A Changing World Order

The first quarter of 2025 will be remembered as a period of profound transition.  In global markets, the old certainties of US market leadership were upended, and the need for genuine diversification returned to the spotlight.

Upheaval in US markets

After two years of extraordinary gains, the US equity market entered 2025 looking expensive, particularly among the Magnificent 7 technology giants (Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia, and Tesla).  These companies had driven the S&P 500 to record highs, but their dominance left the market top heavy, and vulnerable to a shock.

Valuing the US stock market (February 2025)

(A high Price / Earnings ratio indicates higher valuation or more expensive market)

Price / Earnings Ratio

Source: Bloomberg

In recent years, capital flows into the US equity market have been somewhat self fulfilling.  Although many foreign investors were actively investing in the US, many were also doing so passively, as the US stock market became a larger percentage of global indices.

International investors owned a record 18% of the US Equity market by the end of 2024

Source: Federal Reserve, Goldman Sachs Global Investment Research

US Market Volatility in 2025

There had already been a market wobble in February after China’s DeepSeek unveiled a cost-efficient AI model that challenged US tech supremacy, questioning the outlook for several Magnificent 7 names.  President Trump had also caused some concern by announcing various protectionist trade measures.  However, the real volatility started shortly after the quarter end when Trump announced sweeping new tariffs on 2^nd April or ‘Liberation Day.’  With cars, pharmaceuticals and other imports in the firing line, fears of a global trade war and the inevitable inflationary fallout mounted.  The result was a sharp correction in US equity markets, with the S&P 500 falling almost 5% on 3^rd April alone.  The Magnificent 7 led the fall, with tariff exposed sectors also suffering significant selling pressure.

However, the pain and confusion was relatively short lived.  On 9^th April Trump announced a 90 day pause on ‘reciprocal’ tariffs, with the exception of China, and the US equity market bounced.

S&P500 (1^st Jan 2025 to 30^th April 2025)

Source: TradingView

Trump pressures Powell

Meanwhile, despite pressure from Trump on Federal Reserve Chair Jerome Powell to cut interest rates, the Fed held rates steady.  One key concern is that higher tariffs will impact consumers via goods prices and businesses via input prices, stoking inflation.  In the quarter, a higher than expected inflation reading and new weakness in consumer confidence combined to trigger fears of stagflation (slowing growth with rising inflation).

US inflation (CPI) and interest rates

Sources: Reuters, Bureau of Labor Statistics, LSEG

Europe & UK

While the US stumbled, other regions and sectors found strength.

In Europe, Germany’s new government approved a landmark €1 trillion spending plan, targeting defence, infrastructure, and climate initiatives.  This marked a decisive end to the continent’s post Cold War “peace dividend” and signalled a new era of expansionary fiscal policy.  European equities as measured by the STOXX Europe 600, gained 7.4%, with banks, defence, and energy stocks leading the charge.

In the UK, sentiment improved as better than expected corporate results and a rotation out of expensive US tech drove flows into undervalued sectors.  Banks and defence firms lead the FTSE 100 to a 4.5% gain for the quarter.  However, it wasn’t all smooth sailing. The UK’s Spring Statement Rachel Reeves announced £8.4 billion of spending cuts to comply with fiscal rules, raising fears of stagflation.  As a result, consumer facing sectors such as housebuilders, retailers, and travel lagged, reflecting a cautious outlook for the domestic economy.

In February, the Bank of England cut interest rates from 4.75% to 4.5%.

UK Inflation and interest rates

Sources: ONS, Bank of England

Emerging Markets:

Emerging markets performed well, with the MSCI Emerging Markets index up 2.9% in sterling terms.  China, after a rocky start, rebounded strongly following government stimulus, AI optimism, and the promise of less regulatory pressure on tech firms.

Safe Havens: Global bonds and gold

Typically, in times of global turmoil or uncertainty, the US dollar and US treasuries tend to perform well, representing a flight to safety.  However, these are not normal times, given the uncertainty surrounding US economic and political stability, and both the currency and US Treasuries have fallen as a result of Trump’s policies.

More generally, however, global bonds delivered positive returns as volatility spiked in equities.  UK gilts returned 0.6% for the quarter, helped by the interest rate cut in February.

