The imposition of tariffs by the Trump administration puts more wind in the sails driving the dominance of tech and related sectors versus the rest of the market.
Taking the technology sector broadly defined as the GICS industries Technology, Movies & Entertainment, and Interactive Media & Services, which we refer to as ‘TEIMS’, these industries encompass the stocks making up the Magnificent 7 (except for Tesla). The TEIMS industries have dominated equity market returns since the late nineties, at first in the US and then globally over the years. The arrival of the artificial intelligence (AI) revolution further increased the dominance of these industries as semiconductor demand skyrocketed. Tariffs favour these sectors relative to the rest of the market as their export revenues are more services-oriented and hence somewhat protected from tariffs on goods (see Exhibit 1).
This phenomenon may help explain why earnings growth expectations for TEIMS stocks have changed little since ‘Liberation Day’. One might have expected greater negative earnings revisions for non-US markets as tariffs were thought to hurt exporters to the US more. Their revenues and margins would suffer as tariffs rose, while US companies would see a benefit from redirected demand (offset to some degree by higher costs for imported production inputs).
In fact, 2025 year-on-year TEIMS earnings growth forecasts have been steady at between 19-20% for both the US and for the rest of the world, while those for non-TEIMS industries have dropped by more than 3–4 percentage points. The encouraging news is that these negative revisions seem to have stopped and earnings growth expectations have stabilised (see Exhibit 2).
One should nonetheless be careful to not overstate the impact of tariffs on equity earnings and therefore prices. One might have anticipated stock prices for goods-producing companies to suffer more than services-producing firms with the announcement of tariffs. The sell-off immediately following the ‘Liberation Day’ announcements was indeed worse for most goods-producing stocks. But as markets have recovered, goods-producing stocks have lagged only slightly, as other positive factors (e.g., European infrastructure spending) provided additional fuel to the rally. Moreover, the final level of tariffs looks likely be far lower than initial “reciprocal” rates announced on Liberation Day, and negotiations could yet lead to lower tariffs on US exports.
Investors can approximate the division between TEIMS and non-TEIMS industries via the NASDAQ 100 and Russell 1000 Value indices in the US. Growth indices are a poor proxy as non-TEIMS growth stocks are unlikely to see the same rate of earnings gains. The country indices most heavily exposed to the theme include the US, where TEIMS industries make up 38% of the market capitalisation for the MSCI USA index, and MSCI Emerging Asia, where the weight is 37%. This is in contrast to Japan and Europe, where the MSCI index weights are just 13% and 9%, respectively.
US equities
The market’s initial reaction post President Trump’s victory in the US elections was that the outlook had improved for US economic growth and particularly for US equities. The view was premised on the outperformance of US equities during the first Trump administration, anticipation of deregulation, fiscal stimulus, increased mergers and acquisitions activity, lower energy prices and tariffs, insofar as they would lead to increased investment in the US (even if there was a short-term hit to earnings).
These assumptions were not necessarily misplaced (though oil prices have spiked recently due to the conflict in the Middle east). US equity market performance, however, has not followed the script: from the election to 12 June 2025, the S&P 500 had gained 6.7% vs. 9% for the MSCI All Country World Index ex-USA (ACWI, local currency terms), though US equities had also underperformed at the same point in the first Trump administration. The disappointing result is only partly due to the larger-than-expected US tariffs. Germany’s infrastructure plans were a positive surprise, as is the willingness of NATO member countries to significantly increase defence spending. The DeepSeek announcement revealed the potential in Chinese technology, abetted by renewed support from the government.
Another key factor explaining the weaker performance of US stocks is slowing consumer demand, exactly as most investors had anticipated (even if this was subsequently largely forgotten). Prior to the US election, the assumption was that — aside from a Kamala Harris victory — the economy would see a ‘soft landing’ in 2025. That is, excess savings would finally run out, leading to a decline in consumer demand, slower GDP growth and lower inflation, which would enable the US Federal Reserve to cut policy rates.
