View From The Top: All to play for

View from the very top: Forget the headlines and focus on the bigger picture. Halfway through 2025 equity markets are at all-time highs, while bond yields are lower, the Dollar weaker and gold higher. Even if the path has been distinctly nonlinear, the Trump administration has got almost everything that it has sought. At the same time, the US (and global) economy has avoided a recession. It looks unlikely to get one this year. Our base-case revolves around slowdown rather than stagflation. Further, if the Fed and other Central Banks can cut interest rates from a position of strength, then this tends to be very positive for risk assets. Financial markets are often effective discounting mechanisms and with peak uncertainties perhaps now in the rearview mirror, the set-up for the remainder of the year looks compelling. However, we see no scope for complacency and believe that the strategy that has served us well in 2025 – diversifying both across and within asset classes – remains the playbook into year-end.  

Asset Allocation:

• Equities: Exposure to stock markets globally has worked so far this year, with the MSCI World Index outperforming the S&P 500 Index by 4 percentage points (in Dollar terms). With US equities having beaten global equities in 13 of the last 15 years, a key question is whether 2025 proves to be an exception to this rule. Now may be a great time to be a contrarian, particularly since a weaker US Dollar should provide a boost to American equities and with earnings expectations set low ahead of the pending Q2 earnings season. Diversification beyond the mega-tech complex has certainly helped year-to-date, and we believe going forward that a balance between growth and value as well as across regions should deliver returns to interesting opportunities also exist in emerging market equities.
• Fixed Income/Credit: The yield on 10-year US Treasury debt has fallen in the last month and is below where it began the year. Although there are good reasons to believe that yields may trend lower – especially were interest rates to start falling in the US – fixed income as an asset class may struggle to outperform equities. Debt has been in a secular bear market for the last five years and rising government profligacy may not reverse this. The Bloomberg Index of long-dated (or over ten-year) debt is currently trading with its highest yield since 2008. Active investment grade and high yield issuance speaks equally of a desire to lock in currently elevated yields. Our approach within the space is one of caution.
• Currencies: With the US Dollar having depreciated by more than 10% versus all major developed world crosses year-to-date, there may be a case for mean reversion in the remainder of the year. At the least, with the Dollar Index at a three-year low, it may be currently oversold. We do not believe any other currency will supplant the longer-term global reserve status of the Dollar any time soon.
• Gold: The precious metal has delivered a greater than 25% return year-to-date, supporting our contention that it should occupy a crucial space in investors’ portfolios. Inflows into the asset are close to record levels and Central Bank ownership is the highest in 60 years (per data from the European Central Bank). Gold is a strategic asset, serving as a portfolio diversifier and hedge against both geopolitical uncertainty and economic instability. 
• Alternative Assets: We believe this asset class can provide another useful form of diversification, against both inflation and fiscal debasement. Other positives include their illiquidity premium and collateral-based cashflows. We advocate selective allocations across this broad and diverse area, favouring differentiated and uncorrelated strategies.

If there has been one message from 2025 so far, then it is a simple one: forget the sensationalist headlines and focus on the bigger picture. Markets (equities especially) have shown a continued ability to climb metaphorical walls of worry. Uncertainty is the default, not an exception. Further, we all – investors included – have become more inured to the force of unpredictability that is Donald Trump. While we see little scope for complacency, the set up for the second half of the year looks attractive.

The facts speak for themselves. Equity indices in both the US and globally touched new all-time highs at the end of June. Bond yields are lower, as is the US Dollar, while the oil price is down relative to the start of the year. The Trump administration has got what it wanted – a set-up which should make the US economy more competitive – and recession has been avoided, so far. This has been achieved despite conflicts in Europe, the Middle East and Africa, a trade war and deepening domestic political divisions over debt.

The path forward will not be linear, but the strategy of buying the dip has certainly worked well so far this year. For investors, our key message remains stick with a strategy of diversification. When we look forward, the key questions to consider are what’s priced in currently, where are the risks and what is the upside?

The optimists’ case is premised on the persuasive notion that investors are inherently forward looking. Put another way, many worst-case scenarios have already been discounted and are reflected in slower GDP and earnings growth assumptions for the remainder of 2025. Resolution or compromise on the contention topic of tariffs could be considered as a source of potential upside.

