iCapital Market Pulse: Finding Areas of Conviction in an Uncertain Market Environment

Markets have rallied from their April 7th (Liberation day) low, as the S&P 500 is roughly 22% higher since then¹. Equities have recovered on the back of better-than-expected economic (hard) data and trade talks/agreements heading in the right direction. Despite this, there is much uncertainty around the current environment, as investors are still faced with many questions. Indeed, will economic growth hold up, or will we face a supply shock later this year? When will the Fed cut? And how will trade and tax discussions evolve over the coming months?

Given many of these questions, it seems like the outcomes are very binary – either things will be better or worse than expected. However, given the uncertainty in how these catalysts will ultimately evolve, markets will have to price in a range of potential outcomes. Therefore, we think it is important for investors to focus on areas where there is conviction. In today’s environment, we maintain our conviction in income assets and our focus on structural themes such as Infrastructure and AI Software and Power.

Markets are still faced with a wide range of potential outcomes

While it still seems like developments are moving in the right direction, as highlighted with the 90-day pause and reduction in tariffs between the U.S. and China, there remains much uncertainty around how key catalysts will play out over the coming months. This could create a more binary environment for how markets can perform from here as they will have to price in a wide range of potential outcomes. Therefore, it will be important for investors to monitor how economic growth, trade talks, tax and monetary policy evolve.

Economic growth: Hard data continues to hold up better than soft data. In fact, the Citi Economic Surprise index for hard data has recently recovered, whereas soft data continues to come in below expectations.² Given this, the spread between hard vs. soft data is now near its historic wides as it is currently above its 90th percentile – going back to 2003 as seen in Exhibit 2.³

However, there is also the risk that the hard data may start to weaken from these levels given the pull forward in demand from tariff announcements. This pull forward was highlighted by imports into the U.S. rising by 41.3% on a quarter-over-quarter annualized rate, which is one of the highest readings in history.⁴ This has increased the fears of a potential supply shock as we have seen ocean freight bookings and actual container ships entering west coast ports drop since the start of the year.⁵ If growth in the U.S. does start to weaken and recession risks rise, then the S&P 500 would likely trade back down to the 4,800-5,000 level.

Trade Policy: Currently, trade talks/negotiations seem to be moving in the right direction given the 90-day pause from the administration, the preliminary trade deal with the U.K. and the recent announcement with China over the weekend. These actions show that the administration is focused on de-escalating the situation, specifically with China, indicating that we have seen a peak in tariff rates and will likely see lower tariffs than what was proposed on Liberation day.

However, it does seem like tariffs will remain in place. While the proposed reciprocal rates should come down, the administration seems to be set on a 10% across the board tariff rate as they look to raise revenue and help offset the costs from the extension of the Tax Cuts and Jobs Act (TCJA). While this “tariff-lite” policy should be a positive for markets, a 10% across the board tariff is still likely to subtract 0.7 pp from GDP growth and boost inflation by about 0.9 pp – potentially giving way to a stagflationary environment in the near-term.⁶

Taxes: One area where markets will start to shift their focus over the summer is how the extension of the TCJA unfolds. While the bill will be an extension of current policy, there are still items that could be added to support growth. This includes no taxes on tips, overtime pay and social security. In addition, many of the business provisions, including R&D expensing, net interest deductibility and write-offs for building factories in the U.S. should also support growth. Indeed, based on estimates, these provisions are expected to boost long-run GDP growth by 0.7%-1.2%.⁷

The administration has set very aggressive goals and they would like to see the extension of the TCJA passed by the Fourth of July.⁸ However, there is a risk that the extension may get delayed to later this summer or in the worst case this fall, as Republicans determine how to pay for the bill – Medicaid cuts, state and local taxes (SALT) and raising the top-income threshold are currently being debated.⁹ While we are likely to see an extension of the TCJA at some point this year, the longer it takes to pass the bill, the less likely we are to see any benefits from this policy in 2025.

