The euphoric peaks and abyssal precipices of global markets in calendar year 2025 have no doubt ensured this year will enter the annals of the history books.  

As this rollercoaster year draws near its close, global markets remain at crossroads, making portfolio construction and asset allocation a perplexing endeavour for investors everywhere at present.

The perplexing crossroads of global markets

One-time existential questions around global trade, geopolitics and economic cycles earlier in the year have progressively resolved with the effluxion of time, only to raise several more dilemmas for investors.

Slowing disinflation, de-anchored inflation expectations, flagging economic activity with weakening labour markets and mixed signals from fiscal and monetary policy makers all add up to a wariness that strife may be lurking around the corner and it could be prudent to take some chips off the table.

Back to basics: the stabilising role of government bonds

It is always instructive in times like these to recall one of the foundational principles of investment management - asset allocation is the main catalyst for the performance of investment portfolios.

As such, investors need to understand their tolerance for withstanding risk and volatility (most of us think of this in terms of portfolio drawdown scenarios).

As valuations across asset classes, such as shares, credit, property and fixed income have swung violently (think liberation day versus today), investor sentiment has been suspended as it were, oscillating mercilessly between the elation of euphoric valuations and the fear of impending crises (none of which have yet eventuated, of course).

Against this backdrop, the remarkable resilience of risky asset classes in the face of trade and geopolitical turmoil, policy ineptitude and the vicissitudes of outrageous fortune, may have prompted a degree of complacency amongst many market participants.

This has desensitised many market participants to key investment risks.

Specifically, given astonishing returns across many securities, sectors and markets, considerations relating to investment risk in all of its variegated forms, (including the volatility of returns, correlations between returns, and tail events defined in the broadest possible way) have seemingly taken a back seat, as investors chase unprecedented performance.

Some assets, including government bonds, are often overlooked during times like these. They have historically provided consistent, low volatility and largely uncorrelated return streams almost every year during the past three decades including multiple financial crises, bonds continue to serve as the ballast for well-constructed portfolios.

Notwithstanding the secular and cyclical headwinds described above, Australia offers one of the highest yielding, best in breed (AAA rated) and now deeply liquid government bond markets. We do not need to worry about huge fiscal largesse and decaying credit quality seen in many western bond markets, and with our own domestic economy outperforming that of many anemic western peers, who continue to suffer from low or scant growth, we have a marketplace that has now priced RBA rate hikes into 2026.

While our own economy is solid, it still remains subject to shocks. Regardless of differing views around the probabilities of interest rate hikes occurring, there is general agreement that if the RBA does need to tweak rates to cool inflation, it will be a very mild hiking cycle given the fragility of macroecomic landscapes. Markets will start pricing the probability that such a move will add to domestic unemployment and recessionary risks, with bond markets likely to rally in the expectation of another pivot in policy direction and adjustment in risk profiles.

With many Australian Federal Government bonds now yielding close to 5.00%, and some high quality State Government bonds yielding close to 6.00%, they can help to play a stabilising role in a portfolio facing uncertainty. These assets offer government-backed income, strong liquidity and downside protection in extreme market conditions.

While their defensive qualities may rarely be called upon, similar to an insurance policy, they can provide a reliable income stream while serving as a safeguard during periods of market stress, particularly within a diversified portfolio that includes higher-risk assets.

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