View from the very top: It wasn’t supposed to be like this. A volatile and unpredictable US President has upended almost all prior assumptions, whether about diplomacy, economic growth or asset allocation. Investors are having to learn to live with this. Unsurprisingly, both businesses and consumers have become more cautious. Growth expectations have been downgraded and inflation forecasts raised. The most important question, however, is not whether we are heading for recession but to ask if policy chaos will get better or worse from here. Clarity on tariffs cannot come quickly enough. A more stable second half of 2025 could follow were the Trump administration to de-emphasise tariff policy and refocus on supply-side reform and deregulation. This could also spur an increase in deal-making. At the same time, monetary policy remains flexible, with significant scope for easing. Against this backdrop, investors need to remain both nimble and opportunistic. A truly diversified portfolio makes sense.

Asset Allocation:

  • Equities: The first quarter of 2025 has seen a massive change in stock market leadership, with a clear rebalancing out of previously concentrated sectors. Value has outperformed growth and almost every other developed world region has delivered better returns than the US. These dynamics are healthy and not abnormal, especially after the prior extreme rally. For context, global equities are just 7% below their all-time nominal high. Tariff risks are now better discounted in earnings estimates than at the start of the year, in our view, although further uncertainty could depress multiples and raise equity risk premiums. We favour areas that are less sensitive to risks to economic growth, trade policy and AI hype, and seek diversity in terms of both geography and style.  
  • Fixed Income/Credit: The yield on ten-year US Treasury debt is markedly lower than its January peak, but has gyrated markedly since the start of the year. Contradictory forces are at work: a lower growth outlook might imply lower yields, while more persistent inflation would keep yields elevated. Policy uncertainty argues for extending duration. Notably, credit markets do seem to be pricing growth concerns via widening Investment Grade and High Yield spreads as well as the increasing cost attached to protecting against default. Selective investments in this asset class make sense. 
  • Currencies: The Trump administration has made no secret of its desire for a weaker US Dollar, since this helps with trade rebalancing. The Dollar has indeed fallen by more than 5% since its January peak, although strength in the Euro (on expected fiscal loosening across the continent) and the Japanese Yen (on tighter monetary policy) have been partially responsible. Given recent prior Dollar ascendency, this unwinding may have further to run in the near-term.
  • Gold: The precious metal has been a perennial feature in our asset allocation approach. Its continued ascendency in 2025 reflects its obvious positioning as a safe haven. Think of gold as the logical asset to own given all the conflicting headlines and geopolitical uncertainties. We see it as a crucial diversifier. Central Banks remain ongoing buyers.
  • Alternative Assets: We believe this asset class can provide another useful form of diversification. Many alternative assets offer collateral-based cashflows. At the same time, they benefit from an illiquidity premium too. We advocate being highly selective across this broad and diverse area, favouring differentiated and uncorrelated strategies.

It wasn’t supposed to be like this. A quarter of the way through 2025 and almost all start-of-year assumptions have been subject to abrupt revision. The much vaunted ‘Trump bump’ has morphed quickly into a ‘Trump slump’, which has affected meaningfully both economic assumptions and asset class performance. More broadly, the world is learning how to live with a highly unpredictable and erratic President. Investor expectations have correspondingly been reset. This is a difficult environment through which to navigate, on any reckoning. Ongoing bouts of instability have become the norm and may well remain so. Such a backdrop reinforces strongly the logic for portfolio diversification, in our view.

Why have expectations changed so rapidly? Perhaps the simplest answer is the unfortunate realisation that the economic playbook that informed logic thus far this century cannot be used going forward. Think of this as a paradigm shift away from globalisation. Trump’s hardball approach has been a clear catalyst for change. A less charitable but nonetheless practical assessment might note simply that investors are struggling to understand the President’s strategy, the barrage of often unrelated announcements. Unpredictability, sadly, does not equate to power and leverage.

Economic policy should be stable, practical and impartial. Currently, it is none of these things. As a result, the US administration is losing control of the narrative – and investors have woken up to this fact. Policy chaos is doing real damage. This is showing up in the macro data and hence in investor expectations too. The risks to US exceptionalism are now much better understood than they were at the start of the year. If there is a recession, then it will be made in Washington (and not on Wall Street or Main Street). An additional, unfortunate, surprise for investors is the President’s apparent indifference to the downside of his actions. The mythical ‘Trump put’ has certainly not been at all evident so far.

The problem for investors is that growth expectations have come down so far in 2025, but not inflation expectations. The messaging from the Federal Reserve – sadly not the most important voice in town currently – reflects this. Believe the Fed and stagflation is now more of a risk. Jerome Powell has even talked (perhaps euphemistically) about growing tail risks for the economy. The Central Bank’s GDP estimates have been cut for this year and next at the same time that inflation estimates have been increased. Members of the Federal Reserve Open Market Committee call out elevated risks around both inflation and unemployment, noting that both metrics are currently on the wrong side of the Bank’s dual mandate.

