The Fragility of Investment Assumptions: Trump, Truss, and Modern Portfolio Theory

In September 2022, Liz Truss succeeded Boris Johnson as Prime Minister of the United Kingdom. Within weeks of her ascension to the top job, she quickly made headlines with an aggressive economic gamble: a “mini-budget” featuring over £45 billion in unfunded tax cuts. Despite economists' warnings about her budget's risks, Truss pushed forward.

Markets reacted swiftly and harshly, leading to declines in stocks, bonds, and most notably the British Pound, which was down 15% at one point in the month of September 2022.

Typically, in times of uncertainty, investors shift their capital from riskier assets like public equities into more stable options like government bonds or safe-haven currencies such as the US dollar, Japanese yen, or Swiss franc. However, under Truss’s leadership in the UK, all three asset classes—stocks, bonds, and the pound—declined. This unusual pattern marked a loss of confidence in the United Kingdom as a safe place to park financial capital. Investors weren’t rotating from one asset class to another — they were retreating from all UK assets simultaneously.

We’ve seen a more moderate version of the same phenomenon in the United States over the past two months. Historically, U.S. markets have exhibited a negative correlation between stocks and bonds, and U.S. Treasuries and the U.S. dollar have typically acted as safe-haven assets during periods of global market stress. This historic pattern has been challenged recently based on President Trump’s erratic policy changes since “Liberation Day,” as investors have started selling all US assets – stocks, bonds, and currency at the same time.

For over half a century, U.S. treasuries and the U.S. dollar have served as a safe harbor during turbulent times. While it is too early to draw conclusions, a loss of “safe haven” status would have profound implications for portfolio management, and the global economic system at large.

This brings us to Modern Portfolio Theory (MPT), the foundational approach used by most portfolio managers. The central premise is that an investor should seek to construct an “optimal portfolio.” This optimal portfolio (which sits along the “efficient frontier”) can be assembled by looking at return, volatility, and the covariance matrix for various asset classes.

The implicit assumption behind MPT (and other similar models) is that the future will look a lot like the past. In recent years, we have seen these historical correlations challenged, and Trump’s policy moves are another reminder that the future may look very different than even the recent past. Portfolio managers may find that their safe haven assets (like U.S. dollars and U.S. treasuries) no longer cushion the blow of stock market declines, as their models predicted they would.

At Northwood Family Office, we take a different approach—one that does not rely heavily on historical correlations or efficient frontiers. Instead, we focus on a goals-based investing framework. A goals-based investing framework is founded on the premise that the purpose of investing is to meet specific client goals, such as funding lifestyle expenses, buying a property, philanthropy, or starting a new business.

Clients often have different pools of capital, which are matched to a specific purpose. For example, a client may hold U.S. dollars or USD fixed income investments, if they plan to purchase a property in the U.S., or as a source to fund future USD expenses. In the current environment, this approach has led us to avoid much of the recent pain associated with investments in long dated bonds and the declining U.S. dollar. More importantly, whether or not historical correlations continue to hold, our clients can be confident that their individual goals are well provided for.

In the end, Liz Truss’s economic experiment in the UK triggered major pushback, culminating in her resignation after just 49 days in office. This made her the new answer to the trivia question: Who is the shortest-serving prime minister in British history?

Although markets have reacted positively to Trump backing down on some of his more incendiary trade policies over the last few weeks, the long-term implications of his actions on economic and trade policy are still unknown. The U.S. dollar has been the global reserve currency since the end of World War II, and there isn’t an obvious replacement for it at this time. With that said, Trump still has over 3.5 years left in his term, and we could continue to see long-held assumptions about the global economic order challenged during that timeframe.

Interested in Learning More?

Northwood is a professional, boutique firm that specializes in serving the needs of families of wealth with a personal touch. We’d love to start a conversation. Contact us here.

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