Gold, a classic safe haven investment amid global uncertainty, hit record highs over $3,000/oz, continuing the strong performance that started in 2023.

Gold price (5 years)

What does it all mean? Policy uncertainty & the end of US exceptionalism

The Trump administration’s aggressive trade and spending policies have fundamentally altered the global economic landscape.  The US, typically the engine of global growth, a vital source of optimism and stability, is now shrouded in uncertainty.  Business and consumer confidence have declined, and the risk of recession has risen.

Trump’s tariffs: How the US tariff rate has evolved in history

Source: Yale Budget Lab

The tariff uncertainty has weighed on investment decisions, as the Bank of America Global Fund Manager Survey showed significant outflows from the US in March, with the allocation going mainly to the Eurozone, UK, Emerging Markets and cash.

Bank of America Global Fund Manager Survey

Source: BofA Global Fund Manager Survey

Further developments after the quarter end

Since the end of April, global markets and economies have been shaped by a dramatic easing in US-China trade tensions.  On 12^th May, the US and China announced a surprise breakthrough, agreeing to a 90 day suspension and substantial rollback of the reciprocal tariffs imposed in April.  Both sides reduced headline tariffs from punitive levels, while maintaining some baseline tariffs and leaving room for further negotiation before the August deadline.  This truce immediately calmed financial markets, sparking a sharp rally in equities across the US, China, and other major markets, and reversing much of the risk aversion that had dominated April.

The US-China tariff spat

However, the relief has not erased the scars of the trade war.  The US dollar remains weak against major currencies, reflecting diminished international investor confidence and concerns over the long term credibility of US trade policy.  US economic data remains mixed: the Conference Board’s Leading Economic Index fell sharply in April, indicating persistent headwinds for growth and a continued decline in consumer and business sentiment.  The US economy contracted by a 0.3% annualised rate in the first quarter, although this was primarily due to a temporary 41% surge in imports as businesses raced to get ahead of tariffs.

So although the tariff truce has brought short term relief and optimism, the underlying environment remains fragile.  The 90 day window for further negotiations means trade risks could quickly re-emerge, and the economic data signal that both growth and inflation remain finely balanced.

While the effects of higher tariffs and spending cuts have not yet started to bite, corporates continued to make progress in the first quarter, with over 76% beating their earnings expectations.  The second quarter results will be telling…

The Art of the Deal & the US debt mountain

There are reasons to be optimistic, despite the chaos experienced so far in 2025.  In Trump’s book, “The Art of the Deal” he advocates starting negotiations with bold, extreme positions to gain leverage.  Trump has described the sweeping tariffs as giving the US “great power to negotiate,” which aligns with the book’s emphasis on using aggressive tactics to compel opponents to engage.  So we should continue to expect more inflammatory rhetoric, followed regularly by U-turns.

Trump has an iceberg on the horizon with the US Treasury needing to refinance a record $9 trillion of debt in 2025, the majority of which will fall due by July, and it would help if interest rates, or more specifically, the yield on Treasury bonds was lower.  So far, Treasury yields have been edging higher in response to Trump’s policies and rhetoric, so we expect more U-turns and policy moderation in the next few months.

US Debt

75% of the $36.2 trillion US debt is held domestically with the remainder owned by foreign entities.

Japan holds $1.13 trillion, with the UK holding $779.3bn, having overtaken China in March as the 2^nd largest non US holder of Treasuries. China holds $765.4bn.

Source: Federal Reserve Bank of St Louis, April 2025

Summary

The first quarter of 2025 marked a turning point for global markets, as US exceptionalism gave way to heightened policy uncertainty and shifting leadership abroad.  US equities stumbled amid trade tensions and tariff shocks, while European and UK markets outperformed on the back of fiscal stimulus and investor rotation into undervalued sectors.  Emerging markets and safe haven assets like gold also found strength, underscoring the value of diversification in an unsettled environment.  The outlook remains fragile, with growth and inflation finely balanced and further policy surprises likely.  For investors, against this backdrop, maintaining a diversified, flexible approach is essential, as the global economy navigates an uncertain and rapidly shifting landscape.