Investment Strategy
May 20, 2025
How to protect portfolios from increasing deficits
U.S. equity markets are declining this week after a downgrade of the U.S. sovereign debt rating and the narrow passage of President Trump’s tax bill in the House. Details are covered below.
Weekly moves:
- In equities, the S&P 500 is down -2.0% heading into the holiday weekend. The tech-heavy NASDAQ 100 (-1.5%) is outperforming but remains negative. Internationally, European equities (-0.1%) are nearly flat, while offshore Chinese equities have gained about +1.1%.
- In fixed income, bonds are selling off. The debt downgrade, increased fiscal deficit projections and a weak 20-year Treasury auction have pushed yields higher at the long end of the curve. The 20-year yield is up +8 basis points (bps), and the 30-year has reached its highest levels since 2023, climbing +9 bps, reflecting increased term premium.
- Gold is serving as a hedge against geopolitical and deficit risks, rising +3.9% this week. Oil (-1.5%) is declining as OPEC+ members are discussing a potential third consecutive oil production increase in July, considering an additional 411,000 barrels per day.
Below, we explore how investors can add resilience to their portfolios amid the prospect of higher fiscal deficits.
President Trump’s tax bill narrowly passed the House with a 215-214 vote, advancing a multi-trillion dollar package aimed at preventing a year-end tax increase while significantly increasing the U.S. debt burden.
The reconciliation bill has shifted focus away from tariff policy over the past month, though this morning President Trump made two new tariff threats over social media. The first is a threat to place “at least” a 25% duty on iPhones unless Apple makes them in America. In the second, the President said he was “recommending” a 50% tariff on goods imported from the European Union starting on June 1st. First-quarter earnings reports from about 95% of S&P 500 companies show that over 85% mentioned “tariffs” on their calls. An empirical research analysis found that only ~11% of companies reported an explicit tariff impact, suggesting a 7% decline in gross profit margins.
86% of S&P 500 companies mentioned “tariffs”
Number of S&P 500 companies that mentioned “tariffs” on earnings calls
Source: Bloomberg Finance L.P. Data as of May 22, 2025.
Nonetheless, earnings growth for the year now stands at 12.4%, relatively in line with the 12.6% prior to the earnings season kick off.
With a delay until July 9th for reciprocal tariffs to take effect, and more clarity from companies on tariff impacts, investor focus has largely shifted from tariffs to deficits and the tax bill.
The bill faces Senate opposition, with Republicans divided over permanent tax cuts and spending cuts. Currently, the bill aims to make many of the tax cuts in the 2017 Tax Cuts and Jobs Act (TCJA) permanent, estimated to cost $3.8 trillion over ten years, with net spending cuts reducing the estimated net cost to $3.2 trillion over ten years.1
This increase amounts to $320 billion annually, requiring $26.6 billion in monthly tariff revenue to maintain a constant deficit.
Tariff collections aren’t enough to cover deficit shortfall
Monthly tariff collections, $ millions
Sources: Haver Analytics, Daily Treasury Statement. Data as of May 21, 2025. Note: monthly tariff collections calculated as a $3.2 trillion increase in the deficit over 10 years, according to the Penn Wharton Budget Model, Congressional Budget Office, Joint Committee on Taxation, and House Committees.
Increasing deficits are not a new phenomenon in the United States. Just last week, Moody’s became the latest nationally recognized statistical ratings organization (NSRO) to downgrade the United States sovereign credit rating (following the S&P in 2011 and Fitch in 2023), citing increasing fiscal deficits as the reason for the downgrade.
Bond markets have been selling off, not just due to the downgrade, but also due to the prospect of increasing deficits as global investors diversify away from U.S. dollars. Unlike before, U.S. growth estimates are declining. Earlier this year, Wall Street expected deregulation and continued U.S. exceptionalism, supporting higher 10-year rates. Now, rates are rising due to deficit fears, not growth expectations.
