US equities are adjusting to China-US tensions

Fears of a Trump-induced US recession, rising US-Chinese tensions and over-investment in artificial intelligence (AI) technology have weighed on investor sentiment in recent weeks. Some of the AI related names, like Nvidia, are down more than 20% from their peak, and US stocks have underperformed their peers so far this year.¹ However, it is worth noting that the S&P 500 is back to levels last seen in September. 

To paraphrase the classic song title “Stuck in the middle with you” from folk rock band, Stealers Wheel, it seems US equities are getting caught up between Sino-US geopolitical tensions. Ironically, it is the under owned stocks in export sensitive economies, like China and the EU, that have prospered on expectations of greater fiscal spending brought about by President Donald Trump’s ‘America First’ agenda. 

On the US side, it seems that Trump’s trade protectionism agenda has backfired. The mighty US tech sector has seemingly lost its sheen, and the risk of a US recession has increased. The notoriously volatile Atlanta Fed’s Nowcast estimates a contraction of 2.4% at an annualised rate for the first quarter of 2025. Much of that decline comes from imports brought forward ahead of expected US tariff increases, which led to a large drag on estimated gross domestic product (GDP). It is not yet clear if this is just a temporary stalling in growth or something more significant. Final sales to domestic producers, a more specific measure of domestic private consumer demand that excludes exports, is still growing at a 0.8% rate, which is probably a better read of the health of the underlying economy.  

Trump may be placing greater importance on keeping the cost of government borrowing down at the expense of the equity market. That’s because Trump’s party, the Republicans, will be asking Congress over the coming months to raise the debt ceiling limit by over $4 trillion as part of a comprehensive legislative package to deliver on his domestic priorities. Trump will want to show that the US public debt market is stable ahead of a likely “Birthday Summit” with President Xi Jinping in June when both presidents celebrate their birthdays. Trump will want the Chinese to commit to buying more US treasuries to fund his agenda.  

Furthermore, in an interview on Fox News on 10 March, Trump appeared to talk down long-term interest rates by saying the US economy is experiencing a “period of transition”. That’s because he wants a weaker US dollar to support the competitiveness of US manufacturing. Indeed, Trump made this point in a speech to a joint session of Congress on 4 March when he said, “We need a weaker dollar to bring back our manufacturing jobs. A strong dollar makes it difficult for our companies to compete globally." 

Trump is also using the war in Ukraine, and the threat of removing financial and military support, as leverage to get European nations to step-up fiscal spending on defence and ideally, US military hardware. Following the recent German election, there is a desire from the leadership of the new incoming government to raise fiscal spending by reforming the so-called “debt brake” – a mechanism to ensure budget deficits are kept down on a structural basis. This includes more German public expenditure on infrastructure and an open-ended commitment to raise defence procurement. Essentially, this expansionary fiscal policy could narrow the US-European growth gap and give impetus for the euro to appreciate against the dollar.  

On the China side, Beijing is using a subtle response to Trump’s trade tariffs. Xi’s recent meeting with Jack Ma, the co-founder of tech giant Alibaba, was choreographed to show the tech sector has implicit approval from the Chinese political leadership.  

In addition, the release of DeepSeek (an AI model by a Chinese startup) in January did not help the US tech sector either. Given its low-cost base, DeepSeek raises questions on whether US companies should be spending so much money on computing hardware. 

China is using its ‘soft power’ to weaken US dominance in financial markets and its economy down a notch to strengthen the country’s negotiation hand ahead of an inevitable President Trump-Xi summit to discuss trade and investment.  

Despite the correction seen over the past few weeks, there are five reasons we believe that US stocks can recover from these levels. 

1. Resilient US economy: Although it is early days, the ructions seen in equities does not appear to have dampened consumer expenditure. That’s because with inflation slowing and jobs being created, annual real take-home pay grew nearly 2% in January. Moreover, deregulation and expected tax cuts should drive hiring over the medium term. The National Federation of Independent Businesses’ survey (a barometer of small business sentiment) shows that hiring intentions are at their highest level in over a year. Importantly, this should give consumers the confidence to shop. 
2. Company earnings outlook is positive: Providing the US economy continues to grow at a relatively healthy clip, this increases the chances that companies can deliver on consensus earnings’ expectations. As it stands the consensus expects MSCI USA earnings-per-share (EPS) growth of 12.1% in 2025, a modest downgrade from 14.5% at the start of the year. However, in early January, EPS for 2026 has been revised up to 14.5% from 13.2%. Overall, the outlook for company earnings is constructive. 
3. A weaker US dollar: Arguably, the key takeaway for investors from recent Sino-US geopolitical tensions is that the US dollar has depreciated. This adds support for US stocks in several ways. First, they become cheaper for non-US investors. Second, fundamentally, a weaker US dollar should boost US multinationals’ profits from overseas when translated back home. And third, dollar weakness indicates that there is a greater supply of the currency than demand. Potentially, this creates favourable financial conditions for equities to recover from oversold levels should money flow back to risky assets.   
4. Less demanding valuations: The recent US equity price falls mean valuations for the so-called US ‘Magnificent Seven’ (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla) look more favourable. For instance, their aggregate forward price-to-earnings ratio is at a 40% premium compared to the rest of the US S&P 500, its lowest level since 2018. Nvidia is trading on a valuation of 24 times earnings, which looks relatively attractive considering its high profit margins and potential for rapid growth in expected sales over the coming years from AI demand.2 
5. Lower long-term interest rates: The US 30-year Treasury yield is currently at 4.6%, down 0.4% points from a peak in mid-January. Fundamentally, given US mortgage rates are priced-off the long-term cost of government borrowing, less money is being spent on making interest payments, potentially giving a boost to the housing market to drive economic growth. Lower Treasury yields also support stocks by making equity valuations look more attractive to government bonds. 

US equities have felt the brunt of uncertain China-US geopolitical tensions. Clearly there are market risks associated with trade tariffs and broader policy uncertainty. On the upside, the ‘Magnificent Seven’ stock valuations have adjusted to more reasonable levels. The US dollar appears to have peaked to create favourable financial conditions for stocks. Moreover, the economic outlook remains encouraging, supported by consumption and the labour market. 

Trump appears willing to tolerate volatile markets in the short term to achieve his longer-term goals of weakening the dollar and keeping the cost of government borrowing down to fund his domestic priorities. For that he will still need to find common ground with Xi in the coming months.