Will it All Work Out in the End?

While the dust has settled somewhat on the ‘Liberation Day’ turmoil, it still seems too soon for market commentators to draw lessons from the episode. The S&P 500 ended April down less than 1%, recovering strongly from the sharp declines seen in the trading days following the tariff announcement. This rebound came after US President Donald Trump implemented a 90-day pause on tariffs for all trading partners except China and softened his rhetoric (if not his actions) towards China.

But that doesn’t mean we’re out of the woods. The 90-day pause may simply defer the question of global tariffs to early July, while the interplay between sector-specific and broader-based tariffs remains unclear. A subtle but important question now is whether Trump has taken any lessons from this episode or whether he has become even more inclined to make bold announcements, only to revise them days later. If it is the latter, it suggests that 'policy volatility', a much-used euphemism for unpredictable economic leadership, is likely to remain elevated for the foreseeable future.

Regardless of the actual impact of tariffs, which could be severe, the uncertainty alone can have real economic consequences, as companies may delay or alter investment plans – as a US company, would you build a new factory in Asia right now?

Throw in a persistently sticky inflation picture – itself possibly made worse by tariffs – and a weak US consumer, and one has all the ingredients for an economic slowdown. And while sell-side estimates for earnings growth tend to lean on the optimistic side at the best of times, the current projection of 11% earnings growth over the next 12 months for the S&P 500 seems positively Panglossian.

Don’t count on central banks

Most commentators have wrongly forecast a recession at least once or twice since COVID, which explains the understandable hesitation to do so again. However, in my view, the central expectation should be for downside earnings surprises over the next few earnings seasons.

This weakness could be all the more persistent if tariffs do stoke higher and stickier inflation, thereby limiting central banks’ scope to react to an economic slowdown. If this is correct, those of us accustomed to central banks stepping in to bail out stressed corporate balance sheets, as seen in nearly every crisis of the last 20 years, may be caught off guard by the impact on credit markets from any forthcoming malaise.

Higher defaults and lower recovery rates could be on the cards for the next 12 months, which makes the relatively muted response in High Yield credit spreads during the worst of April’s volatility all the more puzzling.

All of this presupposes that there isn’t another left-field announcement from the White House. Several potential catalysts for further volatility remain on the table, including challenging the independence of the Federal Reserve, withdrawing support for Ukraine in a way that grants Russia a perceived victory in the conflict, and seeking to impose oversight on non-US assets and territories such as Greenland and the Panama Canal.

Collective complacency

Another key concern is the US debt mountain continuing to grow without a long-term fiscal plan to bring it under control. Under previous administrations, the idea of the US writing off debt – effectively defaulting – would have been unthinkable. However, given the challenges DOGE has faced in lowering federal spending, the possibility of Trump focusing attention on the debt itself cannot be entirely dismissed.

All this raises broader, long-term questions about the stability of the status quo: the resilience of the US dollar as the global reserve currency and the role of the US as a world leader. Despite significant asset price moves in equities, credit, and government debt over the past two months, there’s a persistent, collective complacency and a view that things will ultimately work out. The remainder of this year should provide clarity on whether that assumption is justified.

Key drivers of hedge funds' performance: An early April snapshot

Equity Long/Short (ELS):

• In late April, most global equity indices staged an impressive recovery after extreme tariff-induced losses earlier in the month. Throughout April, equities were driven primarily by sentiment around top-down macro factors rather than bottom-up fundamentals
• Earnings season has kicked off and the market response to earnings is somewhat in keeping the above. S&P companies, those beating earnings expectations are generally not being rewarded as much, while those missing expectations are underperforming more than average on the next trading day. That said, Goldman Sachs reports that long alpha has been stronger in the fundamental ELS space, with shorts contributing positively in the systematic space
• Performance across ELS held up in April, despite some sharp drawdowns to start the month. Regionally, European ELS managers led the way – especially those with exposure to defence names – while Asian ELS managers had a weaker month. From a directionality standpoint, managers with higher beta experienced higher extremes and volatility versus market-neutral managers
• There have been signs of respite in equity flows as funds turned net buyers of global equities following about two months of net selling activity. Much of this has been driven by short covering rather than long buying, and this has been consistent across regions

Credit:

