Investing in peak uncertainty: a view across asset classes

Business Times

5 days ago

MARKETS have entered a new era of turbulence. While US President Donald Trump's tariffs have come down considerably following recent US-China negotiations and a 90-day pause, they are nonetheless still historically high and widely expected both to hurt growth and spur inflation.
While a soft landing for the US economy remains our base case, we now see greater chance for a mild recession. The policy response is also uncertain, and the stagflationary nature of the shock means that fiscal and monetary offsets may not arrive soon enough to sidestep a downturn.
The US Federal Reserve remains in 'wait and see' mode despite overt pressure from Trump to cut rates. Fed members are indicating that they may stay on hold for longer and be slower to provide rate relief. The recent spike in yields, following Moody's downgrade of the US based on expectations of deteriorating fiscal balances and debt levels, underscores the mounting pressure on policymakers.
We expect that entering 2026, the US economy would have slowed and price levels would most likely have adjusted after a one-off spike in inflation, enabling the Fed to be more dovish.
Fixed income: diversify, diversify
The biggest surprise following recent tariff woes may be how calm the corporate credit markets have been relative to the rates or equity markets. Corporate credit is on a solid foundation heading into a potential slowdown or mild recession, but the overarching issue is arguably whether the US government's actions could more permanently erode confidence in the US financial markets.
The selling-off of Treasury bonds may signal a lack of foreign buyer demand and is likely one of the reasons the dollar has weakened. If confidence and trust in the US are permanently damaged, this will have longer-term implications for demand and pricing of US assets and will weigh on future growth expectations from both a macro standpoint and for corporate earnings.
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In an uncertain environment, the bottom line is that investors need to be more diversified across asset classes, industries and geographies. We believe global diversification is especially critical. US credit and its underlying fundamentals have long been viewed as superior, but the differential is shrinking. Because of that and given the current heightened uncertainty, we would not favour being overly weighted to the US.
We are now more constructive on the European outlook, as the Trump administration is forcing Europe to rethink its fiscal expenditures on both military and infrastructure, especially in Germany. Europe may also benefit from a kind of forced collaboration on trade issues and spending after the bloc had started to fracture, leading to a more positive outcome down the road despite some short-term pain.
Parts of emerging markets (EMs) are also on a solid footing, with the vast majority of EM corporates having fairly minimal exposure to trade to the US. Notably, the banking sector across EMs is generally well-positioned to withstand downside risks in the global economy. While rate cuts have reduced profitability, these cuts factor into a stable economic outlook that supports loan quality and liquidity across the system.
We also believe recent volatility shows that Asian US dollar credit may be an interesting alternative to US and European fixed income, particularly in a drawdown environment.
Looking ahead, we think valuations are more likely to cheapen than tighten, given the potential for more negative headlines.
Buying opportunities in investment-grade credit
While we don't believe investment grade (IG) credit is at significant risk from the tariff policies, we think a cautious approach is warranted to help avoid exposure to potential risk and tap potential opportunities.
We do not think investors should pile into high-quality assets, but we view the widening of spreads since Apr 2 as a potential buying opportunity for active managers.
Autos remain the most exposed among US IG credit sectors to the tariffs' impact, and shifts in sentiment are also likely to hit discretionary consumer cyclicals, such as travel, and retail overall. We believe prospects for the financial and communications sectors are more favourable due to their strong fundamentals and relative immunity from the impact of tariffs.
Equities: Focus on companies, not sectors
The volatility that has characterized equity markets over the past several years had intensified leading up to Apr 2. We look at companies with a view to identifying mispricing that may indicate their prospects are underappreciated by the market, while assessing risk to ensure quality.
We have heard consistently from industrial companies that capex spending by their customers has been on pause since the middle of 2024 as they awaited the US election results. While the hope had been that this uncertainty would lift after the election, we now expect industrial spending to remain on hold.
Some strong and positive underlying trends are still supporting industrials, including the resolution of post-Covid de-stocking, which should bring about a reduction in earnings volatility and shifts in funding requirements. Another positive is the rising adoption of artificial intelligence (AI) in industrial settings, especially as costs come down.
Most industrial companies say they can pass along whatever tariffs are imposed and continue to maintain their profits, which would set the stage for a potential industrial rebound.
In healthcare, there are headwinds, however. Pharmaceuticals are one target of the Trump administration for sector-specific tariffs. The market is attempting to price in this headwind to sales and earnings, but while we expect a tariff range of 15 to 25 per cent, clarity is lacking.
Also uncertain is whether the rate will apply to lower-value raw materials such as active pharmaceutical ingredients or to the higher-value finished dosage forms.
Multi-asset positioning
Given the uncertainty, we remain neutral on risk assets and more focused on finding allocations with stronger structural tailwinds for today's new landscape.
In equities, European defence stocks face a rejuvenated decade ahead, given the removal of Germany's debt brake and the need to provide the primary layer of defence in the future. As for the US, re-shoring provides stepped-up opportunities over a multi-year period for select industrial stocks. In China, the Internet sector has government support again, and companies are no longer worried about expanding margins and investing in their business.
In fixed income, we continue to favour shifting a portion of one's duration exposure to Europe, particularly gilts. We came into this year favouring mostly developed market sovereigns and some Asian high yield. Credit spreads have now widened everywhere, so it's timely to nibble selectively elsewhere.
In alternatives, gold was already benefiting from deteriorating economic relationships and rising geopolitical risks. Should the US and China fail to reach a detente, China's next step beyond today's stimulus may be much more aggressive growth in the central bank's balance sheet, which would support global M2 outpacing global nominal gross domestic product – gold's true propellant.
In this era of peak uncertainty, we believe investors should seek thoughtful active management that takes a longer-term view while also remaining watchful for volatility-driven opportunities.
Steven Oh is global head of credit and fixed income; Michael Kelly is global head of multi-asset. With assistance from Rob Hinchliffe, head of global sector cluster research. They are with Pinebridge Investments.