Global Allocation in the Context of a Trade War

Trunity Partners’ Founder — Mona Zhang — held an investment seminar with our investors and buy-side/sell-side friends. The topic was “Global Asset Allocation in the Context of the Trade War.” The session focused on analyzing the true intentions of the Trump administration, the strategies used to achieve those goals, and provided insights into the outlook for the U.S. dollar, U.S. stocks, and U.S. Treasuries, as well as global liquidity trends. It also covered the long-term competitiveness and economic fundamentals of regions such as the U.S. and Europe. The event lasted about two hours and was packed with valuable content.

1. USD, U.S. Stocks, and U.S. Treasuries

Since the beginning of 2025, U.S. stocks have undergone a significant pullback, with market sentiment swinging wildly. The S&P 500 and Nasdaq have both dropped below their 200-day moving averages, with peak drawdowns of 24% and 30%, respectively. Investors are now facing heightened risks including geopolitical tensions, interest-rate cycles, supply-chain shifts, and economic strategic realignments. Common feedback from investors includes a “triple dilemma”: no attractive assets, unclear market trends, and reluctance to go overweight.

Recently, the VIX (fear index) briefly surged above 50. If we extend the VIX index historically, it is now practically comparable to early‑2020 when COVID first hit—indicating extreme pessimism and near-pandemic levels of irrational fear.

Investors are now focusing on three key questions. First: Are dollar-denominated assets still worth investing in? Second: Are U.S. stocks now unattractive due to extremely pessimistic fundamentals under the Trump administration? Third: Is there a default risk in U.S. Treasuries, given the enormous debt and rising yields? Today, we share our views on these three questions.

1.1 USD

We begin with the dollar—as the world’s reserve currency. Why has it achieved and maintains that status? We created a radar chart comparing several major currencies—Swiss franc, U.S. dollar, euro, yen, Canadian dollar, and renminbi—across six fundamental dimensions:

1. Economic size and quality of growth;
2. Inflation control;
3. Interest-rate appeal (higher yields attract capital);
4. Current-account balance (export‑oriented economies accumulate foreign reserves);
5. Political stability, rule of law, and central‑bank independence;
6. Capital openness (ease of free capital flows).

Despite some issues—like a persistent current-account deficit—a comprehensive comparison reveals that the USD remains stronger than the Swiss franc or euro on balance.

Japan, for example, suffers from long-term deflation and a central bank overly subservient to its government, despite current-account strength. Canada is in a recession with weak inflation control despite policy and institutional stability. China’s renminbi remains heavily capital-controlled, limiting its global reserve currency potential.

Hence, despite some decline in relative advantage post-COVID, the USD retains structural dominance.

A long-run currency chart since the Bretton Woods collapse in 1971 shows that while the dollar has gone through cycles—strong (1970s–’85), weak post‑Plaza Agreement, depreciation during the dot‑com bust, then strength again from 2014 to 2024—it has remained central to global trade, liquidity, and reserves.

Short-term: The USD should continue to hold reserve status, with no viable substitute in the near term.

1.2 U.S. Stocks

A long-term chart over the last decade shows S&P 500 up ~168.5%, Japan ~126.2%, Europe ~81%, China ~5%. While Japan’s recent two‑year performance has aligned more closely with the U.S., U.S. corporate earnings remain globally leading. Despite the pullback from trade-war fears, U.S. companies—especially global ones—maintain competitiveness, justifying long-term optimism.

1.3 U.S. Treasuries

U.S. Treasury concerns are real, even among professionals. Current holders include the Federal Reserve, U.S. domestic institutions, and commercial banks, making up ~70% of holdings (including pensions). Non-U.S. holders represent ~29%, led by Japan, China, the UK, Luxembourg, Ireland, etc.

Concerns exist that foreign holders may exit, but domestic buyers have room. Recent reports describe sharp Treasury yield swings due to hedge-fund collapses and speculation about increased selling by Japan via Goldman network trades. But major support mechanisms include:

Relaxation of SLR (Supplemental Leverage Ratio) rules, enabling U.S. banks to hold more Treasuries with less capital.

The “Treasury twist”—the Treasury itself intervening in its own market—and Direct Fed purchases of new 3- and 10-year bonds.

These tools support anchor stability. Compared internationally, U.S. government debt-to-GDP (~120%) is lower than Japan (~260%), China (~150%), and Italy (~140%). Many developed nations—France, UK, Germany—have comparable levels. Importantly, domestic holders are the majority in Japan and China (~90‑95%), making their debt less vulnerable, whereas U.S.–European bonds have higher foreign-holder percentages. In broader debt-to-GDP including corporate and household debt, the U.S. (~278%) ranks below Japan (~440%) and China (~375%), with the U.S. household (75%) and corporate debt (81%) relatively moderate.

Summary on USD, U.S. Stocks, Treasuries:

• USD: Hard to replace in short term, though its absolute dominance has weakened post‑pandemic.
• U.S. Stocks: Strong companies trading at attractive levels tend to outperform, especially multinationals with large overseas revenue.
• Treasuries: Despite higher yields, multiple domestic support mechanisms exist—default risk remains extremely low.

2. Market Outlook

We offer an analytical framework across timeframes:

• Short-term: Liquidity + risk appetite. Cash injection today doesn’t immediately shift sentiment until fear subsides.
• Mid-term: Liquidity + fundamentals (EPS growth, and, critically, the 10-year Treasury yield).
• Long-term: Liquidity + relative attractiveness across jurisdictions, based on Porter’s Diamond Model factors (factor conditions, structure, regulation, external opportunities).

