View from the very top: There is a path out of current uncertainty. 2025 to-date has had no shortage of surprises, but we may currently be close to peak tariff confusion. An optimistic outlook would point to the scope for trade deals, a Presidential administration that may be more willing to listen and a refocus on priorities other than tariffs. The banking system remains sound and consumer balance sheets appear in good health. Even if the Federal Reserve looks unlikely to act in the near-term, there remains significant monetary flexibility. Of course, some damage has already been done in terms of both the undermining of credibility of the US and the impact to its economy. An economic slowdown has probably begun, and America may experience a (technical) recession. Equities typically recover before the macro data, but if there is one crucial lesson from the turmoil of the past month then it must be that thoughtful diversification in asset allocation matters more than anything.
Asset Allocation:
- Equities: Intra-year corrections within equity markets are normal. The MSCI World Index’s peak-to-trough fall of ~17% through to April 8 looks unremarkable in the context of other drawdowns such as those of the pandemic or the dotcom bust. More impressively, the market has since rebounded, with the MSCI World less than 7% below its all-time high. Nonetheless, risks to earnings estimates are currently weighted to the downside, given current market uncertainties and a slowing economy. An anti-concentration trade has been playing out since the start of the year, and we anticipate further diversification away from mega-cap US tech towards other regions (e.g. Europe and Japan) as well as market segments (small and mid-caps). Active managers should be well-placed to benefit from market dislocations.
- Fixed Income/Credit: Many market assumptions, including the perceived safety of US Treasury debt, have been questioned over the past month. Nonetheless, 10-year US Treasuries yield almost the same now as they did at the start of April. Contradictory forces remain at work: a lower growth outlook might imply lower yields, while more persistent inflation would keep yields elevated. Uncertainty in the outlook is reflected via widening credit spreads, especially in high yield. Our approach within the space is one of caution especially around duration.
- Currencies: The move in the Dollar Index – at its lowest since early 2022 – represents a reversal of long-time Dollar dominance. De-dollarisation is an understandable strategy given the current policy stance of the US administration. Both the Swiss Franc and Japanese Yen are benefiting from their safe haven status. Over time, we expect mean reversion.
- Gold: The precious metal is enjoying a golden age, having outperformed almost every other asset class in the last year. Although we have been long-standing gold advocates and are pleased to see it continuing to achieve new nominal highs, we do note that the gold trade has become increasingly consensual. Nonetheless, Central Bank buying activity (as an additional hedge away from Dollars) is likely to remain supportive in the near-term.
- Alternative Assets: We believe this asset class can provide another useful form of diversification. Many alternative assets offer collateral-based cashflows. At the same time, they benefit from an illiquidity premium too. We advocate being highly selective across this broad and diverse area, favouring differentiated and uncorrelated strategies.
Few months have been quite like the one that has just passed. Consider the constant barrage of news flow and profound uncertainty it has wrought. Massive intra-day swings in almost all asset classes speak to inevitable nervousness. However, step back from the noise and many markets ended April broadly in the same place where they started the month. The yield on 10-year US Treasury debt is just 4 basis points lower, while the MSCI World Index closed up 0.7% (in US Dollar terms).
Despite these headlines, investors should strap themselves in for more volatility. In this environment, it is important to keep calm. Diversification is a logical strategy, especially when combined with disciplined risk management. From every chaos, clear opportunities will emerge too. To navigate through this complex and arguably unprecedented environment, consider the following five points –
1: All market crises are messy and complex; each is different
What stands out from the current period of market dislocation in marked contrast to others such as September 11, the Great Financial Crisis or the COVID-19 pandemic is that this one is self-inflicted, or policy-induced. To the extent that there is hope, the implication is that it can also be reversed. As investors have come to realise, the Trump administration’s narrative has been one of incoherence and constant U-turns. With such erratic leadership, seldom has uncertainty been this high.
It is hard to dismiss the credibility impact to the US. Events from the past month (or arguably since Donald Trump became President) have made America look both weaker to its rivals and less reliable to its friends. Investors have seen things that they cannot unsee. Even if the President’s agenda is clear – at least to himself and his team – it is creating massive confusion in financial markets. The response has manifested itself clearly in a capital flow out of US assets. If there is a methodology at work in team Trump, then it appears to be about re-ordering America’s place in the world. The door has been opened for the country’s financial dominance to be challenged. Investors need to prepare themselves.
