. The U.S. and China de-escalated from extreme retaliatory measures in mid-May, which provided further relief to the markets.
Many countries have engaged with the U.S. on trade negotiations before the July 9 deadline; however, there is uncertainty whether deals could be struck by then and if a pause will be extended. Inflation has so far proved more benign than feared, but the widely held view is that tariff-induced price pressures will filter through supply chains in the coming months. Additionally, tariffs may yet threaten global economic growth.
This past quarter was a risk-on market environment, and we underperformed relative to benchmarks mainly due to our holdings in Asia & the Pacific Basin—especially in Greater China—and in some select defensives. We enter the new quarter cautiously optimistic but alert to continuing policy risks. Our investment strategies focus on the long term, allowing us to navigate short-term economic fluctuations. We prioritize businesses that align with secular trends and have strong competitive advantages and market positions. Our portfolio companies are chosen for their high profit margins, strong balance sheets, and consistent cash generation. We believe these qualities will endure even in challenging macroeconomic conditions. In our opinion, our investment process is not affected by tariffs, and the well-defined characteristics of our portfolio companies mean they should be better able to withstand external economic shocks.
Our concentrated, conviction-weighted portfolios are designed to outperform market growth rates over an investment cycle. Additionally, our portfolios are diversified across a wide range of secular growth themes. For instance, within the top ten holdings of our international strategy, in addition to holdings in artificial intelligence (AI), themes include industrial automation, financial services in emerging markets, e-commerce, mobile gaming, and digitalization.
OUTLOOK
With trade talks still in progress, the ultimate shape of global tariff policy is far from settled. The current 90-day suspension of reciprocal tariffs expires on July 9, though White House officials say it could be extended if agreements are close. Even so, any country that fails to reach a deal risks much higher duties. And while markets generally expect scaled-back versions of “Liberation Day” tariffs, it would still be enough to pose a downside risk to global economic growth. The coming months will test the patience of markets, the resolve of policymakers, and the resilience of consumers in the U.S. and abroad. In the absence of a clear resolution, tariff threats may persist as a driver of uncertainty, delaying decisive action by central banks and weighing on spending.
The U.K. has already inked a preliminary accord, making it something of an outlier. The E.U. has been working toward an agreement in principle with the U.S. that would permit discussions to continue past the July deadline. It has indicated its willingness to accept the 10% universal tariff on many bloc exports, provided the U.S. grants lower rates for strategic sectors such as pharmaceuticals, alcohol, semiconductors, and commercial aircraft. Additionally, the E.U. is pressing for quotas and exemptions that would effectively reduce sectoral tariffs on autos, steel, and aluminum. While the proposed framework favors the U.S., European officials believe it is a compromise they can live with. Canada has been able to resume talks after it rescinded a digital services tax on U.S. tech companies. Additionally, negotiations with Mexico, India, Japan, Vietnam, and other trading partners continue.
It is widely expected that tariffs will contribute to higher consumer prices in the coming months, a view that has restrained the Fed from cutting interest rates. Yet, tariff-induced price increases have been modest so far, casting doubt on how pronounced the inflationary effects will be. President Trump has publicly pressured Fed Chair Jerome Powell to lower rates. Within the Fed, opinions diverge sharply. There is great uncertainty over when and how much businesses may pass along the cost of higher import taxes into consumer prices. The concern is that higher tariffs might derail the Fed’s yearslong fight to defeat inflation. Some Fed officials argue that any rate cuts should wait until tariff-induced cost pressures fully materialize, while others argue that rate cuts are warranted relative to current inflation rates. New economic projections released recently reflect this internal schism: among 19 rate-setters, 10 foresee at least two rate cuts this year, seven anticipate none, and two expect just one.
Powell acknowledged that while inflation pressures have been muted so far, significant price increases could emerge in June, July, and August as tariffs filter through supply chains. He also conceded that the actual impact might prove smaller than projected, a possibility that would weigh heavily on future policy decisions. A misstep—either cutting rates prematurely or maintaining restrictive policy in the face of contained inflation—could lead the Fed into more decisive moves later.
Meanwhile, the health of U.S. consumers looms as the most immediate risk to the U.S. economic outlook. Data released by the Commerce Department revised first quarter consumption growth down sharply to an annualized 0.5% from an initially reported 1.8%. The softness has persisted into the second quarter, with consumer spending declining consecutively in April and May. Discretionary categories have been hit especially hard, signaling that consumer confidence may be fraying under the weight of economic uncertainty.
China recognizes the urgency of bolstering domestic demand. The government announced a plan to stimulate consumption by boosting wages, increasing pensions, introducing financial incentives for childbirth, and shoring up stock and property markets. Yet, concrete policy details have been scant. Chinese households remain cautious amid a protracted downturn in the property sector and ongoing labor-market challenges. Bigger picture, years of talk about shifting toward a consumer-driven growth model have yielded little progress, and the trade war with the U.S. only magnifies the need for a more balanced economy.
President Xi faces a dilemma. On one hand, he aspires to make China self-sufficient in critical technologies—ranging from electric vehicles and batteries to construction machinery to health care—while also extending his country’s influence in global supply chains. On the other hand, he has resisted broad handouts to consumers, wary of fostering “welfarism.” As a result, the structural reforms required to strengthen the social safety net, raise household incomes, and pivot the financial system toward supporting consumer finances have stalled. Without such measures, China risks remaining overly reliant on industrial investment and exports, which can be a precarious position in the midst of protracted trade tensions.
In the International Fund, roughly 15% of assets are invested in Greater China* holdings, which is overweight relative to the benchmark. In the Global Fund, roughly 10% of assets are invested in Greater China* holdings, which is overweight relative to the benchmark. We believe our Chinese holdings are at valuation levels, in the context of their long-term growth outlooks and competitive positioning, that more than compensate us for the risks. Our Chinese holdings are exposed to secular growth areas of the domestic economy (private consumption and health care) that align with government priorities, have strong balance sheets and resilient cash flows, and are not reliant on restricted Western technology inputs for future growth.
Our investment strategy focuses on companies that benefit from long-term secular trends and have strong competitive advantages and market positions. Additionally, we have deliberately chosen companies with healthy profit margins, robust balance sheets, and consistent cash flow generation. Essentially, we have selected portfolio companies that we consider to be financially stable, even in challenging times. As a result, we believe our portfolios have the capacity to surpass market growth rates in the long run. In our opinion, our investment process is not affected by tariffs, and the well-defined characteristics of our portfolio companies mean they should be much better able to withstand external economic shocks.
Some of the most promising growth opportunities over long investment horizons may not be heavily influenced by current global events or specific regional circumstances. These opportunities include our investments in and around cloud computing, software-as-a-service, digital transformation, AI, semiconductor technology, e-commerce, payment systems, industrial automation, electric vehicles, and innovative biologic and biosimilar therapies. Additionally, there are other exciting growth prospects related to the rapid expansion of consumer markets, particularly in emerging economies and notably in Asia, which are driving the demand for various consumer products and financial services. Slowing global economic growth should not undermine the enduring strength of these investment themes, or the business models and market positions of the companies in our portfolios.
U.S. market valuations remain significantly elevated, with the cyclically adjusted price-to-earnings (CAPE) ratio recently reaching levels near historical peaks. In contrast, international markets trade at considerably lower valuations, offering a better starting point for expected future returns. Thus, we remain strategically positioned with a preference for international equities. We believe that our selective approach and emphasis on quality will effectively mitigate tariff-related risks while capitalizing on secular growth and valuation-driven opportunities.
*Includes China, Hong Kong, and Prosus.
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