Published on 04 Feb 2025

Volatility set to rise in year of Wood Snake; investors would do well to diversify

THIS year, 2025, is the year of the green Wood Snake, the sixth animal in the Chinese zodiac calendar. In Western culture, the snake is largely viewed with trepidation, as snakes are cold-blooded and often inhabit dark, visibly poor environments. Furthermore, encounters with venomous snakes can be fatal.

In Asia, snakes hold a far more complex and varied symbolism. In Indochina culture, which had indigenous snake-worshipping traditions, the snake or Naga, is considered an auspicious creature, one that brings protection and blessings, and is often used to decorate Hindu or Theravada Buddhist temples and monasteries.

However, Confucianist East Asian cultures typically see the snake as cunning, ruthless and manipulative, although its depiction in Chinese folklore has become less negative in recent years, as modern versions of Chinese classics such as Legend of the White Snake depict it in a more sympathetic light.

People born in the year of the snake are said to be resilient and courageous with strong leadership and interpersonal skills, and the snake is supposed to be the most tenacious of the 12 zodiac animals. Indeed, the founding fathers of modern China and India, Mao Zedong and Mahatma Gandhi, were born in the year of the snake and likewise, President Xi Jinping of China.

However, snake years have been tricky for investors. Since 1920, the Year of the Snake has been the worst performing of the 12 zodiac animals, with the S&P 500 returning an average of minus 3.3 per cent per Snake year, compared to the Dragon year's average of 14 per cent. And true to its nature, the Year of the Snake has struck venomously, with US President Donald Trump's imposition of 25 per cent tariffs on Canadian and Mexican goods (10 per cent on Canadian energy imports) and an additional 10 per cent levy on goods from China. He also reiterated a threat to hike tariffs on the European Union, citing the "tremendous deficit".

For now, Trump has agreed to delay tariffs on Canada and Mexico goods for a month.

The speed, scope and breadth of the tariff implementation are aggressive and surprisingly also include energy imports from Canada, although at a reduced rate of 10 per cent. That the Trump administration is willing to impose tariffs on energy imports goes against the conventional wisdom that cost-of-living considerations would act as a restraint.

The tariffs against Mexico and Canada, if sustained, have the potential to dampen US gross domestic product growth by an estimated 0.8 per cent in 2025. Tariffs will also add 0.4 per cent to US core inflation, as Mexico and Canada together account for about 30 per cent of the US' total trade.

"Purely economic"

Unlike the trade war in 2018, which was targeted largely at China, the current round of tariff implementation seems "hydra-headed", as President Trump commented that the tariffs were "purely economic", linking them to the US' bilateral trade deficits with various countries. Deficits cannot be "negotiated" in the same way as non-trade issues such as immigration and drug control.

The tariffs are likely to cause an overhang on markets and contribute to volatility. Markets will be required to hold a structurally higher risk premium across all asset classes for the foreseeable future, as there is clearly room for the tariffs to expand both in scope and magnitude. For example, the US, Canada and Mexico have been operating as one single trade area for more than three decades with unified supply chains across multiple industrial sectors, most notably automobiles.

The effective breakup of this trade area puts US manufacturers at a severe disadvantage versus those producing elsewhere. There will be greater economic pressure on the US to extend tariffs to other non-American producers still benefiting from integrated supply chains.

Nonetheless, there are lessons we can learn from 2018, when trade tensions between the US and China escalated. In the six months following that development, emerging Asian equities lost 18 per cent and Asian currencies declined by 8 per cent.

As tariffs are a terms of trade shock, we should expect the dollar index to react positively and Asian equities to react negatively as earnings are likely to be affected.

Trickle-down effect

In Asia, a weaker Chinese yuan has implications for other Asian currencies, and we believe the Indonesian rupiah, Malaysian ringgit and South Korean won have a greater sensitivity to a falling Chinese yuan, notwithstanding the tariff implications on the global trade cycle and commodities, which are the usual determinants of intra-regional currency dispersion.

However, there are mitigating factors now, such as global trade, which peaked in 2018. Relative effective exchange rates of Asian currencies are relatively cheaper. Net international investment positions in Asian assets are generally light.

For instance, net foreign institutional holdings in MSCI China remain subdued, while similar holdings in Thai, Malaysian and Philippine stocks are near all-time lows.

Furthermore, several concerns may temper Trump's appetite for escalation.

The Trump administration would not want to jeopardise US economic growth, risk inflation or stock market volatility by leaving the tariffs in place for a sustained period.

The Year of the Snake will likely be more volatile, and volatile markets require an increased focus on portfolio diversification and hedging.

In equities, capital preservation strategies can potentially manage downside risks.

Gold, high-grade and investment-grade bonds offer some insulation against uncertainty, and they can help diversify portfolios. While the US dollar has room to strengthen over the near term, we expect it to gradually give up its gains over 2025.

The writer is regional CIO south Apac, UBS Global Wealth Management. He is also adjunct associate professor, Nanyang Business School, Nanyang Technological University

Source: The Business Times