Monthly Market Commentary - July 2025

Global stock markets posted solid second quarter returns, recouping losses from the first three months of the year to move into positive territory for the first half of 2025 despite lingering trade tariff concerns and conflicts in the Middle East. The MSCI All Country World Index (0.7% - all returns total, for first six months of 2025 and in sterling, unless otherwise stated) rose, boosted by strong gains in the UK and Continental Europe. However, an adverse currency move meant that US equities posted a negative first-half return, despite a strong recent period. Bonds have outperformed (Gilts 2.5%) and provided some ballast during what has been a volatile six months for financial assets.

Historic dollar depreciation

The US dollar declined further in the second quarter, posting its worst first half of a calendar year performance since 1973 — the year the gold-backed Bretton Woods system was abolished and exchange rates were officially allowed to move freely — and its worst six-month performance since 2009. Sterling reached a post-Brexit high around US$1.38 (9.7%). Without this move, US equities would have returned high single-digits in percentage terms.

On-off tariffs have not helped investor confidence but the relatively strong performance of US equities in US dollar terms (+10% in Q2) suggests the depreciation is more due to growing concerns regarding the sustainability of US government debt and expectations of more aggressive Federal Reserve cuts going forward.

Wall Street hits record highs

US equities (MSCI North America -2.6%) have rebounded strongly from the verge of bear market territory as corporate earnings held up fairly well and economic data remains largely solid. Although we welcome the strong snapback, we believe some caution should be heeded. 2025 earnings growth is now expected to be 9.4%, down from 14.3% in January, according to FactSet. Valuations also remain elevated, with US stocks significantly above their 10-year average price/earnings multiple.

Tariffs on, tariffs off

Stock indices swooned in early April after US President Donald Trump announced punitive trade tariffs. A swift recovery ensued when a 90-day pause on the higher rate reciprocal tariffs was declared on all countries bar China. US equities posted their best daily gain since 2008 while US tech stocks chalked up their best daily rise since 2001, demonstrating once again that the largest moves to the upside often occur after substantial declines. 90-day tariff pauses are due to lapse in the coming weeks (world ex-China on 9 July, China on 12 August) but there is a sense that a high-water mark has been reached and we are unlikely to see a return to the highest rates. While this is welcome, US tariff levels during the pause (10% world ex-China and 30% on China with higher levies applied to certain imports such as steel, aluminium and cars/autos) still represent a headwind to global growth.

A broad-based gilt index returned -1.4% in May, with longer-dated (Gilt 15year+: -2.5%) and inflation-linked (-2.3%) underperforming. While equity investors welcomed the tariff de-escalation bond markets were less enthused by the lower potential revenue generated and also Trump’s “big, beautiful” tax bill passing through the House of Representatives. The bill is expected to increase the budget deficit and has drawn criticism from Elon Musk, who says it undermines the work done by his government cost-cutting team.

Bonds have the president’s eye

While the US president may not be as sensitive to negative stock market movements as during his first term, he does still have a watchful eye in this regard and the bond market seemingly represents something of a guardrail against more destructive policies. This is due to the burgeoning US debt load, with outstanding Treasuries doubling in the last eight years to US$29tn at the end of May — equivalent to 95% of annual US economic output with net interest payments costing 3.1% of US GDP last year, more than the 2.9% spent on defence. The bond market is also where we will be watching closely for any adverse moves in response to the Republicans’ “big, beautiful bill,” which is estimated to add nearly US$3.3tn to the deficit.

Strong first half for bonds

Shorter-dated bonds outperformed in the first half of the year (Gilts 0-5 year 3.1%, Gilts 15yrs+ 0.4%) as well as investment grade corporates (3.6%). UK chancellor Rachel Reeves is in a tight spot as spending reforms seem unlikely to deliver the desired savings while lower growth forecasts eat further into the minimal fiscal headroom. Speculation that Reeves may be removed from her role resulted in a notable move higher in Gilt yields, suggesting a replacement may not be as market-friendly.

Summary

The first half of the year reminds us of the benefits of being invested despite risk events like trade tariffs and Middle East conflicts. Looking ahead, the expiry of tariff reprieves and data points on growth and inflation are potential market-moving catalysts. We anticipate markets to remain volatile and with equities trading at above average valuations, they are more prone to corrections around risk events. That said, underlying earnings growth should drive markets higher over time. We see bonds as offering attractive valuations and yields should move lower, adding to total returns in the absence of inflation and/or fiscal deficit surprises. Meanwhile, hedge funds have historically offered returns between equities and bonds alongside the additional diversification benefit of outperforming bonds during inflationary shocks.

Approver: Quilter Cheviot Limited, 15 July 2025