Perpetual bracing for impact
In a May 2025 letter to clients entitled ‘Brace for Impact’, Perpetual Asset Management Australia (ASX:PPT) echoed the cautionary sentiments of legendary investor Paul Tudor Jones, warning investors to “brace for impact” as markets fail to price in an economic slowdown already underway.
Their letter highlights a precarious optimism in U.S. equity markets, despite looming threats from trade wars, elevated valuations, and diminishing diversification from traditional safe havens like U.S. treasury bonds.
A fragile calm amid tariff tensions
President Trump’s recent softening of rhetoric on tariffs and the Federal Reserve has provided markets with a temporary reprieve, stabilising prices after an eight per cent decline in U.S. equities from their February 2025 peak.
However, Perpetual warns that this calm is deceptive. The ongoing trade war, if sustained, is projected to stifle U.S. Gross Domestic Product (GDP) growth by approximately two percentage points, potentially stalling at zero per cent to 0.5 per cent in 2025, while simultaneously driving core inflation higher over the next two years. Despite a near-10 per cent drop in share prices, Perpetual reckons U.S. markets remain priced for perfection, with S&P 500 valuations in the 83rd percentile and 12-month forward earnings-per-share (EPS) growth forecasts at a robust 12.3 per cent – nearly double the historical average and unjustifiably high.
Such optimism appears unsustainable given the economic headwinds confronting the U.S.
Overvalued markets and rising risks
Perpetual notes that U.S. equities, particularly megacap tech stocks, have seen a valuation de-rating, with forward price-to-earnings (P/E) ratios dropping to 30x from higher levels, compared to 18x for the remaining S&P 493. Yet, these metrics remain historically expensive, leaving little margin of safety. Perpetual argues that risk premia in both equity and credit markets must rise from today’s “anaemic” levels to reflect the heightened uncertainty. U.S. markets, therefore, risk retesting their April 2025 bear market lows in the coming months.
The global appetite for U.S.-denominated assets is also waning. Since 2014, global investors have increased their U.S. equity holdings from 20 per cent to 30 per cent of portfolios, but a reassessment of U.S. earnings-per-share (EPS) growth and a depreciating U.S. dollar (down eight per cent year-to-date per the DXY index) could trigger renewed selling pressure. The rare simultaneous losses in U.S. equities, bonds, and the dollar – a phenomenon seen in only five per cent of months over the past two decades – signals declining foreign demand, particularly for long-dated treasuries, as U.S. core inflation is expected to outpace that of other developed economies.
Rethinking diversification
For the second time in three years, Perpetual reflects on the fact that U.S. treasury bonds have failed to provide effective diversification during an equity bear market. U.S. ten-year treasury bond prices have declined while yields have risen by 13 basis points since March 2025, undermining their role as a safe haven in portfolios. Perpetual attributes this to a structural shift: periods of above-average inflation, like the current decade, historically deliver the lowest real bond returns. This challenges the traditional reliance on government bonds and long-duration illiquid assets for portfolio protection.
As we have noted in previous blog posts here, “when inflation – averaged over a 2-year period – exceeds four per cent, the correlation between stocks and bonds has never been negative. In other words, bonds don’t offer the much-lauded diversification and stability benefits [when inflation risks rise].”
While we advocated for investors to research and consider our Private Credit Funds instead of publicly traded fixed interest products, Perpetual advocates for a broader diversification toolkit, emphasising strategies with positive convexity during market stress. One such approach Perpetual advocates is the strategic use of bought put options, which limit losses to the option’s purchase price, offer insurance by consistently mitigating equity downside risk, and avoid the need to sell high-return assets like equities.
The problem of course is that timing is critical – options should be bought when market complacency is high and implied volatility is low to maximise cost-effectiveness. And the other problem is a solid knowledge of derivates, time decay and ‘the Greeks’ of option trading is necessary.
Instead, diversifying part of a portfolio into Private Credit, which can offer monthly income, attractive returns, and monthly liquidity, may, for some, prove to be a preferable option to trading derivatives such as options.
Navigating the road ahead
With U.S. growth widely expected to stagnate and supply chains already disrupted by tariffs, Perpetual’s letter highlights the importance now of downside protection, particularly for investors nearing or in retirement. The firm advises reallocating from expensive U.S. equity markets to less crowded markets and implementing explicit portfolio protection strategies.
Perpetual’s bearish outlook suggests markets are skating on thin ice. With elevated valuations, overly optimistic EPS forecasts, and a Federal Reserve unlikely to intervene unless a full-blown recession looms, investors are advised by Perpetual to adopt proactive strategies to safeguard their portfolios. I think there are more elegant solutions that offer diversification. I also think selling U.S. stocks outright will, in the long term, prove unwise.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
