Tariff Tantrum

Holding the U.S. base case, but uncertainty is higher: Tariff uncertainty is at all-time highs and we see higher potential for a negative outcome. Regarding broader policy uncertainty, higher tariffs could weigh on low-income consumers, falling asset prices pose risk to higher-income consumers, and labor market drag from federal layoffs is starting to surface. Uncertainty from tariffs and other government policies could persist for several months as processes unfold. Policy risks have coincided with downward revisions to growth expectations and upward revisions to inflation forecasts. Consensus expectations for full-year 2025 U.S. GDP growth were lowered to 2.0% from 2.2% last month. Expectations for core Personal Consumption Expenditures (PCE) over the next couple of quarters modestly increased. While cooling, the U.S. economy is expected to continue to grow, and recession probabilities are low.

Our base case expectation remains for U.S. economic growth to slow to around trend, inflation to ease with the potential for near-term boosts from tariffs, and the Fed to proceed with a gradual pace of rate cuts. Uncertain tariff policies continue to pose both upside and downside risk, including economic disruption from policy shocks.

A brighter outlook for Europe: Germany announced massive fiscal reform that would allow defense spending to essentially circumvent the debt brake and also deliver a €500 billion infrastructure fund over 10 years. Approval is still pending but looks likely. The fiscal boost should provide multi-year support to the European economy and is occurring at a time when central bank rate cuts are starting to lift activity from low levels and Russia-Ukraine tensions are easing. We see higher odds that the Euro Area can achieve around 1% real growth. The improved growth outlook has started to feed through to better earnings revisions for non-U.S. equities, particularly relative to weaker U.S. estimates. Tariff risk is still a factor, but we believe the fundamental changes are sufficient to remove the underweight to developed ex-U.S. equities.

Maintaining the U.S. equity allocation: Government policies have weighed on the U.S. equity market, with the S&P 500 Index nearing a 10% correction in a span of less than a month. Given the recent drawdown, weaker sentiment, and no major change to the baseline economic expectation of a soft landing, we do not think it is an opportune time to reduce U.S. equity exposure. Instead, we preferred to fund the increased international equity allocation with high yield. High yield has posted a positive total return year-to-date, which is a notable feat given the magnitude of the U.S. equity market drawdown. We view the trade as an opportunity to take profit in one area in order to reduce underweight exposure to an asset class with the potential for tactical outperformance. Overall, the committee still likes high yield. The tactical portfolio is overweight equities and real assets, and underweight fixed income. We recommend having some inflation protection and staying diversified in what has been an uncertain environment due to government policy.

— Peter Wilke, CFA – Head of Tactical Asset Allocation, Global Asset Allocation

POLICY UNCERTAINTY IS VERY HIGH

A great deal of uncertainty centered on tariff impacts continues to keep equity markets on edge.

Credit Markets

February marked an increase in equity market uncertainty as tariff threats, geopolitical unrest and weaker economic data all contributed to a reset of risk appetite in stocks. Despite rising equity market volatility, the high yield (HY) bond market held firm with declining Treasury yields helping to offset modest spread widening. High-yield funds have continued to see robust inflows. Assets under management (AUM) for dedicated HY retail bond funds rose to a 3-year high of $360.7bn and are only $13.4bn below the record high. Meanwhile, HY ETFs currently have a record $90.1bn of AUM, which accounts for a record 25.0% of the traditional retail HY mutual fund base.

Based on the increase in AUM of these passive products, there could be an increase in forced buying and selling in smaller bonds and issuers than in prior years due to the new breadth of the product. This cohort of the market can provide an abundance of opportunity for active investors looking to capture mispricing and inefficiencies in the market. Fundamental credit work and security selection is paramount to generating excess returns in this segment of the market especially alongside the complicated economic backdrop.

— Eric Williams, Head of Capital Structure, Global Fixed Income

HIGH YIELD ACTIVE VS. PASSIVE FLOWS

High yield funds have continued to see robust inflows.

Source: Northern Trust Asset Management, Lipper FMI, JPMorgan. HY = High Yield. Data from 12/31/2010 through 2/28/2025. Historical trends are not predictive of future results.

• High yield ETFs have increased meaningfully in size over the last 12 months.
• Based on the increase in AUM of high yield passive products, there could be an increase in forced buying and selling in smaller bonds and issuers than in prior years.
• Market technicals in ETFs can provide an abundance of opportunity for active investors looking to capture mispricing and inefficiencies in the market.

Equities

After hitting an all-time high on February 19, U.S. large caps sold off 9.1% over the next 15 trading sessions. Increased uncertainty has led to a striking reversal in market leadership as investors sought shelter in low volatility and high quality stocks. These stocks have outperformed the broader benchmark by 5.5% since the sell-off began and are essentially flat year-to-date. Outside the U.S., investors are finally reaping the benefits of diversification with developed ex-U.S. markets up 0.2% during the sell-off period and up 7.8% year-to-date.

The U.S. earnings outlook remains constructive despite downward analyst revisions in February. However, given the recent drawdown, weaker sentiment, and no major change to the baseline economic expectation, we do not think it is an opportune time to reduce U.S. equity exposure. For developed ex-U.S. equities, Germany’s proposal for massive defense and infrastructure spending is expected to boost growth for several years. Challenges remain, including the ongoing tariff turmoil and other longstanding structural challenges to growth. Overall, we believe the fundamental changes are sufficient to remove the underweight to developed ex-U.S. equities.

— Jordan Dekhayser, Head of Equity Client Portfolio Management

SHELTER FROM THE STORM

Defense and Diversification paying off in 2025.

Source: Northern Trust Asset Management, MSCI. U.S. is MSCI U.S., Developed ex-U.S. is MSCI World ex-USA and Quality Low Volatility is the Northern Trust Quality Low Volatility Index. Data from 12/31/2024 through 3/12/2025. Past performance is not indicative or a guarantee of future results. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index.

• High quality and low volatility stocks provided significant protection for investors during the recent market route.
• Developed ex-U.S. stocks provided much needed diversification as proposed infrastructure and defense spending in Europe boosted markets.
• With a long-awaited catalyst for Europe emerging, we closed our underweight to developed ex-U.S. stocks.