June 06, 2025

At the start of the year, we expected uncertainty on inflationary policies, continued high levels of fiscal spending globally, lacklustre Chinese economic performance, and persistent geopolitical risks. While these factors remain, we expected a more challenging backdrop than has materialized thus far. Even so, it has been a volatile period in terms of news flow and market movements.

Looking back

Looking back over the past five months, there have been a number of key developments, largely centered on the United States (US). Contrary to expectations, US President Trump has pursued growth-negative policies (from tariffs and spending cuts to immigration) over more growth-stimulating policies (such as tax cuts and deregulation). Liberation Day came as a surprise to the markets. This triggered a broad-based selling of equities but was followed by a snapback that has been supported by a generally positive rate of change in the trade policy, financial conditions, earnings and a weaker US dollar.

Overall, equity markets have performed better than expected. While Artificial Intelligence (AI) jitters triggered by the launch of Deep Seek technology out of China, and concerns on slowing earnings, impacted the “Magnificent 7’s” share price, so far earnings have remained very strong.

Another notable development has been Trump’s One Big Beautiful Bill Act. The bill includes permanent tax cuts but also has more spending than was initially estimated, and this could ultimately push real interest rates higher. In its current form, the debt to GDP ratio will likely expand at an unsustainable rate. And this may affect what is finally passed through the Senate.

Going forward, the outlook is dependent on the extent of tariff damage that has already been done. On the other hand, we could also see some positive offsets for growth in terms of tax cuts and deregulation.

We have a constructive view on equities and credit. At the same time, we think equity markets are too complacent about recession risk and expect continued volatility until we have more hard data on how trade policy is impacting growth. We expected that quality companies are likely to weather narrative volatility better.

The post-global financial crisis period of very low real rates seems to be over. Yields in the two largest borrowers, the US and Japan, are leading the increase. In both countries, higher long-bond yields are the result of expanding deficits and more investment spending. In the case of Japan, rates have been low due to deflation, followed by below-target inflation. More recently, labor costs and prices have risen at the fastest pace in 25 years, and interest rates are now normalizing. This has implications for bonds, and we expect more volatility and lower returns.

This also has implications for equities, as higher yields tend to lead to lower valuations. This, in turn, could lead to value areas of the market outperforming. Looking beyond style, we find small caps and emerging markets (EM) sitting at very attractive levels relative to their historical rates.

Opportunity highlights in emerging markets

EM stocks have outperformed the broader developed world stock market this year, and this may continue. The reasons for this are varied. The US dollar is relatively overvalued and has been coming down, thanks to US policy uncertainty, debt worries, and efforts by the Trump administration to bring this about. A lower US dollar is a tailwind for EM stocks.

EM earnings growth is strong and is expected to outperform developed markets (DM) in the coming years. EM valuations are relatively low by historical standards, as well as relative to DM stocks on a historical basis.

EM rebounds have often followed setbacks. While tariffs create uncertainty, the rate of change has been improving. EM businesses were already alert to tariff dangers and have made adjustments where possible. Furthermore, much of the uncertainty may have already been reflected in EM stocks.

The sheer scale of EM companies and countries, coupled with the inherent market inefficiencies, create a vast range of opportunities for active managers. Similarly, EM may provide a valuable portfolio diversifier if US exceptionalism continues to be a question on investors' minds.

Conclusion

We continue to manage portfolios through the market’s inevitable twists and turns. We are monitoring inflationary policies, fiscal spending and debt levels, and the persistent geopolitical risks. In the midst of uncertainty, opportunity exists for those who can weather the volatility.

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This post is for information only and is not intended as investment advice. The views expressed are those of the author at the time of publication and are subject to change at any time.

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