The Big Picture: Divergent Policies, Divergent Markets

Global financial markets are no stranger to divergence, but some periods in history stand out as particularly fragmented. At their core, such episodes, characterised by significant outperformance in some markets and notable underperformance in others, often originate from a single source – policy.

Take the 1980s for example: Former US President Ronald Reagan’s sweeping economic reforms – popularly known as ‘Reaganomics’ and characterised by deep tax cuts, deregulation and a strategic boost in defence spending – not only unleashed a boom in US equity markets and the US dollar but also profoundly impacted international dynamics. While emerging markets, particularly Latin America, felt the burden of their dollar-denominated debt, export‐driven economies in parts of Asia and Europe struggled as their goods became less competitive on the global stage. The result was a stark divergence in the performance of US markets and much of the rest of the world, which faced severe economic and financial strain.

History doesn't repeat itself, but it often rhymes

Fast forward to today, and we are in the midst of an even more significant policy shift. US President Donald Trump has signalled a pivot towards American self-reliance and isolationism, outlining a policy agenda that supports domestic industries and reduces global interdependence.

Regardless of whether these policies foster US economic growth, one thing is clear from history: policy shifts tend to have unintended and unexpected consequences that ripple through markets as participants take time to digest their impact.

For example, the announced reciprocal tariff regime – with tariffs at the highest levels since the early 20th century – targeting the EU, China and the rest of the world is currently centre stage. As a result, Europe is taking steps towards strategic autonomy while China is restructuring its regional supply chains to reduce dependence on US markets. As in the 1980s, these dynamics are putting significant pressure on global markets, while also exacerbating disparities in regional market performance. The key difference between now and then is that, at the time of writing, several market commentators are forecasting the decline of US exceptionalism, while investors are struggling to understand the implications for the global economy.

Decoding divergences

From a quant perspective, greater divergence in markets is positive. Highly integrated financial markets reduce opportunities for systematic managers to identify and exploit idiosyncratic price drivers, as returns are dominated by market-wide factors and beta. In contrast, less correlated equity markets increase opportunities to identify mispricing and take advantage of sustained dislocations.

As any seasoned trend-follower will know, the overall information ratio (IR) of a trend-following strategy is largely determined by the individual market IRs and their correlations. In other words, as markets diverge and correlations decrease, the combined IR increases. This improvement in diversification allows trend-following strategies to take greater risk in any single market, which tends to generate higher returns. As ever, there are caveats: not every fall in correlation will yield significant benefits, particularly during short-lived correlation changes driven by directionless markets.

In Figure 1 below, we plot the risk-adjusted returns of a trend-following strategy against developed and emerging market equity correlations. It clearly shows a consistent relationship between lower equity correlations and higher risk-adjusted returns over many market cycles. This is because periods of market fragmentation provide systematic strategies with a broader range of independent trends to capture. Put simply, lower equity correlations create significant opportunities for alpha extraction.

Figure 1: Lower equity correlations have historically driven higher risk-adjusted returns in trend-following strategies

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Source: Bloomberg and GFD database. Equity correlations based on monthly performance of developed and emerging markets (1 November 1980 to 31 March 2025). Reagan administration - 1 November 1981 to 31 October 1998. Trump's second mandate - 1 November 2024 to 31 March 2025. Based on 3-year rolling equity correlation and trend-following returns.

Closing thoughts

As policymakers worldwide steer their economies along divergent paths – from the legacy of Reagan-era fiscal dynamism to the shift we are seeing today towards greater national self-reliance – the resulting fragmentation of global markets signals an opportunity for trend-followers. These strategies have proven they can be adept at capitalising on market dispersion and converting uncertainty into potential gains.

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