As Trump returned to the White House, executive orders began to fly, and attention quickly turned to the major trade deficits with Canada, Mexico, and China. The neighbouring countries received hasty calls to action but managed to delay tariff implementation while talks progressed. On the other hand, China faced a raft of tariffs and, rather than formally engaging in dialogue, responded with its own.
At times like this, the world can feel uncertain. Corridors of trade are shifting. As we saw with politics throughout 2024, predicting the first-order effects is difficult, and predicting the second-order effects on markets is even more so. Despite this, it is worth considering how markets may, over time, become desensitised to tariff headlines, especially if they detect a pattern in how negotiations play out.
Markets must also contend with multiple headlines. The rise of AI alternatives from China has raised questions about the sustainability of profits among the ‘Magnificent 7’, most notably Nvidia. Perhaps more interesting than the return of tariffs this year has been the recent increase in short-term volatility of the S&P 500 relative to its equal-weighted counterpart, as shown below. The chart gives an indication of why we were careful when increasing the allocation to the US earlier this year. Introducing the equal weight exposure takes the edge off concentration within the US allocation, but we also need to be mindful of how it can be a very different journey at times, as shown throughout 2020.
Source: AJ Bell 13/02/2020 – 10/02/2025
China remains a key focus due to renewed trade tensions with the US. While unrelated to tariffs, the uniqueness of China's position in the global equity market has led us to introduce a new asset allocation structure for Emerging Markets and Asia ex-Japan in 2025. This adjustment aims to provide greater transparency, flexibility, and control.
Emerging Markets and Asia ex-Japan equity regions can be a source of interesting long-term growth prospects, however there’s nuance within these broad regions. Across the industry, many asset allocations, including previous versions of our own, have included an ‘All Country (AC) Asia Pacific ex-Japan’ allocation, which significantly overlaps with Emerging Markets at a country level. The extent to which this happens depends on the benchmark provider you choose. For example, MSCI classifies South Korea and Taiwan as ‘Emerging’, whilst FTSE indices classify them as ‘Developed’. There are, however, bigger and more consistent problems with China and India, both of which sit in the AC Asia Pacific ex-Japan and Emerging Market (EM) indices at a considerable weighting (over 20%).
For some this may not be a problem, because it is possible to unpick the underlying country- level allocations – whether using passive or active strategies. The problem for those using a Mean Variance Optimiser (MVO) is the collinearity that is created by having inputs (in this case, benchmarks) that contain the same underlying assets. Simply put, this is when the MVO can see that two asset classes have high correlation, but cannot distinguish the true reasoning because it is only looking at the headline benchmarks, not the underlying constituents. This is much the same with sectors and factors which are, by nature, constituents of the global equity or country benchmarks. Here the principles of MVO are being pushed to the extent that the outputs are of limited quality. As the saying goes: rubbish in, rubbish out.
We’re constantly looking for ways to improve our process, and this topic has bubbled away for a couple of years. China has been the focus, given it also suffers from a demographic headwind and there’s a plethora of structural and geopolitical issues to debate. This is broadly not the case with India. The good news is we now have the tools at our disposal to implement a change. Products that follow an Emerging Market ex-China benchmark are increasingly coming to market and pricing is becoming competitive.
As a result, we have reorganised our benchmarks from Emerging Markets and AC Asia Pacific ex-Japan, to Emerging Markets ex-China, China, and Pacific ex-Japan. The latter is a Developed Market index, consisting of Australia, Hong Kong and Singapore. This reorganisation solves the collinearity problem in our MVO, and gives greater visibility and control over our allocation to China, should we ever wish to intervene.
| 2024 SAA | 2025 SAA |
| Emerging Markets | Emerging Markets ex-China |
| AC Asia Pacific ex-Japan | Pacific ex-Japan |
| China |
We do not expect to make any changes to our allocation to China based on the tariff noise. As mentioned earlier, first and second-order effects are difficult to judge — it may not be tariffs that ultimately dictate the direction of Chinese equities this year. Furthermore, their relatively low valuations suggest a significant amount of negative sentiment is already priced in. Whist we may often talk about specific country and sector positions of interest, it is worth remembering the portfolios remain well diversified so that returns in any given year do not hinge on the performance of one market or theme.
The value of investments can go down as well as up and your client may not get back their original investment.
Past performance is not a guide to future performance and some investments need to be held for the long term.