Cross-currents: Macro resilience vs policy concerns. The S&P 500 has staged a remarkable rebound since the trough of the “Liberation Day” sell-down, fuelled no less by Trump’s volte-face on tariffs threats and subsequent extension of timelines. More importantly, broad-based macro resilience and a “Goldilocks” trading environment also gave risk sentiments another boost. As we head into the final quarter of 2025, we expect the S&P 500 to navigate the cross-currents of stable macro conditions and rising policy concerns – especially those pertaining to Fed independence.

• Macro resilience: Macro momentum remains upbeat, as evidenced by the US economic surprise indicator, which has been trending north since end-June. ISM and retail sales numbers show no signs of an extreme slowdown in economic activity, while the Atlanta Fed GDPNow is forecasting growth of c.3% – in-line with growth trend since 2022. These stable macro conditions are, in turn, translating into an optimistic earnings outlook, with analysts forecasting 12% growth for 2026, supported by a mixture of top-line revenue growth and EBITDA margin expansion. The US cyclicals vs defensive ratio suggests that investors are pricing in further rebound in economic surprises.
• Policy concerns: While tariff-related policy concerns have dialled down significantly, a new headwind has emerged on the horizon – the potential erosion of the Fed’s independence. Trump’s attempt to remove Fed Governor Lisa Cook and bend monetary policy to his will is unprecedented. If left unchecked, it will undermine the central bank’s hard-won credibility and threaten the dollar’s status as the world’s reserve currency. The widening divergence between US Treasury 30Y and 2Y yields reflects rising investor concern over policy risks in the US, including budget deficits and de-dollarisation. Further erosion of the Fed’s independence will only deepen this divergence, pushing long-term yields higher while plummeting the dollar.

The start of a new Fed easing cycle: What to expect? It is common knowledge that Fed monetary easing will be positive for US equities as valuations get boosted by a lower discount rate (using the UST 10Y as a proxy). Based on the futures market, the central bank is expected to cut rates five to six times by end 2026. But while the Fed can control the short end of the curve, the long end is dictated by markets – and today, we are in a very different cycle compared to yesteryears.

Rising concerns over US fiscal largesse and policy chaos have kept long-term yields elevated despite talks of impending rate cuts. Given limited success in cutting back on government spending, we expect these headwinds to linger for the foreseeable future. This, in turn, will keep longer-term bond yields elevated and dampen the effectiveness of Fed monetary easing, both on the economy and financial markets.

Watch your blind spots: Valuation and earnings risk. Since the trough of “Liberation Day”, the S&P 500 has rallied sharply as the market priced in falling policy risks and impending monetary easing. But the optimism is unfortunately not matched by fundamentals as the earnings forecast remains flat, contributing to the spike in valuations. At 24.3x forward P/E, valuation for the S&P 500 is edging close to the +2 SD expensive mark. Meanwhile, earnings momentum is showing signs of tapering off, particularly in the S&P 500 ex-technology space. Even within the technology space, unprofitable companies are expected to remain in the red through 2026.

Separately, we are closely watching how tariffs will impact earnings in the coming quarters. We have long maintained that the tariff income which the US government currently enjoys must be funded somewhere. Should importers absorb some of the pain, it will translate to earnings downgrades – a trend already evident among US retailers. For instance, Walmart has said that US tariffs are driving up costs and squeezing profit margins this year.

4Q25 US Sector Strategy – Position for Fed easing

Ride the Fed easing cycle with technology plays. Performance for our sectoral allocation calls was a mixed bag in 3Q25 (as of 5 Sep). While our overweight basket (+4.1% on average) outperformed the neutral basket by 1.7 %pts, it nonetheless underperformed the underweight basket by 0.8 %pts. Within the overweight calls, communication services and technology performed well at +11.5% and +5.8% respectively. However, consumer staples and healthcare were a significant drag on performance.

The robust performance for the underweight basket is attributed to the consumer discretionary sector. Our original assumption of a consumption slowdown due to new immigration policies, weak affordability, and DOGE-related job cuts did not materialise as US consumers proved to be more resilient than expected. As we head into 4Q25, we advise investors to position their sector allocation for the Fed easing cycle. We are making the following portfolio switches:

• Upgrading consumer discretionary to neutral: US consumption is expected to receive a substantive boost from Fed rate cuts as consumers borrow more cheaply to fund purchases. More importantly, high growth, technology-related companies within the sector (such as Amazon) tend to perform well during periods of policy accommodation. This, coupled with positive impact from the extension of tax cuts under Trump’s “One Big Beautiful Bill” Act, suggests that a more neutral portfolio stance is warranted.
• Downgrading energy to underweight: Oil prices are expected to stay subdued in the current range amid: (1) OPEC+’s plan to unwind more than 2.2mn barrels per day of supply cuts by September and (2) a muted geopolitical risk and sanctions environment. Given a widening demand-supply gap, we have lowered our forecast for average WTI crude oil price for 4Q26 to USD61/bbl (from USD65/bbl), which does not auger well for the outlook of energy stocks in the S&P 500.
• Downgrading consumer staples to neutral: With growth stocks being the geared beneficiaries of a Fed rate-cutting cycle, we see limited opportunities for consumer staples companies to outperform in 4Q25. Hence, a neutral call is more appropriate at this juncture.

Ride the bifurcation wave: Increase exposure to US technology and bring overall US equities exposure to neutral. The robust 2Q25 US earnings season saw 80% of companies reporting positive earnings surprise, while 70% registered earnings growth. But despite the robust headline number, huge bifurcation exists. Case in point: earnings growth for technology-related sectors (technology and communications services) averaged 18% in 2Q25. However, sectors outside of this group registered an average growth of only 0.8%. We believe that this bifurcation trend will persist as tariff headwinds will have a bigger impact on traditional industries with thin margins and low bargaining power. Technology companies are better positioned to ride the new normal of heightened geopolitical and policy tensions. From a portfolio construction standpoint, we advocate investors to increase exposure to US technology and bring overall US equities exposure to neutral.