[CONTRIBUTION] Can tariffs stem fading US exceptionalism?

By Raymond Cheng

Since the beginning of the year, financial markets seem to have priced in the rising odds of a recession in the U.S. Gold has led the pack in terms of returns, followed by bonds, whereas global equities barely eked out any gains, mainly dragged by the U.S.

The U.S. market angst continues to build amid intensifying trade rhetoric ahead of April 2, when President Trump is set to unveil his reciprocal tariff plan. Trump has touted the day as “Liberation Day” for Americans on the assumption that they will ostensibly regain some of the wealth given up to other countries due to perceived unfair trade practices.

By imposing tariffs against key trade partners, will Trump be able to turn around the U.S. stock market, which has notably underperformed other regions this year? How should we position our investment portfolio in these turbulent times?

Tariffs not the only driver of US underperformance

Market focus on Trump tariffs appears to have masked many other factors behind the recent U.S. equity underperformance. Trump adviser and Tesla CEO Elon Musk’s Department of Government Efficiency’s initiative to aggressively cut federal jobs has weakened consumer and business sentiment, raising concern about the outlook for U.S. retail spending and corporate reinvestment. Moreover, so-called "U.S. exceptionalism" has been called into question by the emergence of China’s low-cost chatbots, such as DeepSeek.

Meanwhile, global bond yield differentials are also narrowing. Euro area and Japan 10-year government bond yields have both surged 40 basis points from the start of the year, contrary to the 30 basis points contraction in the U.S. 10-year yield. This has caused the dollar index to slump nearly 5 percent. Such a confluence of factors eclipsed the tariff scare, catalyzing the outperformance of Chinese and European equities vs. the U.S. year-to-date.

Reciprocal tariffs do not derail soft-landing base case

The prospect of wide-ranging tariffs has lifted Americans’ one-year inflation expectation to a 32-year high of 3.9 percent. If such elevated expectation persists, it will impede the Federal Reserve's (Fed) ability to implement rate cuts in response to any notable growth slowdown.

We believe that self-proclaimed “Tariff Man” will keep leveraging tariffs as a negotiating tactic, cognisant that the longer it takes to negotiate with every trading partner, the more adverse impact it will have on U.S. consumers and business sentiment. Hence, it is no coincidence that Trump has proposed “flexibility” in the upcoming tariff measures. That said, tough talk on tariffs is paving the way for the deployment of the rest of Trump’s growth-oriented policy tool kit, including deregulation and tax cuts.

On balance, we expect tariff uncertainty to abate and inflation expectations to moderate over time. This reinforces our base case for the U.S. economy to achieve a soft landing in the next 12 months. As such, we broadly agree with the Fed’s economic projections, which foresee slightly higher inflation and slower, though still positive, GDP growth of 1.7 percent this year. We assign only a 20 percent chance of a U.S. recession in the next 12 months.

How to position portfolio for volatile Trump 2.0 era

Since we anticipate bouts of market volatility in the next few weeks, it is more important than ever to build and maintain a well-diversified foundation portfolio across asset classes. We have advocated an overweight allocation to gold, which has historically been an effective hedge against any inflation and geopolitical risks. Adding exposure to alternative investments is also a time-tested way to reduce portfolio sensitivity to market movements resulting from policy noise.

We retain our overweight stance on global equities, with a slight bias towards the U.S. on the heels of its recent pullback. Within U.S. equities, we recommend diversifying away from the semiconductor sector into software, communications and domestically oriented financial sectors while dialing up on defensive, value plays in the health care sector. The U.S. dollar looks oversold and may rebound in the near term around any tariff announcement. However, we expect the greenback to weaken in the longer term. This warrants adding exposure to international equities on any near-term pullback.

Targeted exposure in Europe, Asia

We recommend targeted positioning in Europe, with a focus on the banking and industrial sectors, driven by an expected economic recovery fueled by Germany’s defense and infrastructure spending boost.

In Asia, excluding Japan, we like China's offshore equities. Nevertheless, we believe a barbell strategy is justified given China equities have already rallied strongly, and there is a chance of further U.S. tariffs hurting sentiment in the near term. Hence, we balance our preferred growth-focused Hang Seng Tech index exposures with defensive, high dividend-paying non-bank state-owned enterprises listed in Hong Kong.

In bonds, we shift our preference from government to corporate bonds to capture the opportunity created by the recent rise in the yield premium on U.S. corporate bonds due to growth concerns. We consider corporate default risk to be relatively contained, thereby providing a window of opportunity to tactically add Developed Market high yield corporate bonds.

As tariffs and inflation remain key macro risks in the foreseeable future, a common mistake is not investing and instead parking your wealth in cash. Holding large amounts of cash is akin to letting inflation erode long-term returns. Diversifying your portfolio across asset classes and geographies is pivotal to navigating the current volatile times.

Raymond Cheng is chief investment officer for North Asia at Standard Chartered's wealth solutions unit.