Fed Cuts: If we look at the current pricing of Fed funds futures, roughly three rate cuts are priced into the market for 2025.¹⁰ However, given the uncertainty around trade and the better-than-expected hard data, there is a risk that the Fed remains on hold. Based on recent commentary, the next Fed cut could be pushed well into the second half of the year – the first full cut is now priced for September.¹¹ This is important because when the Fed started cutting rates in 2019 – insurance cuts – this supported markets for the remainder of the year.

However, if labor markets do start to weaken, this could bring forward the Fed cuts. For the time being, labor market data has been holding up well as nonfarm payrolls have expanded this year and jobless claims remain low. Nevertheless, it is projected that tariffs could boost the unemployment rate by 57bps this year.¹² Therefore, if the Fed is cutting in response to labor market weakness, this would be a less favorable environment for equity markets.

While these four catalysts should be supportive, they also present very binary outcomes for markets. Given the range of outcomes that may need to be priced in, we think it is important for investors to focus on areas where they have conviction.

Areas where we have conviction in the ongoing period of uncertainty

Despite the recovery in risk assets, as highlighted above, the backdrop remains quite uncertain. But there are three areas where we maintain our conviction and we believe could serve as key portfolio allocations. These areas include structural themes such as AI and Infrastructure as well as a continued preference for income in portfolios – via defensive sectors and Private Credit.

AI: This theme seems to have taken a backseat after the DeepSeek news broke in late January. Despite the sell-off across the AI space in the last couple of months, commentary from several companies this earnings season continues to show the strong demand behind both the AI Power and AI Software themes.

A primary concern coming into the quarter was whether we would see cuts to the hyperscalers capital expenditures (CapEx) growth. However, we did not, as these companies largely maintained their guidance on CapEx, which is expected to grow by 39% YoY, as seen in Exhibit 4.¹³ Finally, because of the sell-off, we think there are areas of value within AI Software and AI Power. Despite a valuation reset for many of these companies, earnings revisions have trended higher, suggesting that the market is becoming more optimistic on AI monetization.

Infrastructure: There is a desperate need for our country’s infrastructure to be updated. Earlier this year we wrote about the structural opportunity set for the infrastructure asset class (link). Currently, it is estimated that $3.2 trillion will be spent annually through 2040 to upgrade roads, energy, and railways as well many other public necessities.¹⁴ With so much focus on the government’s fiscal position – deficits – we think many of these projects will be funded through private funds, which currently sit on $350 billion in dry powder.¹⁵

We also believe there are tactical tailwinds that could support Infrastructure. If inflation does remain sticky given the tariffs that have been enacted by the Trump administration, this should support the asset class, as infrastructure typically outperforms in moderate and high inflation environments, as seen in Exhibit 6.¹⁶

Income: Given the wide range of possible outcomes, we think investors can continue to count on income within portfolios. Even if the market environment continues to trend in the right direction – especially as trade deals get cut – uncertainty remains elevated. Therefore, we think it makes sense for investors to “get paid to wait out the market volatility.”

In public markets, we favor defensive sectors such as real estate and utilities, which have attractive dividend yields of 3.39% and 2.87%, respectively.¹⁷ In alternatives, we continue to favor private credit, which has been able to deliver relatively consistent returns. Historically, private credit has generated an average annual return of 9.5% over the last 20 years.¹⁸ With a current starting yield of roughly 11%¹⁹ , we think this could provide quite a buffer for not only the asset class, but also investor portfolios.

Private lenders should also benefit from banks pulling back from lending because of policy uncertainty and the macroeconomic outlook. With Private Credit GPs sitting on over $200 billion of dry powder, seen in Exhibit 7, many of these firms should be able to step in and provide capital for deals that are being put on pause.²⁰

With the potential for a wide distribution of market outcomes, we believe investing in high-conviction near-term income opportunities could help support portfolios. At the same time, an allocation to more structural themes like AI and Infrastructure could continue to perform well despite the policy uncertainty coming out of Washington D.C.