Bears sound smart, but optimism pays

We had the fortune of sitting on a market outlook panel recently, which provided a good opportunity to review the first half of 2025, as well as take a view on the coming six months and beyond. Unsurprisingly, the conversation was broad. This article touches on the key concepts discussed.

We began with a review of what (on earth) has happened in the first half of the year. Somewhat astonishingly, had you gone on holiday six months ago and returned last week, you would be forgiven for thinking the answer was "nothing at all": the S&P 500 is at all-time-highs (in dollar terms), credit spreads are as tight as they were when you left, market volatility is low and sentiment is positive.

Yet volatility there has been: Q2 alone saw the sharpest moves in markets since 2020, and the Financial Crisis before that, with 8%-plus intraday swings rooted in the whims and urges of one man, in one office, at 1600 Pennsylvania Avenue.

For President Trump, tariffs are something of an ideology - he has been talking about them as the solution to all of America's problems for four decades - so it can be no surprise he has pushed them through. Indeed, when all said and done, and whatever else his second term throws up, the overriding emotion he will likely feel is pride - after all, he will have overseen the largest rise in tariffs, resulting in the highest effective tariff rate, in over 70 years.

It appears that 10% tariffs are the new 0%, and a likely outcome is they end up somewhere around 15%, the costs of which will be spread amongst suppliers, importing companies and the ultimate consumer. Interestingly, Empirical Research look at the impact of tariffs (inflationary, inefficiencies) and the One Big Beautiful Bill (tax & red tape reductions) and suggests the effects of each broadly come out in the wash. This is in aggregate; both tariffs and the OBBB are regressive in nature, meaning lower income cohorts bear the brunt of the changes.

If tariffs are offset by the OBBB, it is plausible that the tariffs do not result in higher inflation after all. Consider also that 90% of US inflation is currently made up of Services, and roughly half of Services inflation is "rents", which is a (very) backward-looking and easily-forecastable measure, and is coming down at a consistent pace. Given the market is pricing a one percentage-point rise in US inflation over the coming twelve months, no goods inflation spike would be a notable tailwind for markets (lower inflation > lower rates > lower yields).

This potential good news on the inflation should be considered in the context of a US economy which has been running "full gas". Unemployment is low (c.4%), wage growth is solid (c.4%) and the savings rate is low (<5%), meaning the consumer is earning and spending. Businesses have been investing: computer and electronic investment has been very strong indeed, and data centre construction continues apace, meanwhile federal investment dollars from the IIJA, IRA and CHIPS Acts are still making their way into the economy and the construction spending appears to be broadening out. Meanwhile, the government has been running a deep fiscal deficit for the best part of ten years - and doing so pro-cyclically, juicing an economy which doesn't need it. So the question becomes: if they're already pulling all the levers, what more can be done? (Cue calls for "an end to US Exceptionalism"…)

It is in this context that investment opportunities outside the US are being more openly considered by many investors. Europe is increasingly part of the conversation.

Unlike the US, Europe is certainly not pulling all its levers; indeed, only very recently has Germany whipped off its hair shirt and thrown caution to the wind by initiating a 4% spending plan. It may not sound like much, but does in fact mark an epochal shift in mindset for the country. We also note that Mario Draghi's 2024 paper (which highlighted the productivity gap with the US, and what to do about it) continues to garner attention, most importantly by European Commission President Ursula Von Der Leyn. Could we see some form of fiscal or banking union and EU-level debt issuance? European Central Bank Chair Christine Lagarde implored exactly this in her June FT opinion piece. If it happens, it might add another challenge to the US Dollar's hegemony.

Further afield, India remains an incredibly promising economy and market - though one must mind one's eye on valuations; as my fellow-panellist reminded us all: a country's GDP and stock market are totally different things - one only needs to look at China's economy and the Shanghai Composite for proof.

Speaking of China, the country continues to manage an unwind of the property excess, which will continue to be a headwind to growth and a dampener of household sentiment (see household savings rates, which have risen to over 30%, for evidence of this (higher savings rates mean consumers are less willing to spend - China's 30% compares to Europe's ~10% and the US' 5%)). However, China is a global leader in advanced manufacturing, rapidly developing its advanced technologies (see DeepSeek earlier this year) and has the lowest energy costs of any major nation, globally. Before China, the US had the cheapest energy (oil & gas), and before that, the UK generated almost 25% of the world's output, a scale intricately linked to its access to cheap and efficient coal.

Bringing it home; the UK. Unloved and overlooked, and perhaps for good reason – the UK has the highest energy prices of 30 countries tracked by the IEA, we have had anaemic growth for 15 years, have deep fiscal deficits and the consequent prospect of ever more taxation (despite the tax take being the highest as a percentage of GDP since the War) … we could go on. However, the negativity throws up opportunities: the UK equity market trades at a 35% discount global equities and gilts (government bonds) have the richest yields amongst major economies. The listed investment trust market continues to throw up opportunities where the shares trade at a - sometimes quite steep - discount to the underlying asset base. One needs to be specific - sniper rather than machine gun, - but opportunities are out there for those willing and able to invest in individual companies.

Bears sound smart, but in the long term, optimism pays. 'Remaining invested' was a central theme to all panellists' closing remarks - there is always something to be worried about and there will forever be bouts of volatility, but in the long term, prices follow fundamentals.