Yields have risen while growth estimates are declining
Left axis = U.S. real GDP growth, YoY%. Right axis = 10-year yield, %
Source: Bloomberg Finance L.P. Data as of May 22, 2025. Note: U.S. real GDP growth represented by median Bloomberg 2025 survey.
Currently, the deficit as a share of GDP is higher than nominal GDP growth, indicating a rising debt stock. However, if the government’s borrowing rate exceeds GDP growth, the debt stock will increase rapidly. For now, the borrowing rate is below GDP growth, providing some reassurance despite the path toward a higher debt ratio.
To protect portfolios from increasing deficits, we suggest adding resilience, defined as assets that could increase income and/or provide uncorrelated returns to both bonds and equities. Collectively, the assets offer the potential to mitigate the severity of portfolio-level drawdowns. Here are three ways to achieve this:
1. Dollar diversification: Investors are distinguishing between countries based on their reliance on external financing for trade and budget deficits. The United States is viewed less favorably, potentially keeping the U.S. dollar under pressure as global investors adjust portfolios. This is evident in higher U.S. government funding needs relative to G-10 peers and a current account deficit, which implies the need to fund it externally.
The U.S. relies heavily on external financing relative to G-10 peers
Sovereign yields relationship to twin deficits
Source: Bloomberg Finance L.P. Data as of May 22, 2025.
U.S. equities have outperformed globally by +2x since 2010, leading to portfolios heavily weighted in U.S. assets. Whether due to lack of rebalancing or capturing U.S. tech growth, it was a sound strategy. However, we see tides changing, and we recommend adding international diversification to underweight portfolios. The U.S. dollar is seen as structurally overvalued due to historical foreign investment inflows and shifting investor confidence amid diminishing U.S. economic advantages and rising political risks.
To mitigate risks from a potentially overvalued dollar, consider diversifying investments into international markets not denominated in U.S. dollars, such as Europe and Japan. Diversification, rather than concentration by definition, means that you likely won’t have the highest return (won’t be holding 100% of the highest-performing asset) in a given year, but it creates a smoother ride for investor portfolios. Using MSCI World as a benchmark, we believe about 30% of your equity allocation should be in non-U.S., with two-thirds of that in Europe. This can help reduce currency risk and further diversify sources of return in your portfolio.
2. Gold: Gold is up ~25% year-to-date amid increased central bank buying and heightened uncertainty.
As we wrote in our Mid-Year Outlook, many central banks (e.g., Saudi Arabia, Taiwan, Japan, China, Singapore, Brazil and Korea) have less than 7% of their foreign reserves in gold. In comparison, Germany and the United States each hold over 75% of their reserves in gold. This means that central banks have room to expand gold holdings. And just this week it was reported that China last month imported the most gold in nearly a year, despite record prices, after heightened demand for the precious metal prompted the central bank to ease restrictions on bullion inflows. Total gold imports to the country reached 127.5 metric tons, a 73% jump from a month earlier.
We believe the precious metal can continue to act as a diversifier to geopolitical risk and higher deficits.
3. Infrastructure. Infrastructure investment offers a compelling opportunity with long-term contracts often embedding inflation hedging for portfolio resilience. Over 40% of historical infrastructure returns are driven by income. Generating income through infrastructure may be attractive (for suitable investors) amid elevated bond market volatility. Since Q2 2008, infrastructure has generated low double-digit annual returns.
Questions on how to add resilience to your portfolio? Reach out to your J.P. Morgan team.
RISK CONSIDERATIONS
All market and economic data as of May 2025 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
- Past performance is not indicative of future results. You may not invest directly in an index.
- The prices and rates of return are indicative, as they may vary over time based on market conditions.
- Additional risk considerations exist for all strategies.
- The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
- Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.
Important Information
A new tax bill is poised to push the U.S. debt burden higher. Here’s what you can do to protect against the risks
Alan Wynne
Global Investment Strategist
Published May 23, 2025
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