Dollar declines and tariff tumult

The rebound in investor sentiment that prevailed in the second half of April continued into May. The stock market gained, leading the MSCI All Countries World Index to rise by 5.8% in US dollar terms over the month, bringing performance since the beginning of the year back into positive territory (+5.5%) and close to the mid-February highs. US government bond yields rose, with the 10 year returning close to 4.50%, while the US dollar was little changed.

The news flow over the past few weeks has remained highly variable and at times contradictory, making it difficult to separate the signal from the noise. In the last month alone, markets have had to assess the implications of the trade agreements reached between the Trump administration and the UK and China. The retreat in reciprocal tariffs, at least temporarily, between the world’s two largest economies helped boost global stock markets.

However, tariff related noise remains elevated. Trump threatened 50% duties on all goods imported from the European Union, only to backtrack and confirm the previously announced 9 July deadline for conclusion of the negotiations. Separately, US courts ruled Trump’s reciprocal tariff regime illegal due to the President overstepping the bounds of his authority. These rulings were, however, suspended pending an appeal by the Trump administration, which subsequently announced the doubling of duties on steel and aluminium to 50%.

The month of May was also marked by Moody’s downgrade of the US sovereign rating in light of the expected increase in public debt and the possible weakening of US institutions. Nevertheless, the House of Representatives, urged by President Trump, has approved a “big, beautiful bill” that contains fiscal measures capable of adding over USD 3 trn to US public debt over the next 10 years, equivalent to 10% of GDP.

The outlook for the US dollar remains precarious despite a more hawkish Federal Reserve relative to other major central banks. The vulnerability of the US dollar despite the increase in the interest rate differential between the US and the rest of the world provides confirmation for many commentators that a structural reallocation of global savings towards non-US markets underway.

In this context, it remains advisable to maintain limited portfolio risk, with exposures close to strategic benchmarks. We remain marginally overweight equities with a bias towards non-US stock-markets although we have used market volatility to neutralise exposure to US equities. This has been balanced by a slight reduction in exposure to Japanese equities, which may find it hard to make progress if the Bank of Japan is more hawkish. Similarly, we used the recent sell off in bonds to neutralise duration exposure, which was underweight. We continue to favour the 3-4 year part of the curve.

Asset Allocation

Global Allocation

Hard data in the US remains strong, although there continue to be mixed signals from soft data which points to a slight weakening of the US economy. There also seems to be more clarity from the European Central Bank, Bank of England and Swiss National Bank, whilst the outlook for the Federal Reserve is less clear. Despite all of the noise from President Trump, we are starting to see greater clarity from the White House in terms of policy direction.

Trend and momentum indicators suggest that the lows observed in April will not be tested again. A small correction in the next couple of months could potentially occur, although we do not expect there to be another sharp drawdown. As a result, we are maintaining the weights resulting from market drift in terms of the broad asset allocation. Fixed income exposure is reduced, moving to a slight underweight position relative to the benchmark, while the equity allocation has increased to a moderate overweight. Market drift has also pushed alternatives exposure lower, reducing our overweight, while cash remains below the benchmark level.

Fixed Income

At the same time as our overall fixed income allocation has fallen due to market drift, we are neutralising our duration exposure, increasing it from 3.5 years to 4 years. This reflects the increase in long-term rates after the Moody’s downgrade of the US. No other changes are being made to our fixed income positioning. Convertible bonds have been amongst the strongest performers within the asset class so far this year, and we maintain our overweight position. High yield also continues to do well, and we maintain our neutral euro weighting and a modest US dollar overweight versus the benchmark. Macro and technical factors continue to appear favourable for investment grade bonds, holding overweight positions across all currencies.

Equities

US valuations are close to neutral, having been in the very expensive zone back in December. In addition, some of the headwinds introduced by President Trump have now faded, so we view it as appropriate to add to US equities, closing our underweight gap to just below neutral. For now, we leave our European overweight unchanged, with all sectors appearing in an uptrend, supported as well by earnings strength. Headwinds from a strong Swiss franc have been a drag on Swiss large cap stocks and macro and technical factors have turned negative. As such we are reducing our Swiss allocation to underweight, although we maintain a preference for small caps. We also note that Swiss large cap stocks could be impacted by Trump’s pressures on the healthcare sector. Our Japan underweight was further reduced due to downward earnings revisions and a hawkish Bank of Japan supporting a stronger yen.

Equity Sectors

Equity Sector Views

UK
Given increasing risks from geopolitics, inflationary pressures, and slowing economic growth, we have increased our exposure to defensive industrial names (including aerospace and defence), with the sector remaining our largest overweight.

We continue to see an opportunity for the outperformance of UK midcaps over the coming quarters, reversing a multi-year period of underperformance due to high inflation and interest rates, as both of these factors normalise. Information technology has been a sector in which we have found specialist UK companies trading on attractive valuations in our view backed by strong structural growth tailwinds.

US
We are overweight in information technology and communication services, as Cloud and artificial intelligence investments continue to grow strongly, and there has also been upward earnings revisions. Our financials positioning is also overweight versus the benchmark, as macro conditions remain healthy and the sector could benefit from deregulation. We remain underweight in healthcare, due to heightened political uncertainties.

Europe
Outside of the changes to account for market drift, healthcare is being reduced from neutral to underweight. The materials sector is also being reduced, moving from an overweight to a modest underweight allocation. Technology positioning has been increased to an overweight position from neutral, while industrials is also added to, reducing the underweight level. For Europe overall we maintain a preference for value, contrasting that of our preference for growth in the US.

Alternatives
We recently increased our allocation to hedge funds, taking the weight from neutral to overweight, although note that there has been mixed performance amongst hedge fund strategies. Within commodities, gold remains strong, but has consolidated recently with some profit-taking occurring. However, we remain cautious on commodities as a whole due to oil remaining very weak and no price recovery yet in sight. Our insurance positioning remains overweight versus the benchmark, with our exposure serving as a valuable portfolio component given its uncorrelated nature.

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