Are investors overlooking the upside risk in markets?
Stronger earnings, improving market breadth, and modest investor positioning could keep markets advancing
[SINGAPORE] Equity markets seem to have taken recent tariff headlines in their stride. So far, investors appear to be treating tariffs as a one-off impact, with little evidence that it will evolve into a broader trade war.
Remarkably, the “Trump trade” – higher equities, a softer US dollar and lower yields – seems to be holding. Perhaps it’s time to pause before it fades. Investors used to say: “Don’t fight the Federal Reserve.” In today’s environment, it might be more apt to say: “Don’t fight President Donald Trump.”
This is not to suggest that risks have disappeared – far from it. Recession fears, geopolitical tensions, and higher-for-longer interest rates still dominate the narrative. As investors, we are conditioned to focus on what could go wrong. Prospect theory explains why: We feel the pain of losses much more acutely than the satisfaction of gains.
However, markets often work in the opposite way. They climb walls of worry and recover faster – and further – than most expect. After a strong start to 2025, with the Nasdaq-100 index up 9 per cent in the year to date and the S&P 500 not far behind, the debate now turns to whether this rally has legs.
What’s often overlooked is the potential for upside surprises – factors that could keep markets advancing despite widespread caution.
1. Earnings and growth momentum could surprise: Corporate earnings are the ultimate driver of equity markets. Two weeks into the second-quarter earnings season, early results have been encouraging. A large majority of companies are beating expectations by a healthy margin, well above historical averages. This suggests that analysts may have been too cautious in their forecasts, thus leaving room for the positive earnings momentum to continue.
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Although the S&P 500 index earnings growth was estimated to slow to around 5.8 per cent year on year in Q2 at the start of the earnings season (based on LSEG IBES Estimates), this deceleration was well-telegraphed and is likely already in the price. From here, the consensus anticipates a notable acceleration in earnings, with third-quarter earnings growth estimated at 8.4 per cent.
Combined with modest US economic growth forecasts that set a low bar for upside surprises, this creates precisely the kind of set-up that markets tend to reward.
2. Liquidity and positioning leave room for risk-taking: Global liquidity continues to expand. Rising money supply is helping to offset the drag from trade tensions and geopolitical shocks, providing a supportive backdrop for risk assets.
Investor positioning also points to caution rather than exuberance. Many institutional investors remain underweight on equities, which suggests that there is room for re-risking if confidence improves. Hedge funds, in particular, have scope to re-leverage, with exposures far from extreme. This “dry powder” could become an additional catalyst should momentum build.
3. Momentum is self-reinforcing: Momentum remains a powerful and often underappreciated force in markets. As momentum builds, it can attract further inflows from investors wary of missing out, creating a self-reinforcing cycle. This behavioural dynamic can extend rallies beyond what fundamentals alone might suggest.
Portfolio implications for investors
For investors, the key takeaway is to recognise that risks are not only on the downside. There is scope for upside risks as well, such as stronger earnings, improving market breadth, and modest investor positioning. Given this, we would adopt the following strategies:
* Staying invested in the growth theme: This remains critical, as missing even a handful of strong days in the market can significantly reduce long-term returns.
* Diversifying thoughtfully: While US equities have driven the recent performance, a weak US dollar environment could create opportunities in ex-US equities, particularly Asia ex-Japan, where we are overweight in our global equities allocation.
* Balancing discipline with flexibility: Avoid chasing returns indiscriminately, but ensure one’s portfolio isn’t overly defensive in an environment where the returns on the path of least resistance may be still higher.
* Reassessing allocations: For those underweight equities, incremental re-risking may be worth considering, particularly as macroeconomic and earnings momentum improve.
The bottom line
Markets are designed to recover. Investors, however, are conditioned to doubt them.
This persistent scepticism – whether about valuations, leadership concentration, or macroeconomic headwinds – is precisely what allows rallies to extend. While risks to the downside remain, the case for potential upside is also strong and should not be overlooked.
The critical question is whether investors are focusing too much on what could go wrong and missing what is quietly going right.
The writer is head of asset allocation at Standard Chartered Bank’s wealth solutions chief investment office
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