Keep the poise, ignore the noise

Away from the noise, net market returns are nothing special. The trade war, whichever way it evolves, is a macroeconomic shock but the reality is less harsh than the rhetoric. 

Year-to-date equity market returns are positive, and some markets are up a lot. 

Meanwhile, overly dramatic concerns about government bonds have not altered the fact that bonds are delivering income to investors. 

Balanced portfolios are doing all right. Keep the poise, ignore the noise.

Fight, fight, fight

The US administration’s prevailing philosophy is to restore the American greatness concept. That implies a confrontation towards those that are perceived to be preventing this greatness from manifesting – foreign governments and institutions, immigrants, and those that have pursued a progressive policy agenda domestically. 

For markets, the most important manifestation of this confrontational approach has been trade policy and the attempt to reshape the global trading system in America’s favour. 

By now we are familiar with the unorthodox and unpredictable way the agenda is being pursued, and how this creates volatility in investor sentiment and market prices. 

For the near future, the US will keep fighting for better outcomes on trade, will back a budget that widens the Federal deficit, and pursue defunding research in areas such as social equality, health and climate risk that do not align with the MAGA agenda. 

The risks of self-inflicted economic damage are clear.

Sentiment

How will we know when America is great again? It is unrealistic to assume that the Administration will settle for less than the blanket 10% tariff, with other specific sectoral and China focussed taxes. 

A confrontational approach by the Administration is likely to be the modus operandi, at least until the mid-term Congressional elections in 2026. As such, investor sentiment is likely to be volatile and markets are likely to be directionless.

Domestic versus foreign

There are likely to be differences in sentiment towards investing in the US between domestic and foreign investors. Antagonism towards the rest of the world is core to the agenda. 

The antagonism surely feeds into asset allocation decisions regarding US assets, as the US loses empathy internationally. 

The policy approach creates uncertainty around US economic fundamentals such as growth, corporate profits, inflation, interest rates, and the dollar. On balance it tilts investors to more of a home country bias.

It is the politicians, not the CEOs

It is not corporate America that is causing the uncertainty, it is political America. US markets are expensive but have demonstrated strong earnings, forecasts for which are still in double digits for this year and next. 

Markets are supported by domestic investors where sentiment does not seem to be as bad (there will be some sympathy with the MAGA agenda). 

There is no recession, there is plenty of liquidity in money market accounts and technology is moving quickly. Some element of US exceptionalism remains in the stock market. 

Balance and diversification are the key for foreign investors. A lower desired level of exposure to the US market given valuation and the other macro risks may be the result but it does not mean the US is a no-go.

Fixed income trend-less

The key risk to Treasuries is that higher coupons on newly issued debt are going to be needed to attract additional buying as deficits get bigger. This pushes up market yields and pushes down prices on existing bonds, leading to negative price returns in bond portfolios. 

For foreign investors in US bonds there is also a fear that the real value of their holdings could be eroded by higher US inflation and an even weaker dollar. 

Despite the unorthodox streak running through Washington, there has been no suggestion that they are going to monetise the debt and inflation away the problem of fiscal sustainability. 

US Treasury Secretary, Scott Bessent, for one, recognises that the inflation of 2021-2023 was driven to some extent by the Fed’s balance sheet policies super-charging quantitative easing. That is not a policy choice today. 

However, it is safer to stay in short-duration fixed income strategies given the volatility of yields at the long end of the curve. Short-duration credit in investment grade and high yield remains a sweet spot in this uncertain world.

Risks are higher. Risk premiums are higher. 

Further episodes of intense market volatility (with the Pavlovian responses from the commentariat) are likely. The world is changing but market capitalism is not dead; it is just the mechanisms are being shook-up. 

That creates uncertainty. But fundamentals are still solid for global markets and the level of confrontation from the US Administration will recede eventually. 

As such, long-term returns from balanced, diversified portfolios with a solid exposure to income flows from credit, and earnings growth from technology, should continue to see wealth grow.