Apr 17, 2025
• US announces reciprocal tariffs, higher than expected.
• These tariffs may slow growth, raise near-term inflation, and risk tipping the US into a recession.
• India remains relatively insulated but could be impacted by a US slowdown and any second order impact.
• With the tariff event behind us, we plan to reduce our equity underweight by gradually adding large-caps via weekly SIPs/STPs over the next 2–3 months.
• We prefer large-caps over mid/small-caps given more reasonable valuations.
Anything But Liberation Day
President Trump introduced “reciprocal” tariffs on the rest of the world on his self-proclaimed “Liberation Day.” However, these tariffs, while broader and steeper than anticipated, have proven anything but liberating for the U.S. economy. Global equity markets, led by declines in U.S. stocks, experienced a sharp sell-off. U.S. government bond yields initially dropped but later rallied significantly, reflecting rising concerns over domestic economic growth. On 09 April, in response to surging bond yields, President Trump suspended tariffs for 90 days on all nations except China, a move that triggered a sharp rebound in equity markets. Meanwhile, tensions between the U.S. and China have intensified, with both sides escalating the trade war through retaliatory tariffs. Going forward, the level of retaliation from trade partners and their willingness to negotiate settlements will be crucial in shaping market sentiment.
Source: Bloomberg, Sanctum Wealth
Above returns are price returns in local currency terms
While India is less impacted from tariffs proposed amid exemptions for pharma and IT exports, certain sectors like textiles and apparel, gems and jewellery, auto ancillaries, chemicals, and select petroleum products may still face some challenges. However, any second order impact including, a slowdown in U.S. growth, combined with a broader global risk-off sentiment, could affect both the Indian economy and markets, unless India manages to secure a trade agreement within the next 90 days.
Global Macro Update
While the U.S. was expected to impose reciprocal tariffs on global trade partners, the magnitude and scope of the measures announced took many by surprise. Effective 05 April 2025, the U.S. introduced a baseline tariff of 10% on imports from all countries except Canada and Mexico. In addition, starting 09 April 2025, higher supplementary tariffs were imposed on most major trading partners. Countries such as Cambodia, Vietnam, Bangladesh, Sri Lanka, and Thailand were particularly affected. Although Canada and Mexico were exempt from the new baseline tariff, they remain subject to the pre-existing 25% tariffs from earlier policies. Subsequently, the U.S. paused these new tariffs for 90 days, giving nations an opportunity to negotiate trade agreements during this period.
Meanwhile, in response to China’s retaliation, President Trump has increased tariffs on Chinese imports to a cumulative 145%. In turn, China has raised its tariffs to 125%. This marks a significant escalation in the ongoing trade war between the two nations.
Reciprocal tariffs announced by US on its trading partners
Source: Media Reports, Kotak Institutional Equities
The recent tariff hikes represent a dramatic shift in the U.S.’s effective tariff rate, surging from just 2.4% in 2024 to several times that level. Although the U.S. has paused the implementation of new tariffs on most countries, excluding China, existing tariffs remain in place for Canada, Mexico, and specific sectors such as autos and metals. Moreover, the steep increase in tariffs on Chinese imports, a major source of U.S. imports, still pushes the overall effective tariff rate on U.S. imports above 20%. Economists predict that this increase in tariffs could lead to a short-term inflation spike of 1-2%. As rising prices reduce real disposable income, consumer spending, responsible for nearly 70% of US GDP, could fall sharply, potentially triggering a recession. Over the long term, this could lead to deflationary pressures.
Beyond the economic and inflationary impacts, uncertainty is stalling corporate decision-making. Companies may need to reconfigure supply chains and consider alternative suppliers in less developed regions with weaker ecosystems. These changes will take months, leading to higher transitional costs and operational risks. Similarly setting up new factories in the US could take many months if not years and could substantially increase costs in the interim.
The above scenario assumes that tariffs will return in their current form; however, this could change depending on the outcome of negotiations over the next 90 days. Experts also question whether the President can implement such sweeping tariff measures solely through executive order, without Congressional approval, which could lead to legal challenges.