Do not forget, intra-year equity market corrections are normal. Further, there is no correlation between the magnitude of these drawdowns and where the stock market ends the year. Add into these dynamics the consideration that valuation metrics (especially price-to-earnings ratios) have historically been a poor predictor of stock market performance. Including the 19% drawdown in the S&P 500 Index from mid-February to early April this year, there have been 15 times this century when this market has fallen more than 10% intra-year. More times than not – by a factor of over 50% – the Index has ended the year higher.

Of course, there are scenarios where the US economy and other parts of the world experience a period of severe stagflation and/or deep recession, but we think a realistic base case revolves around slowdown. This is also reflected in the most recent estimates of the Federal Reserve, which call for 1.4% US GDP growth, 4.5% unemployment and 3.0% inflation for the American economy in 2025. The World Bank and OECD may have cut their assumptions for global growth and might be calling for 2025 as the weakest year for economic expansion since 2007 (excluding the 2008 GFC and 2020 pandemic years), but what strikes us as most notable is the remarkable resilience of the economy.

Assuming that this pattern continues to hold, then there are good reasons to believe that investors will benefit. Even if equity markets were to remain unchanged for the remainder of 2025, then a gain of 5.5% for the S&P 500 Index might be considered reasonable, especially after the prior two years of consecutive 20%+ returns (the equivalent metrics for the MSCI World Index would tell a similar story). Beyond this, several factors give us confidence.

In contrast to prior market cycles, we see few excesses in the financial system currently. Both consumers and corporates remain cautious, while banks have been equally conservative in their lending. Retail sales in the US are at their weakest in two years (even if impacted by unseasonably wet weather in the US in May), and new home sales remain depressed. However, consumer anxiety – as measured by surveys such as the University of Michigan’s or the Conference Board’s – have become less bad, as the impact of tariffs has not been evident thus far. Another study (by Business Roundtable, reported in Axios) shows CEO sentiment at a five-year low. Going forward, tariff resolution could boost confidence, and financial markets. Further, the Trump policy agenda may shift away from tariffs towards more supply-side friendly strategies. At the same time, accelerating AI deployments may provide an additional productivity boost to the economy.

Against this background, long-term inflation expectations have remained contained. The latest University of Michigan survey shows 1-year inflation expectations down to 5.1% (from the previous print of 6.6%), a marked reversal after five prior months in which beliefs over future prices had been rising. Project out over a three-, five- or ten-year period and estimates are also dropping. Zoom back to the present and note that price consumption expenditure – the Fed’s preferred gauge for inflation – has averaged 1.7% annualised over the last three months, below its 2.0% objective.

Investors may plausibly wonder then why the Federal Reserve is not more optimistic in its assessment of the outlook. Forget for a moment that what Donald Trump says might currently matter more than the words of Jerome Powell and consider the default position of the US Central Bank. Caution makes sense and there is little upside to deviate from forecasting weaker growth, higher inflation and higher unemployment. Such a strategy may even be helpful in anchoring expectations. A major downside development in jobs data may be the most obvious reason for cutting rates. The counter-argument revolves around pre-emption, or the notion that the economy may remain strong, but it is certainly not as strong as it was.

In any case, the Fed Funds Futures market is discounting between two and three 25-basis point cuts in interest rates before year-end. To the extent that history is any guide to the future, in scenarios where the Fed eases without a contraction, these tend to be very positive for investors. Look further ahead, and Chairperson Powell has less than 11 months of his term remaining. More likely than not, a future Fed Chair will be a monetary dove, implying easier policy going forward.

Where might it be legitimate to worry? Sceptics may assert that the higher markets go, the further they may have to fall, or that with recent metaphorical walls of worry climbed, the only way is down. However, selling when a market is close to an all-time high has rarely been the right approach. Diversification in the face of strength is a more tenable approach. The logic in such a strategy is reinforced by the range of geopolitical uncertainties that remain.

Elsewhere, there has been little progress on tariff negotiations, while the reckoning over the US fiscal situation has yet to pass. In terms of tariffs, most parties appear to be showing a willingness to compromise, particularly in the context of the imminent expiry of the 90-day tariff pause in July. Globalisation may be going into reverse, but only slowly. Decreased barriers to trade make economic sense. On debt, the Congressional Budget Office is predicting a $3.3tr addition to the US fiscal deficit over the next decade (up from its $2.4tr assumption at the start of the year), but neither investors nor voters seem currently to care. It is hard to know what the tipping point may be, but learning to live with (increased) debt may be akin to living in a world of heightened uncertainty. For now, there is all to play for.  

Alex Gunz, Fund Manager, Heptagon Capital