Can tariffs stem fading US exceptionalism?

Since the beginning of the year, financial markets seem to have priced in rising odds of a recession in the US. Gold has led the pack in terms of returns, followed by bonds, whereas global equities barely eked out any gains, mainly dragged by the US. The US market angst continues to build amid intensifying trade rhetoric ahead of 2 April, when President Trump is set to unveil his reciprocal tariff plan. Trump has touted the day as “Liberation Day” for Americans on the assumption that they will ostensibly regain some of the wealth given up to other countries due to perceived unfair trade practices. By imposing tariffs against key trade partners, will Trump be able to turn around the US stock market which has notably underperformed other regions this year? How should we position our investment portfolio in these turbulent times?

Tariffs not the only driver of US underperformance

Market focus on Trump tariffs appears to have masked many other factors behind the recent US equity underperformance. Trump adviser and Tesla CEO Elon Musk’s Department of Government Efficiency’s (DOGE) initiative to aggressively cut federal jobs has weakened consumer and business sentiment, raising concern about the outlook for US retail spending and corporate reinvestment. Moreover, the so-called ‘US exceptionalism’ has been called into question by the emergence of China’s low-cost chatbots, such as DeepSeek.

Meanwhile, global bond yield differentials are also narrowing. Euro area and Japan 10-year government bond yields have both surged 40bps from the start of the year, contrary to the 30bps contraction in the US 10-year yield. This has caused the dollar index (DXY) to slump nearly 5%. Such confluence of factors eclipsed the tariff scare, catalysing the outperformance of Chinese and European equities vs. the US year-to-date.

Reciprocal tariffs do not derail our soft-landing base case

The prospect of wide-ranging tariffs has lifted Americans’ one-year inflation expectation to a 32-year high of 3.9%. If such elevated expectation persists, it will impede the Fed’s ability to implement rate cuts in response to any notable growth slowdown. We believe that self-proclaimed “Tariff Man” will keep leveraging tariffs as a negotiating tactic, cognisant that the longer it takes to negotiate with every trading partner, the more adverse impact it will have on US consumer and business sentiment. Hence, it is no coincidence that Trump has proposed “flexibility” in the upcoming tariff measures. That said, tough talk on tariffs is paving the way for the deployment of the rest of Trump’s growth-oriented policy tool kits, including deregulation and tax cuts.

On balance, we expect tariff uncertainty to abate and inflation expectation to moderate over time. This reinforces our base case for the US economy to achieve a soft landing in the next 12 months. As such, we broadly agree with the Fed’s economic projections of slightly higher inflation and slower, albeit still positive, GDP growth forecast of 1.7% this year. We assign only 20% chance of a US recession in the next 12 months.

How to position your portfolio for the volatile Trump 2.0 era

Since we anticipate bouts of market volatility in the next few weeks, it is more important than ever to build and maintain a well-diversified foundation portfolio across asset classes. We have advocated an overweight allocation to gold, which has historically been an effective hedge against any inflation and geopolitical risks. Adding exposure to alternative investments is also a time-tested way to reduce portfolio sensitivity to market movements resulting from policy noise.

We retain our overweight stance on global equities, with a slight bias towards the US on the heels of its recent pullback. Within US equities, we recommend diversifying away from the semiconductor sector into software, communications, and domestically oriented financial sectors, while dialling up on defensive, value plays in the healthcare sector. The US dollar looks oversold and may rebound in the near term around any tariff announcement. However, we expect the greenback to weaken in the longer term. This warrants adding exposure to international equities on any near-term pullback.

Targeted exposure in Europe and Asia

We suggest targeted positioning in Europe, favouring the banking and industrial sectors on an anticipated economic recovery led by Germany’s defence and infrastructure spending boost. In Asia excluding Japan, we like China offshore equities. Nevertheless, we believe a barbell strategy is justified given China equities have already rallied strongly and there is a chance of further US tariffs hurting sentiment in the near term. Hence, we balance our preferred growth-focused Hang Seng Tech index exposures with defensive high dividend paying non-bank state-owned enterprises listed in Hong Kong.

In bonds, we shift our preference from government to corporate bonds to capture the opportunity created by the recent rise in yield premium on US corporate bonds due to growth concerns. We consider corporate default risk to be relatively contained, thereby providing a window of opportunity to tactically add Developed Market high yield corporate bonds.

As tariffs and inflation remain key macro risks in the foreseeable future, a common mistake is not investing and instead parking your wealth in cash. Holding large amounts of cash is akin to letting inflation erode long-term returns. Diversifying your portfolio across asset classes and geographies is pivotal to navigating the current volatile times.

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