This is all happening at a time when US growth was already slowing. The Atlanta Fed’s GDPNow estimate suggests the US economy contracted in Q1, likely due to inventory buildup ahead of the tariff announcement. Personal consumption growth has slowed, and consumer confidence has taken a hit amid rising inflation concerns, although the job market remains resilient.
Altanta Fed’s GDPNow estimate for Q1 2025
shows US economy contracted
Source: Atlanta Fed, Bluechip Economic Indicators and Bluechip Financial Forecasts Atlanta Fed GDPNow real GDP estimate for 2025: Q1
Looking ahead, the global macroeconomic outlook will be shaped primarily by the trajectory of negotiations between the U.S. and its trading partners, particularly in the context of escalating tensions with China. While the U.S. administration’s proposed tax reforms and deregulation initiatives may help mitigate some of the adverse effects of the tariffs, their implementation is contingent on Congressional approval, a process that may be protracted. In contrast, the tariff measures are set to take effect now, potentially creating near- term headwinds.
Overall, in its current form post the pause, the new US trade policy could significantly affect growth and lead to higher inflation. The situation remains fluid as negotiations will now begin with US trading partners. Meanwhile investors and corporations must prepare for heightened uncertainty, supply chain disruptions, and increased geopolitical tensions in the interim.
In Europe, the German parliament voted to ease constitutional debt limits, allowing the country to increase spending on infrastructure and defence. Fitch Ratings expects an additional EUR 900bn to 1tn (21%-23% of 2024 GDP) in government expenditure over the coming years, including a proposal to establish a EUR 500bn infrastructure fund. The increased fiscal spending in Germany is expected to have a ripple effect across the Euro area, potentially prompting other governments to follow suit. While the economic benefits are expected to unfold gradually as public investment scales up, near-term growth may face pressure from the renewed uncertainty surrounding U.S. tariffs.
Germany’s spend on public investments lagged its peers
Source: LSEG Datastream, OECD, Schroders Economics Group
Last month, China’s National People’s Congress (NPC) also unveiled another fiscal stimulus plan aimed at boosting consumer and private sector confidence. The plan, totalling around 2% of GDP for 2025, is expected to help achieve the 5% growth target set by the NPC for that year. Despite its size, the plan fell short of expectations. Although China’s exports to the US have declined, with total tariffs on China is now 145%, further fiscal and monetary support will be needed to assist exporters.
Global Market Outlook
Global markets, led by US equities, saw a sharp correction following the tariff announcements on April 2, 2025. Both the Nasdaq and S&P 500 dropped more than 10% in just two days after the announcement. US bond yields and the US dollar both declined initially. While President Trump did not appear worried about equity market’s reaction, the sharp increase in bond yields in subsequent days may have prompted the US to pause tariffs for 90 days.
U.S. equities have nearly erased earlier losses, with the Nasdaq surging over 10% in a single session on April 9, 2025. Despite the rebound, equity valuations remain elevated, trading at over 20x forward earnings compared to a long-term average of around 17x. However, earnings growth is likely to face headwinds from the impact of tariffs, regardless of potential progress in negotiations over the next 90 days. The ongoing uncertainty surrounding trade policy complicates corporate decision-making and poses a risk to earnings. Historically, equities have underperformed in stagflationary environments, a scenario that remains possible if tariff structure currently are implemented. Moreover, the U.S. has long benefited from a perception of stability, contributing to a lower risk premium on its financial assets. Prolonged policy uncertainty could jeopardize this status over time. As a result, we recommend diversifying away from U.S. equities and considering opportunities in other markets.
After a strong start to the year, European equities have corrected more than 10% amid tariff concerns. However, with European governments looking to loosen fiscal policy and equity valuations remaining reasonable, investors may look to rotate from U.S. equities into European markets despite the prevailing uncertainties.
