The death of US exceptionalism has been a theme since the start of 2025. An unpredictable government, with some unorthodox ideas, has disrupted the benign long-term outlook for US companies. Only nobody told stock market investors. After some wobbles at the start of the year, the US stock market is back to the races.
The impact of the tariffs on US businesses is real, even though they have not been implemented in full. The latest KPMG Tariff Pulse Survey found 57% of US companies reported declining gross margins as a result of the tariff regime to date.
Companies warned that they were rethinking supply chains, while preparing for longer-term shifts in cost structures, sourcing strategies and global demand dynamics. All of this was weighing on profitability.
Even the US’s largest businesses have been in the firing line. In May, Apple warned of a potential $900m hit if the tariffs remained in place. The company appears to have secured a carve-out, but the country’s technology giants are global: they manufacture and sell across multiple countries and are therefore vulnerable to rising prices.
Nevertheless, markets have rallied because investors are assuming that president Trump will be cowed by markets into backing away from his more draconian tariff regime. This seems to be supported by the previous decision to postpone reciprocal tariffs for a further three weeks.
There is a question as to whether the ‘TACO’ (Trump Always Chickens Out) trade now looks too optimistic
However, with Trump still making a lot of noise about the possibility of higher tariffs on the EU, Mexico and now Russia, there is a question as to whether the ‘TACO’ (Trump Always Chickens Out) trade now looks too optimistic. The S&P 500 is up almost 16% across the last three months alone.
For some investors this will be an endorsement of their view that the US was exceptional after all, and they can simply keep faith with their S&P 500 tracker. However, there are reasons to take a more nuanced view.
Since the start of the year, market leadership has been far more opaque. Among the top performers in the IA North America sector are the usual smattering of growth-focused funds, heavily weighted to the technology sector. This includes the Baillie Gifford American fund, which has Cloudflare, Meta, DoorDash and Shopify among its top 10 holdings.
But there are also a number of value-focused funds in the mix. Among the tracker funds, it is industrial-focused funds rather than technology that dominate the top of the table. There are even a number of environmentally focused funds there. The technology giants have been far less dominant.
Many fund managers are still predicting a relatively gloomy outlook for the US economy
Even within the technology sector, it has not been the Magnificent Seven that has led the way since the start of the year. Nvidia has been strong, but Apple and Tesla have been weak. There have been far more exciting returns from companies such as defence software group Palantir Technologies (up 97% year-to-date), clean energy group Constellation Energy, or chip maker KLA Corporation.
Many fund managers are still predicting a relatively gloomy outlook for the US economy.
Zehrid Osmani, manager on the Franklin Global Trust, says: “Inflation risk has increased due to the more significant tariffs, which could lead to a slower response by the Fed in particular. This means that our focus on pricing power remains key.
“With the increased uncertainty in terms of tariffs, business and consumer confidence surveys have been deteriorating, which in our view could have a negative impact on the upcoming global leading economic indicators, which increases the risk of a sharp slowdown in economic activity.
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“We have increased our probability of recession over the next 12 months, although our central scenario, should tariffs not be backtracked, is for a sharp slowdown across regions rather than a recession.”
This type of environment might favour a more quality-focused approach, rather than the go-go growth that has characterised markets in recent years.
David Shaw, manager on the AXA Framlington American Growth fund, says some parts of the market look vulnerable in this environment: “Our belief is that earnings estimates for the more cyclical areas of the equity market are too high and that the current bullish sentiment is likely to be tested over the next 12 months.
“At the same time, we believe that interest rates are peaking and valuation pressures should ease. Given that the American growth strategy is tilted towards less cyclical growth companies, we expect both of the above trends to be beneficial over time.”
Deregulation and tax cuts should elicit more investor attention on domestically focused small and mid-sized companies
Equally, it is worth noting a change in market patterns. The past three months has seen a revival in the US Small and mid-cap sector after a bruising few months. The Russell 2000 is up 19.6% over the past three months. This part of the market has also received a boost from the ‘One Big Beautiful Bill’, which announced tax incentives for smaller businesses and some deregulation.
Managers such as Hugh Grieves, manager on the Premier Miton US Opportunities fund, have been banging the drum on the value available in the small and mid-cap sector. He believes deregulation and tax cuts should elicit more investor attention on domestically focused small and mid-sized companies.
Where does this leave investors? It depends what they hold already. If they are already holding MSCI World-style levels in the US (70%+) and in the technology sector (30%+), then doubling up on this trade will introduce more risk.
It may be time to look more creatively at US equities – to value or dividend strategies, or further down the market-capitalisation spectrum.
Darius McDermott is managing director of FundCalibre