2: The economy will not remain unaffected
The Trump administration inherited an economy with strong growth, 4% unemployment, positive hiring and a substantial tailwind from (AI-led) investment. Recent data demonstrate ongoing robustness, with last reported unemployment at 4.2% and inflation at 2.4%. However, these figures paint a backward-looking picture. Should tariffs be implemented, then they will be negative for growth. Uncertainty also makes it difficult for both businesses and consumers to plan.
Think of tariffs as self-defeating. They inflict economic damage on those who enforce them. Tariffs would raise prices, reduce real income, lower corporate profits and decrease economic efficiency. The poorest consumers also suffer most, since tariffs are a regressive form of taxation. Team Trump may also want to consider that since supply chains tend to be integrated, it is hard (or even impossible) to separate importers from manufacturers, in order to tax the former and protect the latter. Governments cannot override the laws of economics.
Irrespective of whether tariffs do end up being fully implemented, some of the damage has already been done. Tariff pain is contagious. Corporate optimism was declining even before tariffs were announced and is currently the lowest since 2009. The National Federation of Independent Business reported its steepest drop in expectations since the pandemic while the Fed’s Beige Book speaks to business paralysis. Consumer sentiment is at a current three-year low and weaker now than at the time of the Great Financial Crisis (all data per Bloomberg). The list goes on.
It is therefore possible that a slowdown has probably already begun and a technical recession (defined as two consecutive quarters of negative GDP growth) may be underway. The first read of US GDP for Q1 showed a 0.3% contraction in the economy. Investors should prepare themselves too for the fact that near-term economic data could worsen before improving, even if there is a change of course in policy.
3: The Fed’s role is complicated; do not expect too much
The Federal Reserve must perform a delicate balancing act. Not only are the two parts of its mandate (inflation and unemployment) in tension, but Jerome Powell needs to manage expectations appropriately. It is only natural for Central Bankers to worry about tariffs. A valid fear is that uncertainty could result in expectations becoming unanchored, particularly in terms of inflation. A scenario of stagnant growth and higher inflationary prospects – stagflation – cannot be discounted.
We are pleased to see that Jerome Powell has held his line for now. There would be little logic for the Fed to step in to intervene in the event of a more pronounced stock market pullback. Action such as an emergency rate cut might only fuel more panic. Liquidity crises might change the equation. The more profound challenge for the Fed is to resolve the dilemma of keeping rates on hold and risking a potentially deeper recession or easing but risk provoking further inflation. We see little upside in being too bold for now, given current uncertainties. Nonetheless, investors (per Bloomberg) continue to discount four interest rate cuts in the US over the next 12 months.
4: There is a path out (even without the Fed)
Were investors looking for reasons to be optimistic, then we may currently be at peak trade uncertainty. Tariff tensions are at a high watermark and could be lowered over time. All it may take is one substantial trade announcement to help restore confidence. Remember Donald Trump’s line in The Art of the Deal, “never accept the first offer.” More fundamentally, were the Trump administration to start to listen better, and the White House to improve the coherency of its communications, then market gyrations would almost certainly diminish. Certain events from the past month would be suggestive of the idea that some form of ‘Trump put’ does exist. The President may be willing to tolerate a certain amount of market and economic pain to enact his agenda, but there is a limit to that tolerance.
The good news is that the banking system remains sound and that consumer balance sheets remain in health. Project forward and it’s possible to envisage a scenario where investing prospects in the second half of 2025 look markedly better than the first. Tariff pain may be over and there might be a renewed focus on fiscal easing and deregulation. A weaker US Dollar is also supportive for the economy.
5: Buy when others are fearful
Markets almost always tend to overreact to surprising or disturbing news flow. It is in these periods that long-term wealth is often made. The ‘end of US exceptionalism’ trade has almost become consensual (per the latest Bank of America Fund Manager Survey). The debate may perhaps be better reframed by the fact that since the end of the Great Financial Crisis, US dominance has rarely been challenged. Its persistence stands out more than the recent interruption. We note the widest dispersion in S&P 500 Index price targets this century (per Bloomberg) – surely an opportunity if ever there were one. Do not forget, in the event of any correction or recession, equities almost always recover before the macro data.
Perhaps the more instructive lesson from the past month’s major mood swings is to remember the importance of diversification. Irrespective of one’s views on American exceptionalism, the current moment stands out to us as a bull market in diversification. The importance of a broad and thoughtful asset allocation strategy has never mattered more.