Chinese equities have been among the top performers this year, fuelled by strong gains in technology stocks. Policy stimulus, regulatory easing in the property sector, and support for private enterprises have boosted investor sentiment. However, Chinese equities also corrected following the tariff announcement. Looking ahead, while export-oriented sectors face challenges due to higher tariffs and the property sector continues to struggle, China’s technology sector may continue to perform well. Government support could be crucial for assisting export-driven companies.
As the trade situation evolves, with varying levels of retaliation and negotiation, global equities are likely to remain volatile, making diversification crucial.
Markets now anticipate a nearly 100bps rate cut by the end of the year, up from the previous expectation of 50-75bps before the tariff announcement. Currently, concerns over economic growth seem to outweigh fears of inflation. However, if inflation reaches 4% or higher, the Fed will face a delicate balancing act between managing inflation and supporting growth. Amid expectations of rate cuts, bond yields initially declined. However, the Fed is dealing with policy uncertainty rather than a sharp decline in economic growth. Higher rates are not a deterrent to economic activity, but policy uncertainty is. Hence, the Fed may decide to take a “wait and see” approach before acting, rather than using all its monetary tools immediately.
Market pricing in more than 50% probability of 100bps or more cut by Dec’25
Source: CME Group, CME FedWatch
India Macro Update
Even if the 26% tariff on exports from India to the US is implemented, India is likely to be less impacted. Goods exports to the US account for just about 2% of India’s GDP, and key sectors like pharma and IT services are exempt from tariffs. However, items like apparel, gems and jewellery, auto parts, and electronics may be affected. India’s competitors, such as Thailand, Vietnam, and Bangladesh, face even higher tariffs currently, making India relatively better off. A slowdown in US discretionary spending, leading to slower global growth, is likely to be a bigger concern, especially for IT firms. Additionally, the interconnected nature of global trade means India could still feel second-order effects from these tariffs if implemented. Therefore, India may not be entirely insulated if the situation escalates.
India not as impacted by US tariffs
Source: Ministry of Commerce, Kotak Institutional Equities estimates FY2025 data is annualized based on 9MFY25 actual data.
India’s policy stance has turned supportive post the union election. Both state and central government have increased capex post the election. The government also provided tax sops in the budget effective from this fiscal year. The RBI under its new leadership has injected liquidity into the system, resulting in a shift from deficit to surplus banking liquidity. It has also lowered risk weights for NBFCs and microfinance institutions and has already cut rates once.
However, high frequency data is still somewhat mixed. While GST collection for Q4FY25 averaged better than Q3FY25, the collection de-grew month on month in February 2025 before rebounding in March 2025. E-way bills, auto sales and PMI also remained somewhat mixed but better than Q3FY25. The GDP growth in Q4FY25 is expected to improve slightly but may still miss the 7% mark. We believe it may take some time for the full benefits of the policy actions to be visible in the data.
India’s CPI inflation has been trending down after falling to below 4% in February 2025. Lower food prices, particularly vegetables and pulses, have been supportive. Economists expect the CPI to remain manageable amid stable core inflation and strong crop production.
As expected, the RBI cut rates by 25 bps in its latest monetary policy, utilising available headroom. It also revised its GDP growth forecast for FY26 downward from 6.7% to 6.5%, while lowering the CPI inflation estimate from 4.2% to 4%. The RBI also shifted its policy stance from neutral to accommodative, signalling a focus on supporting growth while remaining vigilant on inflation. The central bank also reaffirmed its commitment to proactively provide liquidity as needed.
Indian Market Outlook
Indian equities rebounded strongly in March 2025, with the Nifty index gaining over 6%. However, in recent days, the market has given up all those gains. While mid- and small-cap stocks outperformed in March, they have experienced sharper declines in April. Although India is expected to be less directly affected by the tariffs, there may still be indirect consequences, including the potential for a broader global risk-off sentiment. In the event of a full-scale trade war marked by retaliatory measures from multiple countries, the situation could escalate, impacting economies and sectors across the board. That said, this remains a tail- risk scenario and is not our base case.