It should be no surprise to recognise why. The strains in the economy are becoming harder to ignore. Most survey data have been dismal in the current Trump era. Consider that the National Federal of Independent Business report from last month shows small business uncertainty at its highest since the 1970s, when records began. The University of Michigan’s most recent consumer survey recorded its largest monthly drop in sentiment in 32 years. Consumers are unsurprisingly pessimistic about their financial situation. Credit card debt is at its highest in 13 years and when asked about where consumers see inflation in one year’s time, respondents suggest 5.0%, a marked increase relative to a month prior (data respectively from the New York Fed and the University of Michigan). Anecdotal from CEOs across a swathe of industries suggest they are delaying new investments. Caution can become self-reinforcing, creating a downward spiral. A recessionary trade war is called out as the leading risk in the latest Bank of America Merrill Lynch Fund Manager survey.

Some growth slump seems inevitable to us, especially since trade tensions have yet to peak. Of course, growth and inflation metrics rarely trend in a linear fashion. The handover from one administration to another will also inevitably cause some disruption. At the same time, recession, while no longer unthinkable, is still improbable. Recession per se is not the goal of team Trump. Rather, think of the current approach more as shock therapy, a crude rolling back of globalisation. Jerome Powell correctly notes the importance of hard data, which suggests that the economy remains on a solid footing, evidenced by the recent pick-up in manufacturing activity and unemployment at little over 4%. Further, there appears to be little stress in the financial system when considering either corporate or consumer balance sheet health.

However, these musings miss the point. The most important question is not whether we are heading for recession, but to ask if policy chaos will get better or worse from here. Clarity on tariffs can’t come quickly enough. Equally, a more moderate and less belligerent President is something many would hope for. Practically, political constraints and perhaps the cognisance of mid-term elections less than two years away may compel the Trump administration to strike deals before a more serious growth and profit recession takes place. As the world’s largest economy and most powerful nation (at least for now), what the US does matters. Any American recession would be a clear and inescapable reset for the rest of the world. Do not forget, tariffs are a discretionary choice. As easily as they can be implemented, they can be reversed.

The optimist’s playbook, then, would begin by recognising that markets – like macro data – rarely move in a linear fashion. Corrections, or resets, are healthy. Intra-year declines of at least 10% in major equity markets are quite normal. A more stable second half of 2025 could follow a volatile first half, especially were the Trump administration to de-emphasise tariff policy and refocus on supply-side reform and deregulation. Such an approach could also provoke an acceleration in deal-making. Monetary policy remains flexible with significant scope for easing. AI-inspired productivity gains could also prove to be a source of upside for the economy.

Notwithstanding the importance of what the US does, investors may legitimately wonder about the merits of increasing exposure to other regions, particularly Europe. We note the irony that while Messrs Trump, Putin and Xi might prefer a divided Europe to serve their ends, one consequence of their policies has been to unify the continent. Many of Europe’s historic shortcomings have been self-inflicted, but large and exogenous shocks (i.e. Donald Trump) tend to focus the mind, driving continent-wide unity. We may well be at the beginning of a fundamental reshaping of Europe’s economic model, one that will allow the continent to both safeguard itself and accelerate growth.

What’s happening in Europe is both desirable and necessary, although whether the continent is truly committed to genuine structural change remains unclear. Not all countries may follow Germany’s lead fiscally. A move towards communal debt or common fiscal policy may also be a step too far for many. Elsewhere, while the current shift in China represents a more friendly stance towards capital markets, the longer-term intentions of the current regime remain unclear.

Step back and the world is undoubtedly in flux. Markets have begun to recognise this. Perhaps the adage of being greedy when others are fearful (and vice versa) holds some merit. Our counsel remains unwavering: do not panic in the face of uncertainty and continue to diversify actively.

Alex Gunz, Fund Manager, Heptagon Capital

Disclaimers

The document is provided for information purposes only and does not constitute investment advice or any recommendation to buy, or sell or otherwise transact in any investments. The document is not intended to be construed as investment research. The contents of this document are based upon sources of information which Heptagon Capital LLP believes to be reliable. However, except to the extent required by applicable law or regulations, no guarantee, warranty or representation (express or implied) is given as to the accuracy or completeness of this document or its contents and, Heptagon Capital LLP, its affiliate companies and its members, officers, employees, agents and advisors do not accept any liability or responsibility in respect of the information or any views expressed herein. Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation. Where this document provides forward-looking statements which are based on relevant reports, current opinions, expectations and projections, actual results could differ materially from those anticipated in such statements. All opinions and estimates included in the document are subject to change without notice and Heptagon Capital LLP is under no obligation to update or revise information contained in the document. Furthermore, Heptagon Capital LLP disclaims any liability for any loss, damage, costs or expenses (including direct, indirect, special and consequential) howsoever arising which any person may suffer or incur as a result of viewing or utilising any information included in this document. 

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