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        Weekly ETF Brief

        Allocating to US Equities Amid Tariff and Inflation Risks

        The US equities’ performance bandwagon ground to a halt this year — but the US remains by far the strongest-performing equity market in recent historical terms. How should investors approach US equity allocation at such an uncertain moment?  

        6 min read
        Krzysztof Janiga, CFA
        Senior Equity ETF Strategist

        Rising Risks and US Economic Resilience

        US equities have faced multiple challenges year to date. Unexpected China AI competition followed by souring market sentiment put downward pressure on the S&P 500 — and its high-valuation multiples. Tariff-related uncertainty has increased inflation and growth risks, even raising stagflation concerns. On the other hand, the US labour market remains remarkably solid, supporting domestic consumption, and expected GDP growth remains higher than other major developed economies. A soft landing remains plausible. 

        Tariffs, Deregulation, and Other Known Unknowns

        Market-moving determinants in the months ahead include tariffs, domestic deregulation and tax policies, how Europe funds its new realpolitik, Ukraine’s peace process, and further Chinese AI innovation. But it is easier to identify market drivers than to forecast outcomes and their second or third order effects. Even before the recently magnified uncertainty, we encouraged investors to look beyond a broad large-cap US exposure. 

        Now, looking at equity segment characteristics, composition, and historical performance — what US exposures are best positioned for possible macroeconomic outcomes? 

        US Equity Positioning for Divergent Economic Outcomes 

        US mid caps may serve investors betting on a soft landing. US Dividend Aristocrats may be more suitable for those who think tariffs and related uncertainty will lead the US economy into stagflation. Free Cash Flow Aristocrats, which offer exposure to companies with a decade of strong cash flow, are likely to be well-positioned in a hard-landing scenario, where the Federal Reserve (Fed) cuts rates because of rapidly falling growth.

        Figure 1: Suggested Positioning

        Figure shows US economic scenarios and suggested equity strategies for each

        Scenario 1: US Mid Caps for a Soft Landing

        The S&P MidCap 400® Index supports a soft landing with gradually moderating growth and controlled inflation. This scenario is likely if tariffs are less harmful — or less strident — than current expectations, and if there is progress on deregulation and tax cuts. US mid caps would sit in the sweet spot between expensive large caps and more volatile small caps. 

        The S&P MidCap 400 trades at a relatively low 15.4x forward price-earnings ratio (P/E) compared to 20.7x for the S&P 500.1 It’s also expected to deliver similar low double-digit earnings-per-share growth over 2025 and 2026.2 Since Chinese Tech giants began to challenge AI US dominance, valuation levels became a central concern for US equity-focused investors. The broad market-cap-weighted S&P MidCap 400 Index offers a potential solution to that challenge.

        US mid caps offer most of the features typically associated with small caps but also add exposure to higher quality companies. Companies within the S&P MidCap 400 are relatively domestic, generating 77% of their revenues within the US.3 As such they can potentially deliver benefits from the still-strong US economy and offer protection against tariff-related uncertainty.

        Sector composition is largely cyclical with an overweight in Industrials, Financials, and Consumer Discretionary. Defensive sectors outperformed in Q1 but cyclicals may benefit in a soft landing, especially if more benign tax policies and deregulation come into play later in the year. Mid-cap companies tend to be more robust than small caps, a desirable feature given current uncertainty. US mid-cap companies have easier access to capital relative to small caps because of their larger median market cap of $7B.4 The S&P methodology also includes only companies that have reached profitability, improving the quality of the exposure. 

        We acknowledge risks related to the US economy and policy; but on a risk-adjusted basis, the S&P MidCap 400 may be the optimal tool for a soft landing. 

        How to Play US Mid Caps:

        Scenario 2: US Dividend Aristocrats for a Stagflation Slide

        Tariff-related uncertainty has been a factor in the underperformance of the US equity market as worsening sentiment around growth and inflation prospects leads to delayed investment and weaker consumer sentiment. As I write, we await the implementation of a new set of tariffs in early April. These tariffs have the potential to be stagflationary, reducing growth and increasing price pressures.

        In Q1 2025 US Dividend Aristocrats have so far outperformed thanks to their defensive features.5 If uncertainty and tough tariffs endure, US Dividend Aristocrats may again offer a level of protection. This is because the S&P 500® Dividend Aristocrats® Index methodology allows the inclusion of companies that have increased their dividends for at least 20 years in a row. As a result, US Dividend Aristocrats offer access to companies with a track record of generating cash flow and paying dividends throughout economic cycles.

        The index’s yield weighting creates a value tilt offering a degree of protection against inflation-related risks, as it may provide potentially lower interest rate sensitivity, and even exposure to securities that may price in inflation risk. In essence, US Dividend Aristocrats is a quality and value exposure, offering protection against stagflationary concerns.

        How to Play US Dividend Aristocrats:

        Scenario 3: US Quality Free Cash Flow (FCF) Aristocrats for a Hard Landing

        Tariffs may have a transitory inflationary effect but a more permanent and meaningful impact on economic growth, potentially leading to a recession. This outcome is especially plausible if tariff-related uncertainty lingers for too long, which we believe would worsen consumer and business sentiment and lower consumption and investment.

        In this scenario, we’d expect growth to outperform value. Inflation would be less of a challenge, but quality would be necessary against worsening growth prospects. The S&P 500® Quality FCF Aristocrats Index provides a quality exposure with a growth tilt. It includes high-free-cash-flow-margin companies,and free-cash-flow return on invested capital. Quality FCF index P/E multiples are not significantly higher than those of the S&P 500, despite an overweight to the technology sector and a significant tilt to quality.

        How to Play US Quality FCF Aristocrats:

        Insights and Tools for an Unsettled Market

        Market uncertainty will not abate overnight but we hope to provide investors with useful tools to help them position for a variety of economic outcomes. While no one can predict the exact path ahead, thoughtful scenario planning and strategic positioning can help investors feel prepared.

        To help you as you position portfolios for the future, we invite you to explore the performance, sector composition, and characteristics of each of the US equity exposures you may want to consider now. 

        Figure 2: Performance

        Figure 3: Sector Composition

        Figire 3 shows sector variations of selected in indexes

        Figure 4: Key Characteristics

        Figure 4 shows key characteristics of selected indexes

        More on Weekly ETF Brief

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