Financial markets are set for a potentially volatile year. After the S&P 500 hit an all-time high last week, US tech stocks nosedived on Monday following the launch of DeepSeek, a Chinese artificial intelligence (AI) app developed far more cheaply and efficiently than rivals.
Asset managers also expect Donald Trump’s second term to mark a new era of geopolitical uncertainty and unpredictable policy making.
A third factor that could upset financial markets is the resurgence of inflation due to some of Trump’s initiatives such as tariffs, said Ernst Knacke, head of research at Shard Capital. He expects inflation to be increasingly volatile which could lead to more 2022-type environments where equities and bonds plummet at the same time and therefore, diversification has become more important than ever.
Below, Knacke breaks down the main trends he expects to play out over the next four years and how he believes investors should position their portfolios to cope.
Technologists have taken over the White House
Marc Andreessen, co-founder of the venture capital firm Andreessen Horowitz, wrote a column in the Wall Street Journal in August 2011 entitled ‘Why software is eating the world’.
“We are in the middle of a dramatic and broad technological and economic shift in which software companies are poised to take over large swathes of the economy,” he wrote.
A decade and a half later, his predictions have come true, Knacke said. “The technologists behind the software and innovation have taken over the White House. They have got themselves into positions that are very important from a policy perspective. And I think that will have significant ramifications.”
This takeover started with vice president JD Vance, who used to work in venture capital in San Francisco and has close relationships with PayPal co-founder Peter Thiel and other tech billionaires. Vivek Ramaswamy, who co-founded the biotech company Roivant Sciences, is now leading the Department of Government Efficiency (DOGE) along with one of the world’s best-known technologists, Tesla founder Elon Musk.
“Given that technologists have wormed themselves into the administration, I don’t think it’s necessarily [time] to sell your Magnificent Seven exposure”, Knacke said. Trump 2.0 could be an advantageous era for the likes of Alphabet, Amazon and Meta. However, he warned investors not to cluster too much of their portfolios into a narrow band of stocks.
The spiralling US deficit could kybosh treasuries
Treasury secretary Scott Bessent has pledged to bring down the deficit but Knacke is sceptical. “Trump and the whole MAGA [make America great again] vision is not austerity, so if anything, the deficit will probably continue to grow.”
This has negative consequences for the US government bond market. “The willingness of foreign governments and foreign investors to keep funding this US machine by buying bonds is probably going to come to an end and that won’t happen tomorrow, maybe not next year, but there is a chance that this happens within the Trump era, within the next four years,” he said.
Another related trend is “social misalignment between what governments and politicians will do versus what is the right thing for society in the long term”, Knacke continued. He expects government to print money to cover their liabilities which will exacerbate inflation and increase the volatility of inflation.
These structural shifts mean that diversification has become significantly more important – something that Knacke does not think many asset allocators are embracing.
The 60/40 portfolio is broken
“Going forward, we’re not going to have this regime of the past 40 years where inflation is nice and flat, around 2%. Inflation is going to be volatile. It’s going to be uncertain and with that comes the breakdown in correlations [between asset classes],” Knacke explained.
“So my base case is that the 60/40 portfolio is broken and we will have more 2022-type of environments.”
Equities are too expensive at present, with insufficient upside potential, to justify investing in them exclusively, he said. This even applies to people with long time horizons who would usually invest mostly in stocks, such as children or young people starting their careers.
Meanwhile, bonds are paying attractive levels of income but they also look expensive. This is especially true for corporate bonds given that spreads are close to all-time tights. “Credit doesn’t protect you from inflation and it doesn’t protect you against a blowout of credit spreads so from that perspective, credit doesn’t offer any value at all,” he noted.
Therefore, Knacke suggested a portfolio with some exposure to equities and government bonds, complemented by inflation protection from gold and inflation-linked bonds, as well as a diversified source of returns from managed futures.
Managed futures
Managed futures strategies offer a return stream that is not correlated to equities and bonds, thus helping to shield portfolios against drawdowns such as in 2022.
Furthermore, strategies that focus on commodity futures have exposure to real assets, which should do well during inflationary periods, thereby retaining the purchasing power of investors’ wealth.
Managed futures strategies have a major advantage over some other alternative asset classes such as property and private equity in that they are liquid, so if equity markets nosedive, they can be sold quickly and the money channelled into buying cheap stocks.
Returns can be volatile and can vary greatly from manager to manager so it is important to invest in several managed futures funds. Those vetted by Shard Capital include AQR Managed Futures, KLS BH-DG Systematic Trading, Bowmoor Global Alpha, Aspect Diversified Trends and CFM IS Trends.