The first part of this story, at least, appears to be occurring. The personal consumption expenditures (PCE) component of GDP increased by just 0.3% in the first quarter, less than half the average rate in 2024 (see Exhibit 3). The month-on-month 0.2% drop in retail sales in April, compared to an average monthly gain of 0.3% in the first quarter, does not bode well for second quarter PCE. The slowdown would arguably have occurred even if Kamala Harris had won the election as in the first quarter there were few substantive changes to economic policy from the Trump administration.
The key part of the soft-landing narrative that has not materialised is the reduction in interest rates from the Fed. Time will tell whether their focus on temporary tariff inflation over the impact of tariffs on growth is warranted.
Offsetting the decline in consumer demand has been a surge in business investment, as shown by the green bars in Exhibit 3. While the first-quarter 2025 figure partly just reverses the drop in the last quarter of 2024, it is still well above the average year-ago rate. The sectors that contributed the most to the increase were information processing equipment and software, reinforcing the point about AI as a critical driver of economic growth and corporate profits.
Dismay about the size of tariffs has not permanently depressed corporate sentiment. The results of the most recent earnings season were positive, but they were dismissed by some as providing little insight into the future as the first quarter was not impacted by tariffs. The focus was on the outlook and how CEOs viewed profits in the quarters ahead. As it happens, the percentage of companies that raised their guidance did drop to below average for much of the season, but it has now recovered to the same, above-average, level of a year ago (see Exhibit 4). Analysts also do not appear to be particularly uncertain about the outlook for earnings. The standard deviation of estimates for the S&P 500 has dropped back to the level prior to ‘Liberation Day’.
The limited economic data we have post ‘Liberation Day’ has been mixed: weak retail sales, a steady labour market, better Purchasing Managers’ Indices, but worse ISM (Institute of Supply Management) readings, and little sign yet of much inflationary impact of tariffs. We remain data-dependent as the current unique economic environment does not lend itself to analysis with historical forecasting models. If the positive factors described earlier begin to bear fruit, and trade negotiations lead to a reduction in tariffs faced by US exporters, one could imagine a more robust recovery in US equities in the months ahead. The risks are that trade negotiations fail, or that US consumer demand weakens by far more than expected.
A concern for the non-TEIMS part of the US market is valuations. The z-score for the Russell 1000 Value index forward price-earnings (P/E) ratio is 1.4, compared to 0.4 for the NASDAQ 100 (though based on price-to-sales and other metrics, valuations appear higher). This divergence means that high valuations for the S&P 500 P/E ratio stem primarily from the value stocks in the index, not the growth stocks, a big reversal of the pattern over the last decade. The high z-score for Russell 1000 Value also stands out when compared to the far lower score for MSCI Europe, whose composition is similar (see Exhibit 5).
European equities
The low weight of TEIMS industries in the MSCI Europe index clearly did not prevent the market from posting top-of-the-league-table returns in the first quarter: the index advanced by 6% vs. a 4% decline for the S&P 500 (local currency terms). Divergence in monetary policy was a key factor: one major contributor to European equity outperformance was the financial sector as the eurozone yield curve steepened relative to the US. Another contributor was capital goods (including defence) as the German fiscal stimulus sharply pushed up earnings expectations.
It seemed destined not to last, however; once both factors were priced in, the market was likely to revert to the pre-existing, more modest earnings trend; since ‘Liberation Day’, the index has underperformed the US by about 3 percentage points.
The advantage for the financial sector could reverse if/when the Fed finally starts cutting interest rates, though the tailwind from lower eurozone rates should last for a while. As for infrastructure and defence spending, this is unlikely to have a material impact in the near term, with the risk that the boost to earnings in the medium term is not as great as investors hope (and expectations are high; see Exhibit 6).
The ambitions of both the German government and the EU are bold, but they face several challenges. The source of funding for increased defence spending outside of Germany is uncertain as debt levels and taxes are already high and cuts to spending would be unpopular. The European defence industry may struggle, at least initially, to absorb a dramatic increase in orders. European companies account for 34% of the market capitalisation of the MSCI World Aerospace & Defense index, compared to 64% for the US, suggesting that US companies may also be beneficiaries of the new largess.
Finally, for all the desire to invest more in infrastructure in Germany, the country already faces a Fachkräftemangel — a lack of qualified workers. One study by the Institut der deutschen Wirtschaft (IW) estimated that in October 2024, the shortfall was over half a million. And this at a time when, similar to the US, there is a desire to reduce immigration and increase deportations.
