The art of diversification
There’s been no shortage of drama in the first half of 2025, from tariff uncertainty and geopolitical shocks to fiscal brinkmanship and technological disruption. Yet, despite all the volatility, economic fundamentals remain steady, major equity indexes are back near all-time highs, and bonds have delivered robust returns.
For investors, these should serve as strong reminders that staying invested and well diversified pays off, especially during periods of high uncertainty. Indeed, a balanced portfolio spread across asset classes, geographies, and themes would have captured gold’s outperformance and strong gains across Asia-Pacific, European, and emerging market assets since the start of the year. Meanwhile, those who stayed invested in US stocks through their steepest correction since the pandemic were rewarded with a forceful recovery.
However, the US dollar has been the notable laggard as investors began to reassess the drivers of long-running US exceptionalism. We think it’s premature to declare its end—after all, the US remains the most developed, liquid, and innovative market in the world. However, policy uncertainty, elements of de-dollarization, and geopolitical risks do strengthen our conviction that the US should not be a one-stop allocation heading into the second half.
Where else, then, can investors find effective diversifiers? In our view, Asia-Pacific markets offer a range of compelling options, underpinned by several key drivers in the second half.
First, tariff and macro risks are moderating. Though only the UK has come away with a trade deal so far, we think the 9 July tariff pause deadline will largely pass without major re-escalation as Asian partners continue to engage and the US administration becomes more attuned to growth risks. A comprehensive deal with China could prove difficult with both sides targeting supply chain chokepoints—namely rare earths and chips—but ongoing talks have reduced tensions and downside risks.
Ultimately, our base case sees tariffs settling around current levels (30-40% for China, 10-15% for others) by year-end, resulting in a modest growth slowdown. So far, the impact across Asia has been limited by export frontloading and proactive policy easing. Rising FX reserves, strengthening currencies, and entrenched disinflation have also created plenty of monetary and fiscal room to respond. Meanwhile, given a manageable tariff impact and with the property sector no longer a crippling headwind, China’s economy should achieve above 4.5% growth without further major stimulus. A war-induced oil price shock is a risk for energy importers, but we estimate Brent crude would have to rise to USD 100/bbl and above to become painful for the more vulnerable economies (South Korea, India, Thailand, the Philippines).
Second, the US dollar (down 11.6% from its January peak) should remain weak as its growth and yield premiums fade and twin deficit concerns persist. While de-dollarization, which has been slowly under way for the last 25 years, will likely be gradual given the lack of credible reserve alternatives, it's also become clear that US policy choices are leading to more capital hedging flows.
Against this backdrop, we think local currencies can appreciate another 3-4% on average over the next 12 months. Those with a large net international investment position (typically low yielders like the TWD, KWR, and SGD) could see larger upside or remain resilient as Asian corporate, institutional, and private investors hedge some USD 2-3tr in dollar holdings. What’s more, a weaker dollar also eases regional financial conditions and on balance is positive for local equity markets. Case in point, the HKD HIBOR overnight rate has remained at 0% since a rise in foreign capital inflows in early May, helping fuel an ongoing initial public offering boom. Meanwhile, the SGD equivalent has nearly halved since the end of last year to 1.7%.
Third, we think that long-term bond yields are set to fall around the world as growth slows and the Federal Reserve resumes rate cuts, driving inflows into high-quality bond markets and supporting rate-sensitive assets. APAC credit should also benefit from this tailwind, given the attractive yields on offer (YTM of 6.0%) and sound fundamentals across most segments. While Hong Kong corporate issuers (16% of the Asia HY index) represent a key weak spot, we expect the default rate to stay under 1% outside of Greater China.
Finally, structural trends—such as artificial intelligence, power and resources, and longevity—will likely continue to deliver the best long-term earnings growth. Key regional markets have strong links to these transformational themes and are deeply integrated within their supply chains.
How to position in APAC?
Given these drivers, we see an improving setup for global equities into 2026 and beyond. While US stocks should remain a core holding in any balanced portfolio, we also think select emerging Asian markets offer strong diversification potential given more room for policy easing, low-teens earnings growth this year, and light positioning.
Mainland China’s tech sector is increasingly benefiting from local innovation, growing AI adoption, and improving bottom-up fundamentals. With reasonable valuations and potential for additional currency upside, we stay constructive. Meanwhile, despite a strong rebound since the 9 April tariff pause, Taiwanese equities trade at a 40% forward P/E discount to global IT peers and remain well positioned to benefit from structural AI tailwinds, including a broadening of related spending.
India has underperformed year-to-date, but is set for an earnings revival over the next two fiscal years. We also rate Singapore as Attractive given ROE value-up potential, and like Malaysia and the Philippines, offers high dividend yields, improving earnings, and currency diversification benefits.
Overall, these smaller markets all have a relatively low correlation (less than 0.5) with US/developed markets, adding to their diversification value.
Investors should also review and actively manage currency risks. This process could include hedging USD exposure using currency overlays (i.e., by selling USD versus reference currencies on a forward basis), diversifying into alternative preferred currencies like the AUD and EUR, and ensuring loan currency mismatches are managed. Outside the G10, we expect the USDSGD to reach 1.25 (from 1.27) and USDCNY to hit 7.00 (from 7.20) by mid-2026. For excess cash holdings, we see merit in increasing home bias.
As cash rates and bond yields fall, APAC investment grade bonds should deliver attractive carry gains, while measured exposure to Asian high yield names with solid fundamentals can boost returns for a diversified portfolio. Local currency Asian bonds should continue to benefit from the region’s entrenched disinflation and a weak dollar environment, while offering additional currency diversification benefits for investors. We prefer to keep duration near the short end (up to five years) to avoid the volatility in long-end rates amid US fiscal concerns.
Finally, gold should remain an effective hedge against geopolitical risk, with prices further supported by a weaker dollar, declining real interest rates, and central bank and investment demand.
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