Shock, awe and relief

Shock, awe and relief

Last quarter saw investors circle through the full spectrum of psychological states as they dealt with the consequences of President Donald Trump’s economic agenda.

Uncertainty around trade policy morphed into shock and fear post Liberation Day. The breadth and scale of tariffs caused a significant unwinding of allocations to US assets. This started with equities and spread to the dollar and US government bonds. As consumer and business sentiment worsened, equity market volatility hit levels last seen during the pandemic.

As we prepared for portfolio rebalances, we noted that trading would expose client portfolios to mean reversion risk and decided to delay rebalancing until June.

We always make decisions about rebalancing carefully, examining the current volatility of portfolios as well as how they are faring in the prevailing environment. Perfect timing is not possible, but patience was rewarding on this occasion.

As markets gyrated, news of pushback from within President Trump’s cabinet began to circulate. On 9 April, in a stunning reversal, President Trump announced a 90-day pause in the application of additional tariffs on all countries except China. US large cap equity benchmarks rose 9.5% on the day.

The US and China then locked horns, imposing ever higher tariffs on each other’s exports. Behind closed doors, however, both countries sought an acceptable climbdown. On 12 May, the US administration announced a mutual reduction in tariffs which saw an air of optimism finally return to markets.

As first quarter earnings concluded with double-digit earnings growth, investors were left wondering whether there was still a favourable path forward for equity markets.

Global equity markets, led by Europe, recouped their year-to-date losses and ended the quarter at all-time highs.

The path forward

As we approach the end of the 90-day pause (9 July), investors are waiting with bated breath for clarity on what lies ahead. The good news is that US and Chinese negotiators have continued to talk and appear to be making significant progress. However, there is no clarity on other bilateral deals, and 9 July could see a dialling up of tariff rhetoric.

While a negative market impact cannot be ruled out, a repeat of the early April sell-off seems unlikely. This is due to a reduction in US allocations within investor portfolios and a significant decline in the US dollar. A lower dollar supports the attractiveness of US assets for foreign buyers. Coupled with this, a generally deeper understanding exists in the investment community that the executive branch of the US government does not have untrammelled power. It is reined in by institutional forces like the courts and Congress but also by the sheer power of the bond market which stands ready to call any dramatic gamesmanship to order.

It should be noted that US interest rates are amongst the highest in the developed world. As the US central bank maintains its cautious stance towards rate cuts, US fixed income markets will become increasingly more attractive on a relative basis.

US GDP growth has rebounded in the second quarter after a setback in the first. Tariff related uncertainty has negatively impacted 2025 GDP growth, but for now hasn’t caused an economy-wide recession. We continue to monitor the manufacturing and housing sectors for signs of further weakness.

On the other side of the Atlantic, UK economic growth has stalled in recent months as the impact of tax hikes and a reversal of pulled forward housing activity has hit retail sales. The Bank of England has continued its quarterly path of rate cuts, with a further two likely before year end. The European Central Bank, encouraged by the rapid decline in inflation, has meaningfully reduced policy rates this year. While the outlook for the European economy remains anaemic, estimates for next year show improvement.

Just after the end of the quarter we saw a day of some drama for the UK when the chancellor’s difficult day in the House of Commons led to short-lived speculation that her job could be in jeopardy. The rapid rise in the price of UK government borrowing this triggered confirmed how delicately the UK’s fiscal budget is balanced. Markets see Rachel Reeves as a bulwark against the resurgent left of the Labour Party and stand ready to punish the government if it allows for any slippage in its fiscal plans. This further challenges the government’s ability to take action to reignite economic growth and productivity. The chancellor can perhaps be forgiven for feeling under some pressure.

Conclusion

The past few months have demonstrated the importance of maintaining a longer-term perspective when making asset allocation decisions. We have avoided crystallising losses in US assets through sensible decision making during heightened volatility.

As uncertainty around trade continues to hamper US growth prospects, we have used the delayed rebalancing of portfolios to marginally reduce US equity positions. We have removed exposure to US smaller companies entirely in higher risk mandates and modestly lowered US large company allocations. We have reinvested proceeds from these sales mainly into UK equity income allocations. This shift steers portfolios towards the relative safety of large cap quality equities. Though calm may have returned to markets, we mustn’t confuse this with a return to normality.