Emerging market equities
The higher exposure to TEIMS industries is a key advantage for emerging market equities, particularly in the wake of the DeepSeek announcement and the Chinese government’s renewed support of the industry. US-imposed restrictions on technology transfers may impede the development of domestic Chinese technologies, but they will also ultimately spur domestic innovation. We certainly see Chinese equities as ‘investible’ even as some foreign investors have doubted the potential for the market to generate better-than-benchmark returns.
Since the January release of DeepSeek’s AI model, the MSCI China index has outperformed developed market equities by 17 percentage points (as at 12 June 2025). But the outperformance of the broad index has been primarily a function of the TEIMS companies in it. There is a similar concentration phenomenon in China to that of the Magnificent 7 in the US, insofar as a few tech stocks dominate the performance of the broader index. Using the CSI Global China Internet index as a proxy (analogous to the NASDAQ 100 index for the US), Exhibit 7 shows how the relative performance is largely a function of the stocks in this CSI index. The advantage of this dynamic is that if one gets the call on Chinese technology right (and we are optimistic), one will likely be correct on the performance of the broader market.
In contrast to the outperformance of the CSI index, the domestic MSCI China A index has underperformed global equities. This reflects the lingering effects of lockdown restrictions and the bursting of the property market bubble in the country, exacerbated by trade tensions with the US. While some observers are confident that China can offset the impact of US tariffs by stimulating domestic demand, it is not certain these measures will be successful. Households may not respond to fiscal stimulus as confidence remains depressed. In contrast to the US and Europe, sentiment has not recovered from the COVID pandemic. As long as the property market remains subdued, households may be reluctant to increase consumption.
A weaker dollar should also provide a tailwind for emerging market equities. If the dollar declines in value it mathematically improves foreign investor returns as equity prices in non-US currencies are translated into hard currency, but the underlying local currency price appreciation also tends to be greater when the dollar is falling (see Exhibit 8). It is conceivable that the dollar continues to weaken as investors rebalance global portfolios. Moreover, the real, trade-weighted value of the dollar is 16% above its long-run average. The last sustained period of dollar weakness beginning in 2002 occurred when the dollar was just 12% above average.
Small caps
Small capitalisation stocks have generally weathered the tariff storm better than their large-cap counterparts. This stands to reason as large capitalisation companies are more likely to export their products. After an initial, post-US election pop, most small-cap indices were underperforming large cap ones until things turned around following the ‘Liberation Day’ announcements (see Exhibit 9).
But resilience in the face of tariffs is not the entire story. In Europe, consumer demand appears to be robust, with most major countries seeing an improved trend in retail sales in April (Germany is the exception). Policy rate cuts from the ECB are also helping.
The investment case for US small-cap performance was partly based on increased domestic investment following the imposition of tariffs. As with infrastructure investment in Germany, this will happen only over time, but should provide a boost to future profits. The main risk is the consumer, who could balk when faced with higher prices on (imported) goods. The most recent CPI data did not show a significant impact from tariffs, but likely will do in the months ahead. Still, the unemployment rate is low and wage growth is steady at 3.9%. If economic growth remains resilient, we could see further gains in US small-cap stocks.
Another appealing factor of US small-cap stocks is that it allows investors to tap into US growth without increasing their allocation to mega-cap tech. Valuations also look attractive, particularly given the high P/E ratios discussed above for large-cap US value stocks (see Exhibit 5).
There is one qualifier, however, when looking for relative outperformance. It is not certain that US small-cap stocks will outperform US large-cap indices simply because the TEIMS industries in the US large cap benchmarks will likely see superior earnings growth. A more appropriate comparison would be small caps relative to the Russell 1000 Value index, whose composition is similar to the European and Japanese large-cap indices.
In an odd parallel to the beginning of 2024, when recession expectations led many to underweight equities, the dismay at US tariffs has also led many to expect a sustained downtrend in equity prices. Though risks of course remain, we see global growth as more resilient, with the potential for positive surprises later in the year, and central banks as (eventually) supportive. The US may no longer be so exceptional, but there are other (growth) stories in town.
