Are investors underestimating upside risks to markets?

By Audrey Goh, Head, Asset Allocation, CIO Office

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Wealth BuildingInvestment StrategiesStocks, ETFs & Trading

30 July 2025  I  8 mins read

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 dollar, and lower yields — seems to be holding. Perhaps it’s time to pause before fading it. Investors used to say: “don’t fight the Fed”. In today’s environment, it might be more apt to say: “don’t fight President 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% 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, leaving room for positive earnings momentum to continue.

Although the S&P 500 index earnings growth was estimated to slow to around 5.8% year-on-year in Q2 at the start of the earnings season (based on LSEG I/B/E/S estimates), this deceleration was well-telegraphed and is likely already in the price. From here, the consensus anticipates a notable acceleration in earnings, with Q3 earnings growth estimated at 8.4%.

Combined with modest US economic growth forecasts that set a low bar for upside surprises, this creates precisely the kind of setup markets tend to reward.

2. Liquidity and positioning leave room for risk taking

Meanwhile, global liquidity continues to expand. Rising money supply is helping 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 equities, suggesting 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 strategy:

• Stay invested in the growth theme: Staying invested remains critical, as missing even a handful of strong days in the market can significantly reduce long-term returns.
• Diversify thoughtfully: While US equities have driven recent performance, a weak USD environment could create opportunities in ex-US equities, particularly Asia ex-Japan, where we are Overweight in our global equities allocation.
• Balance discipline with flexibility: Avoid chasing returns indiscriminately, but ensure your portfolio isn’t overly defensive in an environment where the path of least resistance may still be higher.
• Reassess 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.

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