• April was an extremely volatile month for risk assets driven yet again by tariffs-related headlines. US high yield (HY) credit spreads were wider for the month and leveraged loans were weak. Primary markets were largely shut while HY bond and leveraged loan funds saw outflows. There were also some failed liability management transactions during the month and banks were stuck with a few hung deals
• Corporate credit managers were mostly negative in April, with a few exceptions. Higher-beta high-yield credits underperformed, while credit-sensitive convertible bonds and American Depositary Receipt (ADR) names cheapened. Portfolio-level hedges contributed positively for some managers. Capital structure arbitrage positions held up reasonably well, though certain stressed/distressed credits and reorganisation equities underperformed
• Credit spreads widened across most securitised product sectors, leading to negative returns as mark-to-market (MTM) losses more than offset the carry for the month

Relative Value:

• Despite the turbulent equity markets, Relative Value held up well, particularly market-neutral strategies like Merger Arbitrage. Merger spreads widened considerably post-'Liberation Day', but very quickly reverted to previous levels. The dislocation was particularly short in European names
• While deal activity in the US has slowed, Europe has seen stable activity, with a notable shift towards share-for-share deals, which is typically a response to market volatility. In Europe, there is also a trend towards minority buy-outs and founder/insider-led bids
• One large announcement was made by two Swiss insurers who indicated they were merging – both firms have a market cap of approximately US$10 billion
• A significant event supporting Japan’s corporate governance theme, Toyota Motor proposed a US$42bn, 40% premium buyout of Toyota Industries, with the goal to simplify its corporate structure, which has intricate cross holdings
• Stressed event credit names came under pressure amidst the tariff and recession fears, as well as profit-taking from post-restructuring situations, where recently restructured companies that had been performing well saw investors lock in gains

Macro:

• April was a positive month for Discretionary Macro strategies
• Significant volatility at the beginning of the month opened strong tactical opportunities while also benefitting trades expressed through options. Defensive trades in equities and a received bias in rates generally worked well during the initial market shock, while steeper yield curves generally worked in favour of macro positioning, except for Japan, where curve flattening caused losses. General weakness in longer-dated US Treasury bonds proved difficult for a handful of managers that focus on relative value in swap spreads and yield curves
• Emerging market strategies struggled earlier in the month as credit spreads widened and emerging market foreign exchange (EM FX) weakened. However, the announcement of a new International Monetary Fund (IMF) deal in Argentina and a broader recovery in risk sentiment helped returns improve as the month progressed

Quant:

• Security-selection-focused quantitative strategies continued their strong performance in April, with the headlines around tariffs having little to no adverse impact. Profit and loss (PnL) generation was notably steady throughout the month, with low levels of volatility in the reported figures
• Statistical arbitrage strategies have been the most profitable, with both short- and medium-term signals seemingly functioning well. On a regional basis European and North American sub-strategies both appear to have generated positive returns
• Factor-based equity market neutral approaches are also up for the month. Those with higher allocations to momentum and quality benefited from strong positive performance, whereas value-biased strategies have struggled
• Dispersion in credit markets picked up following the US tariff announcement; this appears to have led to some short-term pain for quant credit managers. However, as the month has progressed these strategies have turned positive

Systematic Macro:

• The early month market turbulence has not been kind to trend-following strategies, with only very short-term focused players delivering positive returns. For context, the Société Générale CTA CTA index is down 5.0% and the Société Générale Trend index is down 5.6% through 29th April. Strategies went into ‘Liberation Day’ with long non-US equity, long US dollar, long commodities and mixed bond positioning. The risk-off sentiment led to losses in equities and commodities, while the potential negative repercussions for the US economy meant the US dollar was not seen as a safe haven asset and sold off accordingly – causing material losses for some programmes. Positioning has subsequently shifted with most strategies now neutral or short US dollar, long fixed income, slightly short commodities and short equities
• Alternative trend-following strategies also faced challenges. Performance was affected by similar themes seen in traditional programmes, with short fixed income and long mortgage-backed securities (MBS) and credit positions being the primary detractors. Early April long US dollar positioning against a mix of currencies also weighed significantly on returns
• Systematic macro strategies with higher allocations to trend models struggled the most during the month, though other signals were also troubled by the unprecedented upheaval in trade policy. FX and commodity exposures have proved most painful with more balanced long and short fixed income positions generating positive returns for some

On-the-radar:

• Short term: Trump. Tariff announcements remain in flux, and the shift towards sector-specific tariffs could prove as damaging as the broad-based levies announced on 'Liberation Day' before being rolled back
• Medium term: Trump. What follows tariffs? The US President has shown a willingness to disrupt established norms, with a range of other economically sensitive policies likely on his agenda
• Longer term: Fundamentals. The balance between inflation, growth, and policy remains the central challenge for central banks. Economic softness combined with persistent inflation would pose a challenge not seen in most of our careers