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In the wake of the Trump administration's announcement of its new round of its "Liberation Day" tariffs, volatility has hit both equities and bonds. The VIX equity volatility index spiked from 21.5 to a little over 60 in just three sessions, and continued to linger around 50 till the 90-day pause was announced.
But investors would do well to note that the volatility visited on both the equity and bond markets has not been to the same extent. For sure, the amount of damage felt has been starkly different. Between 2 April and 8 April, the S&P 500 fell just over 12% and global equities (MSCI ACWI) fell just over 11%. During that time, high grade and investment grade bonds have remained fairly stable, meaningfully outperforming the more pro-cyclical equities. Also noteworthy is that we have recently turned Neutral (from Preferred) on equities overall in response to the harsher-than-expected raft of tariffs.
This highlights the importance of the rest of a diversified portfolio, which can help cushion returns during bouts of risk aversion that hurt equities. Let's review these now.
Deploy idle cash to high and investment grade bonds. We continue to see quality bond yields as still attractive and would encourage investors to deploy idle cash to lock in these yields. Portfolio income helps to stabilize returns, especially during uncertain times like the present. Case in point: over the fuller 19% correction in the S&P 500 from 19 February to 8 April, the 5-year US Treasury (UST) yield fell 42bps despite a 28bp rise at the end of that period. Although the outperformance has been less pronounced for the longer tenors¡ªwhich are more sensitive to inflation and supply (issuance) concerns¡ªthat segment has nonetheless proved resilient amidst the spike in risk aversion. Going forward, US government bonds are set to benefit from policy rate cuts in the months ahead as US economic growth slows. The steepening of the UST yield curves of late also offers up opportunities for roll-down returns for medium tenors. For global investment grade (IG), we recommend bonds of more defensive and domestically oriented issuers with an average duration of around five years. Potential further spread widening might be offset with carry and further falling government bond yields.
Of course, USTs are susceptible to shifts in the market¡¯s expectations of fiscal discipline in the US. While it is clear that the debt path for the US is on a steep upward trend, driven by an excessive fiscal deficit and increased funding costs, we think a debt crisis is unlikely in the near term.
Asia IG remains our favored segment for the region. We continue to recommend that investors hold on to Asia IG credit, and keep duration more toward the short end (up to 5 years). Issuers in this space are mostly domestically focused, so the direct fundamental impact on Asia credit from tariffs should be limited. Furthermore, a large portion of Asia credit is made up of financials, which do not face a direct impact from tariffs. Asia credit has historically been less pro-cyclical compared to global/US credit, which would make it more resilient in an environment of slowing economic growth and rising risk aversion. We expect that any spread widening will likely be accompanied by falls in US Treasury yields. We recommend only modest exposure to Asia high yield (HY), limited to selected quality BB rated names from a bottom-up perspective.
Go for gold, still. Gold¡¯s limited fall to just under USD 2,956/oz amid liquidity concerns in financial markets and a subsequent rebound underline the resilience of this favored portfolio hedge. The collection of ongoing concerns in financial markets¡ªtrade and economic uncertainties, fears of stagflation, recession risks, and geopolitical tensions¡ªwill likely continue to burnish gold¡¯s allure. With the US at the heart of the ongoing trade war, longer-term allocations to gold by investors are quite likely to rise. The global move to diversify reserves away from the USD that has seen central banks buy gold at a record pace of over 1,000 metric tons annually over the last three years is unlikely to be impeded by the trade war. Private investors appear to be following suit and seem to have spurred a reversal of the multi-year ETF redemption cycle. Our base-case target remains USD 3,200/oz through 1Q26. But we would also caution that if trade and geopolitical risks deepen, our upside case of USD 3,500/oz will come into play. We reiterate our preference for gold, and stay long in our global asset strategy. We continue to recommend a 5% allocation to gold within a USD balanced portfolio as optimal from a diversification standpoint.
