Resilience amidst uncertainty

A recent breakfast conversation with a client really brought it home to me. She admitted the constant news cycle made her consistently question her portfolio. I get it – the urge to act is human. But, as we head into Q2, it is important for investors to remain disciplined and alert to the resilience of their portfolios.

Market outlook: tariff jitters and upside risks

We have been making the case for global diversification against over-allocation to expensively valued and overly concentrated US stock markets, particularly warning our clients of fat tails (i.e. more extremes) driven by policymakers. Since President Trump’s inauguration, we have seen this materialise. Political noise continues to dominate headlines. Tariff surprises – and shifting trade allegiances – have really shaken the markets. Many are warning of the impact this may have on the economy – particularly the US economy.

At the time of writing, we have increased our estimate of a potential US recession from 15% to 35% over the quarter. However, there are degrees within this forecast – stretching from a deep recession to one of slower growth. It is the latter that we believe most likely. The level of tariff uncertainty, added to the sheer volume of new policies, could start to weigh on productivity. That said, the US still has a long way to go before getting to near-zero growth from its current 3% levels. Additionally, the US economy still looks strong, consumer spending is holding up and credit conditions remain favourable.

Looking beyond the bleak headlines, there are also upside opportunities from the momentous German financial package, possible US corporate tax cuts, and new stimulus measures and rate cuts being considered by China.

Moreover, as we noted previously, the US’s share of global trade represents only 11%.¹ With all these tariff uncertainties, it is most likely that those outside the US would take this opportunity to strengthen their trade alliances. It, therefore, comes as no surprise that the trade chiefs of Japan, South Korea, and China met at the end of March and pledged to deepen trade ties against the backdrop of US tariffs.

Portfolio resilience amongst market turbulence

Predicting what policymakers are likely to do is notoriously difficult – even more so with what could be seen as a relatively unpredictable government. As such, rather than making bold predictions and forecasts, we look to remain robust over time.

Our portfolios are constructed with a view of longer-term resilience. This rang particularly true over the last two years, where we have been observing acute market dislocations. This involves diversifying portfolios – in different ways – against extremes. 

Increasing government bonds and maintaining our inflation protection: Inflation, while remaining stubbornly high, is coming down. The fears of the market now appear focused on global growth tailing off.  In an environment where both growth and inflation are falling, bonds can provide protection relative to equities. Over the past year, we have increased our government bond exposures in our portfolios while reducing riskier bond holdings, such as high yield. Further, we have maintained our inflation protection through positions in inflation-linked bonds (and infrastructure assets), helping to support our portfolios’ resilience. 

Diversifying our equity positioning: We have been underweighting US equities due to our belief that the region looks expensive compared to the rest of the world. We have increased our allocation to other regional markets such as the UK, Europe and Japan. We continue to find Emerging Markets, particularly Asia Pacific, attractive. 

It is important to remember that buying insurance after a claim generally comes with a significantly increased premium. This is why we took our protection positions in preparation while valuations were still reasonably attractive.

Talking of attractive valuations, we are continuing to make thoughtful adjustments based on our vigorous process. Our latest house view examined Japanese Small and Mid-cap Equities (“SMID”). We see undervaluation in this space, which is less covered by global equity analysts. The typical domestic focus of Japanese SMID companies has defensive traits given the current political environment, as they have less exposure to global trade disputes, adding to the strong fundamentals and cash-rich culture and strengthening governance we have seen that have so far been benefiting the Japanese stock market as a whole. The yen is also a defensive currency.

Moves into these areas will likely be incremental, not drastic. We do not try to time the market or chase trends. Instead, we look to position our portfolios to weather volatility while still capturing medium-term opportunities.

Navigating behavioural pitfalls

Volatility can test even the most seasoned investors. It’s natural to feel uneasy when markets swing, but the worst thing we can do is make emotional decisions. Evidence shows this is when investors can make the worst decisions, as illustrated in the emotional cycle of investing.

Decisions we make in these environments can significantly impact long-term returns – but counterintuitively, it is taking a disciplined approach – including rebalancing the portfolios to pre-defined long-term allocations so that we sell high and buy low – that typically leads to better outcomes over the long term. 

What is crucial is to be prepared, and part of this preparation is to understand what we would do in such situations – without the emotions in the midst of turbulence. We had done just that a few months ago when we polled some of the senior investment experts within St. James’s Place on what we would do if markets experienced a large drawdown. A majority answered, “to keep to our current process” (of reviewing valuations with considerations to the economic environment, extremes and tail risks) or interestingly, “to take more risks”.

Indeed, “the stock market is the only market where things go on sale and the customers run out of the store”. Instead, we aim to be the fundamentalist in Mr Buffet’s reflection - “Fear is the foe of the faddist, but the friend of the fundamentalist.”

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James's Place.

Past performance is not indicative of future performance. 

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

¹World Trade Organization, World Trade Statistics 2023, Key Insights and Trends