Revisiting certain uncertainty – mid-year outlook

The first half of 2025 has not been dull. Many people, myself included, thought that the new Trump presidency would see some fireworks. But few expected the policy uncertainty that we have experienced in that time – and markets certainly didn’t, given the extent of moves we’ve seen in this first few months.

We have all seen what’s happened with announcements around tariffs, the market sell-off and then bounce-back. Can we draw any conclusions and how do we position ourselves into the second half of 2025 and beyond?

A textbook example of volatility

If someone asked a generic question about what volatility in markets is like, I think we could just point at the S&P 500 since the US election in November last year (figure 1). In rough terms, we seen a 7% rise on the Trump victory, an 18% drop when the tariffs were announced and then a 15% rally when those same tariffs are delayed. In net terms, the market is flat, but the ride has been quite unnerving. VIX, the volatility measure based on S&P 500 options, has hit a higher level only twice in the past 20 years – the great financial crisis and the outbreak of Covid (figure 2). Are the Trump tariffs as disruptive as those two events? Obviously not if most of these tariffs do not materialise, but I don’t think we can rule it out if Trump follows through with his threats.

Figure 1: The S&P rollercoaster

Source: Bloomberg

Figure 2: VIX at levels rarely seen in recent deacades

Source: Bloomberg

Always look at the bond market

In December I asked if we might see the return of bond vigilantes. Today I would qualify that statement: the days of bond vigilantes as described in the 1990s are, for now at least, over. But after nearly 20 years where near-zero interest rates and quantitative easing were the main drivers of yields, we are once again seeing a cycle where policy directly impacts bond yields and in turn these impact policy.

If we are at the end of zero interest rates, and QE and globalisation is, at the very least, reduced, then I think yields are going to be back in more ‘normal’ historical territory for some time.

Inflation is key here. At the start of this year, markets were pricing rate cuts on an assumption that inflation would be back at low levels – thanks to the higher interest rates put in place to deal with the spike in inflation brought about by Covid stimulus and the invasion of Ukraine. We are now seeing a calculation that at least some of this increase may be structural, which I think is correct given that globalisation – which did so much to bring inflation down in the 1990s – is now at least partially in retreat. That globalisation trend was another key driver of a two-decade shift lower in long-term bond yields (see figure 3). If we are at the end of zero interest rates, and QE and globalisation is, at the very least, reduced, then I think yields are going to be back in more ‘normal’ historical territory for some time.

Higher yields have implications for lending and defaults. We are already seeing increases in defaults in short-dated credit markets such as autos and credit cards. This has not yet fed through into higher mortgage defaults, but with US mortgage rates pricing off 30-year treasury bonds, there is a meaningful risk that this increases over the months ahead.

Figure 3: US, UK, Japan, Germany 30-year government bond yields

Source: Bloomberg

The impact on economic behaviour

A backdrop of increased uncertainty around trade policy and interest rate cuts, coupled with the certainty of greater borrowing costs today means that businesses and individuals are understandably deferring spending decisions. Imagine you are a global company considering investing in production. Do you site it in the US, hoping to get under the tariff barrier? Or go elsewhere and hope to avoid any retaliatory actions? The easy choice right now is to wait, rather than decide now and regret it in a few months.

For those hoping for some clarity on trade, I don’t see that coming any time soon. Even if Trump announces clear cut tariffs, we’ve already seen that these can be reversed days later.

For those hoping for some clarity on trade, I don’t see that coming any time soon. Even if Trump announces clear cut tariffs, we’ve already seen that these can be reversed days later. And the secondary effects are also hard to predict. Can the EU act swiftly and collectively? Will Chinese goods make their way into other markets pushing local activity and prices down? We don’t know and have to work with that background.

Whatever way Trump finally moves on tariffs, the full impact will probably not be obvious until we are well in 2026. In the near term, we expect distortion to data on some spending is brought forward (as we saw with some imports in first quarter US GDP data) while other spending gets deferred. On the whole, I think that the US economy still looks okay which in turn means I don’t expect a massive increase in the speed or extent of rate cuts.

Managing volatility

Unsurprisingly, periods of greater market uncertainty lead to greater focus on asset managers and what they are doing. As a CIO I have regular conversations, both formal and informal, with our investment leaders and their teams. For us, the focus when markets are volatile is to hold our nerve and do our jobs, which means two main things: first, we address the cause of the volatility to decide if this something fundamental – as with the start of the global financial crisis – which may mean we need to reassess our positions, or if it is something potentially more transitory – such as the Truss sell-off – where we could be more confident of losses reversing as little actually changed.

Second, we focus on our processes. That can sound somewhat banal but it is true. If your investment process is one that you put to the side when markets are volatile, then it’s not a very good process! For core areas such as equities and fixed income, we are bottom-up investors – so we have to decide if our investment thesis still holds.

For us, the focus when markets are volatile is to hold our nerve and do our jobs

Differentiated active management creates different responses in this environment.

Mike Fox and the equities teams are not seeing widespread deterioration in corporate earnings and remain confident in many core holdings on a bottom-up view, while Will Nicoll’s Fixed Income team recognises that the all-in yield on credit looks attractive, even if credit spreads are not at obvious ‘buy now’ levels, even alongside the recognition that with higher long-term inflation we could see higher long-dated yields.

For Trevor Greetham and our Multi Asset team, top-down factors play a greater role, and with the Investment Clock in the Stagflation phase and heading towards Reflation, this pushes for broad diversification and exposure to both geopolitical and inflation hedges. Or in more simplistic terms, when the short term is uncertain, focusing on the medium and long term is often the best approach.

Risk is always a key consideration – whatever the market conditions. Some of our strategies have specific volatility controls, but if we think about risk as a more conceptual level, the ‘right’ amount of risk to take does not simply go up and down with market levels or volatility. Underpinning all of our investment teams are a set of principles – and four of these are pertinent when looking at risk when dealing with more volatile conditions (see figure 4).

As managers, we have to remember that volatility is about swings in price rather than value.  That is what will drive our activity and positioning over the rest of this year and beyond.