Recent volatility related to US-China trade tensions and credit risk in the banking sector is a stark reminder of macro risks that continue to stalk global markets – and how hard and fast they can hit.
Markets have been reminded twice in as many weeks of how vulnerable they are to bouts of volatility. Last week’s sell-off in bank shares on credit risk concerns came a week after a more violent reaction by markets on Friday 10th October to President Trump’s threat of a “massive increase” in tariffs on Chinese goods.
The threat instigated one of the most tumultuous trading days since early April: US equities fell 3%, corporate credit spreads widened sharply, the VIX spiked and crypto assets saw their largest ever one-day sell-off.
By comparison, credit risk concerns relating to two US regional banks provoked a less severe reaction across equities and bonds, but markets were still rattled, adding to a greater sense of nervousness.
These developments, especially the breadth and speed of the cross-asset reaction on 10th October, underscore two points: in this environment, volatility is only a headline away; and multiple macro risks still have the power to trigger sharp risk-off moves.
Indeed, even though the worst aspects of trade- and tariff-related volatility are largely behind us, and overall credit fundamentals remain strong, risk markets are priced such that any noise unsettling US-China trading relations or idiosyncratic credit issues can cause outsized reactions, even if shorter-term.
In these periods, the question becomes not where to look and when, but how to position across markets to mitigate impact and capture any related opportunity.
Stay alert – stay invested
Overall, we maintain our confidence in our outlook for growth and risk assets over the medium term, with targeted tactical exposures across asset classes and regions reflecting some of the divergences we are seeing among economic blocks.
There are good reasons to be positive on risk assets, through a barrage of market-moving headlines spanning trade, fiscal and geopolitical shocks, growth concerns, inflation risks and AI adoption.
Central to our view is the remarkable economic and corporate earnings resilience demonstrated in the US, a striking feat given the sudden and unexpected developments around tariffs. The durability of growth has been further validated at the start of the third-quarter earnings season, with almost all major US banks delivering strong, and in some cases record, results on profits and returns on equity.
Diversification plays
Single-day shocks like 10th October and last week’s credit wobble do not alter our constructive thesis, but they do create opportunities to observe potential stresses or unintended exposures in portfolios, with the ability to rebalance and reposition as necessary.
One of the more notable recalibrations from our outlook is our paring back of exposure to European equities and the euro to target from overweight – after generating handsome returns over the past few quarters – while increasing exposure to European fixed income.
This was not just discipline, but a way to capture a dislocation between European equities and bonds, largely reflective of a more challenging growth outlook for Europe, potentially provoking the European Central Bank to make additional rate cuts.
In such a growth-constrained setup, bonds can be additive to returns and strengthen portfolio diversification. This aligns with our view that duration – expressed primarily in European rates and in US rates more selectively – looks attractive as long-term yield concerns fade, and as yield curves are expected to remain more stable (if not flatten) after 2025 has seen substantial steepening.
Mixed with these positions in public equities and fixed income, we would also consider favouring alternative investments as an option in providing ballast to portfolios and expressing an overweight in commodities, particularly gold and precious metals, to provide an effective hedge against geopolitical and inflation risks.
Volatility and opportunity
As markets recover from these recent bouts of volatility, attention will turn to where and when the next flare-up may come. As the US government shutdown extends into its third week, this could be one area markets choose to focus on.
It is therefore key that investors stay alert to the continued macro risks that may stalk global markets but use future bouts of volatility to play offense. This is an environment to compound returns through discipline – rebalance on strength, add on dislocation, and let diversification and active levers turn inevitable flare-ups into opportunity.
By Jeff Blazek and Erik Knutzen, co-CIOs, multi-asset strategies at Neuberger
