Uncertainty reduces risk appetite
Financial markets were extremely volatile in April. First, US tariffs announcement pushed markets lower. When US President Donald Trump backpedalled, they quickly recovered and they are now close to ‘Liberation Day’ levels. Although we do not expect a recession, we do expect that the ongoing uncertainty will cause volatility to remain elevated. Therefore, we are using the rebound in financial markets to take some risk off the table. Specifically, we are reducing our equity allocation to neutral and swapping a portion of our corporate bond portfolio to safer covered bonds.
- Equities: agile during volatility
- Bonds: shift to safety
Equities: agile during volatility
Stock markets around the world have seen a strong recovery after Trump hit the pause button on the announced tariffs and recession fears faded. Before that, the US stock indices had declined more than 20% from their highs. Official bear market territory. Now, most stock indices are back to the levels from before ‘Liberation Day’ when the initial reciprocal tariffs were announced. The recovery is largely fuelled by hopes for trade deals and by the fact that the US economy was strong before the tariffs were announced.
However, we believe that there is a bit too much enthusiasm in the current recovery. The economic outlook remains less rosy than it was before ‘Liberation Day’. The 10% universal tariffs are still in effect, and it remains uncertain whether trade deals will be made and how they will look. Additionally, the trade policy uncertainty could lead companies and consumers to cut back on their spending, which can hurt the overall economy. While we believe that the US and world economy are resilient enough to avoid a recession, we also believe it is naïve to assume the market volatility has subsided entirely. Therefore, we are reducing our equity positioning from a slight overweight to neutral. In doing so, we are reducing the risk exposure in our portfolio.
Bonds: shifts to safety
In line with our lower risk appetite in equities, we also see reasons to reduce our credit risk in our bond portfolio. Specifically, we have identified an opportunity to reduce investment-grade (IG) corporate bonds within our high-quality bond portfolio. The credit spreads within this part of the portfolio have come down substantially since the Trump administration retracted its ‘Liberation Day’ tariffs, but we expect these to rise again as the economy slows down. Consequently, we see this as an attractive moment to take some profit.
Additionally, we have identified safer covered bonds to reinvest the proceeds. This is a safe and liquid asset class with a comparable level of safety to government bonds. Moreover, in periods of economic slowdown or recession, these have historically outperformed IG credit. Our expectation of an economic slowdown makes this a sensible shift to safety. After the trade, our positioning in IG credit is reduced to neutral, and we now have a strong overweight position in covered bonds.
Conclusion
Both equity and bond markets around the world have seen a strong recovery in recent weeks. However, the economic outlook has worsened and uncertainty remains high. Therefore, we expect volatility to persist, and we want to use the recent rally to reduce the risk in our portfolios. Specifically, we reduce our equity positioning to neutral and swap IG credit for safer covered bonds within our high-quality bond portfolio.
Richard de Groot
Chair Global Investment Committee