2.1 Short-term

Global M2 (broad money) peaked during the 2020 COVID response, then contracted in 2022 due to rate hikes. Now, signs point to renewed expansion:

• China: 7‑day reverse repo cuts, RRR cut in May—adding ~¥1 trillion liquidity.
• ECB: Six rate cuts since June 2024 in response to euro strength.
• Bank of England: Considering ~25bp rate cut to 4.25%.
• Fed: Yield curve inversion and expectations for rate cuts starting July 2025.
• Risk appetite: VIX peaked in April with tariff announcements—now fear may have peaked, so a bounce is logical.
• Commodity data shows copper up ~15% YTD—suggesting investors are betting on a U.S. industrial revival.

2.2 Mid-term

Inflation: Real-time Inflation data (as of May 7) shows U.S. inflation at ~1.58%. This contradicts higher tariff-driven estimates. Falling rents (due to supply and slowed migration) and easing energy costs (OPEC production increases) are primary disinflation drivers.

Fundamentals: Government layoffs in D.C. damp housing; border policy has significantly reduced illegal immigration, reducing rental pressure. Inventory buying effects on Q1 consumption will likely reverse, damping inflation further. Tariffs remain near 10% average, mostly predictable.

Earnings calls and high-frequency data show economic cooling; businesses and consumers adjusting their pacing. We expect mid-high growth with inflation in a normal range.

Fed policy: Powell has historically been “slow and severe.” Based on current trends, once rate cuts begin, they may be swift and significant, lowering 10-year yields, reducing credit costs—for housing, investment, and, ultimately, aggregate growth. Real estate revival could trigger multiplier effects in materials, transport, and equipment.

Thus, mid-term watchers should focus on earnings resiliency and yield direction. With inflation likely overestimated and Fed ready to cut, market may shift from destocking to real-sector recovery.

2.3 Fiscal & regulatory tailwinds

Ongoing Fed bond purchases continue loosening financial conditions.

Fiscal side: corporate CapEx expensing incentives act like immediate tax relief—encouraging domestic factory investment.

Regulatory rollback (SEC, IRS, FDA—headcount cuts) reduces ESG/DEI scrutiny, accelerating energy, industrial, and real‑estate builds.

These "deregulation" trends benefit energy and heavy industries and have international spillover (Canada, HK).

The combined effects—monetary, fiscal, regulatory—support domestic industrial resurgence, complementing earlier commodity positioning.

Event risks remain: geopolitical conflicts (Middle East, Ukraine, India‑Pakistan) and natural disasters (e.g., major Japan earthquake) could trigger volatility or downturns.

3. MAGA Strategy and U.S. Policy Continuity

Through Porter’s Diamond Model, the U.S. remains attractive:

• Factor conditions: energy, natural resources, water on tap.
• Firm strategy, structure, rivalry: U.S. enterprises lead globally in leadership and execution.
• Regulation: Regulatory rollback has begun reversing prior 'left-leaning' trends.

Geopolitically, both Trump and Biden pursue the same goals—reindustrialization and energy-security—but via different paths: Trump through tariffs, deregulation; Biden via direct subsidies plus green energy. The convergence: both aim to restore manufacturing.

On energy: Biden preferred renewables (with supply-chain reliance), while Trump emphasizes traditional energy and resource diplomacy—e.g., securing Ukrainian minerals amid a potential peace deal. U.S. resource diplomacy targets critical minerals.

“People, money, resources” under MAGA:

• People: to shift academic/political ideology, the Trump camp is clashing with universities (Harvard, Yale), pulling DEI funding.
• Money: corporate investment commitments (Apple, Nvidia, TSMC, Hyundai) offset budget pressures using CapEx incentives.
• Resources: targeting Ukraine’s minerals, LNG, lithium etc. through trade/diplomatic leverage.

Trade war outlook:

• With Europe: Non-tariff barriers (via ESG, regulation) make comprehensive agreements unlikely; tariffs may stabilize at 10–15%.
• With China: Deep decoupling in core high-tech sectors will continue; non-core sectors (e.g., small appliances, garments) will likely revert to more normal tariff levels.
• Others (Japan, Korea, India, UK): bilateral deals expected by year-end; industry invest-back strategies matter more than nominal tariffs.

4. Investment Portfolio Strategy

Our portfolio (since Q3–Q4 2024) targets high-quality U.S. companies at reasonable valuations; “Mag7” stocks have normalized. We also invested in Europe’s high-quality names. EQ portfolios emphasize ROIC, moat, governance. This reduces volatility in downturns, as discipline and business quality provide buffers.

2025–2026 focus: select cyclical and discretionary leaders, as well as “risk-management” stocks supporting large enterprises. Also, Gen AI companies turning real profit.

Key takeaways for investors:

• We are in an era of global liquidity expansion—holdings must beat cash’s purchasing-power erosion.
• Geopolitical, war, disaster uncertainty runs high—spread across countries and asset types.
• Invest in global “leaders” within niche domains—top-quality, moat-based names attract capital in liquidity-rich environments.
• Conclusion on U.S. markets: Liquidity is flowing, fundamentals remain resilient, volatility is expected, but likely contained below April’s extremes. With mid-term tailwinds from policy easing and CapEx incentives, the U.S. economy may engage a late-cycle rebound.
• From a diversified global asset-allocation perspective, continue to seek core U.S. exposure but balance globally. We plan a deep-dive next session on Bitcoin as an inflation hedge alongside gold.