Trade Tensions Pressurize Markets and Sentiment

Track shifting investor sentiment through our latest ETF flows analysis.

Nutritionally, there is no difference between spring and sparkling water. Without the carbonation, sparkling water also has the same chemical properties as water. The carbonation just makes sparkling water more combustible once shaken.

That’s today’s market. Even before the events of April, forecasts were being revised — lower for growth and higher for inflation.¹ The redesign and paradigm shift of global macroeconomic modalities just pressurized markets.

The infusion of the exogenous tariff variable, like CO2 gas being dissolved in spring water to form carbonic acid, transformed the market’s general properties. That led to a spike in cross-asset volatility, a rapid repricing of global economic expectations, downside revisions/weakened guidance of fundamental growth, and a widening of risk premiums across asset classes to reflect a new world economic order.

Based on flows, investors reacted as if the carbonation was about to explode.

ETF Flows Illustrate a Desire for Resiliency and Defense

April’s flows reflect a flickering desire — apparent across multiple dimensions — to recalibrate portfolios to this new economic order. Investors increased their allocations to inflation-sensitive market segments, right as expectations for rising inflation reached the highest level since 1981.²

Investors started to add some resiliency to portfolios leading up to — and in — April (Figure 1). Led by $4.3 billion into gold and inflation-linked bonds, inflation-sensitive ETF inflows spiked in April. The trailing three-month total is now $22 billion, just a tick below pandemic highs.

Given that inflation-linked bonds and gold carry a positive economic relationship to falling growth dynamics, investors appear to be preparing for stagflation.

While those flows reflect bolstering portfolios’ economic resiliency, the trends in ultra-short and short-term-government bond ETFs depict defensive posturing. Or rather, limiting portfolio volatility from the widening of risk premiums across assets classes.

Ultra-short and short-term-government bond ETFs took in $19 billion in April, their second-most ever and just behind the March 2020’s record $20.2 billion. Last month’s inflows, combined with the $11 billion of inflows over the prior two months, have pushed ultra-short and short-term-government bond ETFs’ rolling three-month figure to $34 billion (Figure 2).

This record inflow is well above the $27 billion from 2022 when the Fed was aggressively tightening policy. That policy stance differs from today’s, as the market now expects four rate cuts by the end of the year.³

But today’s forecasts are being made amid the uncertainty caused by the frenetic and flip-flopping pace of policy proclamations. As a result, the defensive, anti-uncertainty positioning with ultra-short and short-term-government bond ETFs is likely to continue, rather than having expected rate cuts trigger moves out of cash-like investments in anticipation of lower yields.

With Markets Pressured, Risk Was Shed

If resiliency and defense were sought and bought, what was shed? Risk. And across multiple areas. Sectors were hard hit (Figure 3). April’s sector outflows of $11 billion were the worst ever, and they were spread across cyclical and defensive segments.

Those large outflows pushed rolling three-month outflows to $21.5 billion — the second-worst total on record. Only the $22 billion of outflows during the summer of 2022 (another time of risk premium widening) was worse.

The defensive and recessionary-biased Utilities sector managed a meager $171 million of inflows in April. Despite the inflows into Utilities, defensive sectors had net outflows of $2 billion. Negative, but far less than the more economically-sensitive cyclical sectors’ $11 billion of outflows.

With nine out of 11 sectors with outflows, combined with the size of the outflows, both the magnitude and depth of negativity is large. And the depth argument gets worse considering that only 46% of sector exposures had inflows on the month.

The trend was also negative. As a group, sectors had outflows on 60% of the days during the month. Historically this rate is 45%. This is what a risk reversal looks like.

Derisking was evident within bond sectors too. Credit instruments saw a record $15 billion of outflows, with all three markets (investment-grade [IG] corporates, high yield, and bank loan & CLOs).

The $5 billion out of bank loan & CLO ETFs was the worst ever, as was the $4.6 billion from IG corporates. High yield’s $5 billion was the fifth-worst.

These flows are a complete reversal of the trend leading up to April, when investors were visibly overweight credit, reflecting a bias toward a rising growth environment (Figure 4).

That type of economic environment is now less likely, both in terms of what’s already occurred, (e.g., revisions to growth combined with the reported weak Q1 GDP) and the knock-on effects to consumption and growth from tariffs that may be ahead.⁴

Waiting for the Carbonation to Fizzle Out

Carbonation fizzles out over time. Even an unopened can of Polar Seltzer will lose its fizziness if you wait long enough.

But investors may not have the patience to wait out the decarbonation of current market volatility. Especially when, with each policy proclamation — either a new declaration or a revision to an earlier directive — the Trump administration continues to increase the pressure on sentiment as if they are wielding their very own policy soda stream.

Short-term cycle trends, as a result, may be more volatile. But although asset classes are moving erratically like the bubbles in shaken seltzer now, the market will find an equilibrium and adjust to the new reality in the long term.

Predicting when that will happen or which asset class will perform best until the market flattens out is challenging. To avoid opening the wrong can of carbonated markets at the wrong time, investors can consider balancing portfolios across assets, geographies, and economic factors during this period of intense volatility and asymmetric outcomes.

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