Reimagining portfolios amid midsummer uncertainty

[SINGAPORE] In the two months since “Liberation Day”, investors have been grappling with this midsummer night’s dream, reimagining how to position for seismic changes in the geo-economic landscape.

Optimism that pragmatism will ultimately prevail despite the US tariff unpredictability sparked a rally in risk assets, as the S&P 500 and Nasdaq indices broadly recovered close to levels at the beginning of the year. As the July deadline for the 90-day tariff reprieve draws closer, we expect elevated volatility as the US engages in bilateral negotiations with global trade counterparts.

As we head into the summer months, we highlight the potential risks ahead and how investors ought to react in preparation. Here are some hot spots.

• Tariff tussle adds uncertainty to economic prognosis

The US tariff policies have been fraught with the vagaries of implementation, including reciprocity between countries, dial-backs, negotiations and, most recently, legal challenges.

For the US and China, some reprieve came from the Geneva meeting in mid-May, when the new additional duties were rolled back sharply – from 145 per cent to 30 per cent for Chinese goods, and from 125 per cent to 10 per cent for American exports – for 90 days. This established channels for talks led by US Treasury Secretary Scott Bessent and Chinese Vice-Premier He Lifeng.

This sparked a risk rally as concerns eased over recessionary risks and the earnings impact. For Europe, the threat of 50 per cent tariffs on European Union exports eased swiftly for trade negotiations ahead of the original July deadline.

The Court of International Trade’s claim that US President Donald Trump’s tariffs – made under executive orders – were unconstitutional was also short-lived, as the ruling was suspended by a federal appeals court.

Industry-specific targets including the punitive doubling of tariffs on aluminium and steel imports to 50 per cent announced on Jun 3 will hit US businesses and metal exporters such as Canada, Mexico, Brazil, Germany and South Korea.

Regardless of primary and secondary impact, uncertainty itself will hamper business and consumption decision-making, in turn hurting growth prospects.

Last month, the Federal Open Market Committee warned that risks to its twin goals of stable prices and full employment have risen. Given the potential stagflationary risks, the Federal Reserve may make only one 25-basis-point rate cut in 2025.

• Mounting US fiscal risks and use of non-tariff measures

Trump’s “One Big Beautiful Bill Act” (OBBBA) of 2025 rekindled concerns over the US’ long-term fiscal sustainability. Recent weakness in the greenback, increasing credit default swaps, and rising US Treasury yields are indicative of investor concerns over the longer-term prospects for the country’s creditworthiness.

While Moody’s downgrade of US debt from “Aaa” to “Aa1” was no major surprise, the decision capped America’s worsening fiscal position, due in part to elevated fiscal spending since the pandemic.

If the OBBBA passes through Senate, the country’s fiscal deficit is projected to rise by US$2.4 trillion over 2025 to 2034, based on Congressional Budget Office estimates. Amid the legal challenges and the US Court ruling on the validity of Trump’s tariffs, potential tariff revenues are also under threat.

The next shoe to drop may come from the updated Section 899, which could facilitate penalty taxes on foreign companies operating in the US if their home country is deemed to levy “extraterritorial or discriminatory taxes” or “unfair foreign taxes”.

Policy uncertainties and fiscal concerns will keep US term premiums elevated, but policymakers may step in to manage risks with potential buybacks, reduction of supply along the long end (in favour of US Treasury bills) or exempting US Treasuries from statutory liquidity ratio calculation.

These measures could provide relief to the supply-demand imbalance along the long end. In fixed income, our tactical asset allocation remains defensively positioned with a “neutral” stance on duration, and “underweight” in high-yield credits.

Reimagining opportunities

• Longer-term concerns over US risks rekindle attention to global markets

Given the 8.6 per cent year-to-date decline in the US dollar index, the US-dollar-denominated total returns of globally diversified equity portfolios have been flattered by currency gains in the euro, Singapore dollar and other emerging market currencies, in greenback terms.

This underscores the value of portfolio diversification across global markets to broaden exposure and mitigate structural risks. In Bank of Singapore’s tactical asset allocation for equities, we maintain “overweight” positions in Asia ex-Japan and Europe, and “neutral” stances for US and Japanese equities.

Notwithstanding the diversification benefits, investors need to consider the fundamentals of each region, country, industry and company in relation to their sensitivity to the inflation and growth shocks that could arise from the fractured trading system and uncertain policy implications, as idiosyncratic risks may rise.

Long-term government bond yields have risen to levels not seen since before the 2008 financial crisis, as fiscal deficits and public indebtedness rise across major economies. While we stay cautious on long-term government bonds in general, China and Germany stand out as two major economies with the fiscal headroom to increase spending.

German yields remain well below pre-2008 levels after years of austerity, while China’s yields are near record lows as inflation remains weak.

• Expect the unexpected – build portfolios to handle uncertainty

We advocate a disciplined and robust asset allocation framework which explicitly acknowledges the uncertainty of market inputs, including expected returns, volatilities and correlations.

The robust optimisation approach aims to construct investment portfolios that are resilient across a wide range of outcomes, shifting from precise prediction to resilience by design. This approach translates into more resilient portfolios, better downside protection, and more reliable alignment with investor goals.

By taking a more strategic approach to building long-term portfolios, investors can avoid being whipsawed by short-term developments, using dislocations as opportunities for rebalancing.

• Diversification matters: gold, alternatives, derivative hedges and investment styles

Despite the pullback in gold prices from record highs of US$3,500 an ounce in late April – as tariff roll-back improved the US growth outlook – the precious metal is likely to be well-supported by central bank buying amid geopolitical and economic uncertainty.

Given the risk that government bonds may not adequately hedge against downside risks, long-term institutional and retail investors are drawn to strategic gold allocations in portfolios as a valuable hedge against the fiscal challenges and credibility of central banks globally.

Alternatives can also act as key diversifiers for investment portfolios with mainly public markets exposures. As with equities and fixed income, regional and sectoral diversification within alternative assets (across private equity, private credit, real estate and hedge funds) is also important.

Selecting fund managers across long-only funds, hedge funds and alternatives managers with different investment styles and sectoral specialities can add to portfolio resilience and mitigate late-cycle risks.

Suitable investors may also consider using derivative and structured product payoffs to hedge portfolios or capture upside, ahead of potential market uncertainties.

The writer is global chief investment officer, Bank of Singapore