Source: Bloomberg, Sanctum Wealth
Indian corporates are about to begin announcing their Q4FY25 earnings results (for the quarter ended March 2025). Nifty earnings growth is expected to be modest, with a year-on-year increase of around 2%. For the full FY2025, Nifty 50 earnings growth is likely to be around 5%. Earnings growth for FY26 is projected to improve to 12-14%, although this could face downward revisions if Q4FY25 results fall short of expectations. While midcap and smallcap earnings are anticipated to be stronger, they have experienced more significant cuts to earnings estimates since September 2024 and could see more cuts in the coming quarter. We believe the benefits of policy support will only start to become visible in earnings from Q1FY26 onwards.
Mid and Smallcap have seen bigger cuts in EPS estimates since Sep’24
Source: Bloomberg, DSP Netra Cut in FY25 and FY26 Bloomberg EPS estimates since Sep 2024 till Mar 2025
After being net sellers in January and February 2025, foreign investors turned net buyers in March. However, so far this month, they have already sold nearly ₹22,000 crore in the cash equity markets. On the other hand, domestic institutional investors have consistently remained buyers throughout the correction. Flows into mid- and small-cap mutual funds have also continued during this period. As a result, we haven’t yet seen any capitulation from mutual fund investors.
Nifty valuations are now in line with historic averages. The 12-month forward PE for Nifty 50 stands at 18.1x, compared to the 10-year average of 18x. However, mid- and small-cap valuations remain above their historical averages. Midcaps are trading at about a 15% premium to the 10-year average, while small caps are priced at nearly a 30% premium. With the earnings gap between large-cap and mid/small-cap stocks narrowing, these valuation premiums for mid and small caps appear increasingly difficult to justify.
Source: Bloomberg, Sanctum Wealth
Despite the 90-day pause, uncertainty around U.S. tariffs is expected to linger, as the U.S. undertakes the complex task of bilateral negotiations with multiple countries within a limited timeframe. We anticipate greater visibility on this front over the next few months. Against this backdrop, we believe it is prudent to gradually increase equity exposure by initiating weekly SIPs/STPs into large-cap stocks over the next 2–3 months, thereby reducing our current underweight stance.
Fixed Income Outlook
Indian bond yields declined in line with global bond yields. The 10-year India government bond yield fell below 6.5% for the first time since 2021. Domestically, the system liquidity has improved with RBI conducting open market operations (OMO) and FX swap auctions. The core liquidity is now positive, and the RBI has already announced a robust OMO calendar for April 2025 which should continue supporting liquidity. The CPI inflation is also trending lower, aided by a decline in food prices, and now sits below the RBI’s central target of 4%. Notably, foreign investors have remained net buyers of Indian debt, despite the broader tariff-related uncertainties.
RBI OMO purchases has improved system liquidity
Source: Bloomberg, Sanctum Wealth
The April monetary policy outcome was broadly in line with our expectations. We believe the RBI is likely to maintain a wait-and-watch stance and is unlikely to cut rates by more than 25–50 basis points in the current cycle unless global growth weakens materially due to prolonged tariff pressures. As a result, we do not anticipate significant gains from aggressive duration positioning and continue to recommend aligning investment horizon with portfolio duration.
Gold Outlook
Leading up to the tariff announcement, gold was one of the top performing asset classes this year. However, prices have since corrected, with USD gold trading below the USD 3,000/oz mark. This pullback may be attributed to profit-booking and liquidation of positions to meet margin calls or raise cash. Despite the short-term decline, we believe the fundamental outlook for gold remains intact. The metal typically performs well in stagflationary environments. Moreover, global central banks, one of the key drivers of gold demand over the past two years, continue to be net buyers. Finally, in periods of heightened uncertainty, such as the current tariff-related tensions, gold often serves as a preferred hedge and could continue to find support.
Global central banks have remained buyers of gold
Source: Bloomberg, Sanctum Wealth
As gold prices rise and equities become relatively more attractive, or as uncertainty begins to ease, we plan to gradually shift funds from our gold overweight position into domestic equities.