Back to School

How were your summer holidays?

I haven’t written one of these notes since April, not because there was nothing to write about, in fact the exact opposite, it has been a whirlwind, more finding the time to do so and keeping up to date. We do also publish the monthly Market Watch update. However, when noticing that the date on the last one of these notes was April 2025, it was clearly time for an update, new school year and all that.

This is how the note in April started;

In all the years my career spans, I have been through a very wide range of economic and financial market events that have generated extraordinary moves in the prices of bonds, equities, gold, oil and every other asset class you can think of. However, I cannot recall one that has been as fast-moving, volatile and possibly irrational as what we have been through in 2025 so far.

It’s not been quite that frantic since then, but it has been very eventful. This chart shows the performance of the S&P500 Index, the most recognised indicator of the US equity market, for this year so far, to the end of August. It is up just under 10% and up nearly 30% since 9 April, the day the pause in US tariff introduction was announced. These numbers are in local currency terms, not GBP, as are the other references to returns below.

Source: Bloomberg Finance L.P. S&P 500 Index 31.12.2024 – 31.08.2025. Past performance is not a reliable indicator of future returns.

It wasn’t just the US that did well, the UK has provided good returns, some European markets have been very strong and the rest, just strong! China and Hong Kong have been very profitable, Japan less so, but still good and Emerging Markets are up some 14% this year. I am struggling to find anywhere that hasn’t been a good region for equity investors.

Of course, the headline numbers hide a wide range of different factors, but a bit more of that later.

Bond markets have also hit the headlines, particularly at home, but also in the US. I don’t want to include too many charts, but they do, literally, graphically show the scale of the moves we have seen.

This chart below shows the yield of the UK 30 year Government bond (Gilt) over the last 25 years. Bonds are valued on their yield, which is the return investors receive, a bit like your bank deposit interest rate. Yields move inversely to the price. The 30 year element is when it will mature and be repaid. This is a “long dated” bond, in other words, bonds are issued with short and long maturities, 30 years is a long period and their prices and yields can be sensitive to expected changes in economic conditions, interest rates and government borrowing requirements amongst other factors.

That’s a bit of a long explanation. My point is; just look at the scale of the move this year, the yield has gone way above the level it reached in 2022 because of the disastrous “Liz Truss budget”, meaning the price has fallen a long way. In fact, the yield has risen from 0.56% in 2020, to 5.6% today.

Source: Bloomberg Finance L.P. 31.08.2001 – 29.08.2025. Past performance is not a reliable indicator of future returns.

So, equity markets have been really good and bond markets have been really bad?

This gets back to my point that there’s a lot hidden behind the headline numbers.

Let’s look at equities. Their prices are driven my many factors, partly what has happened, but also, very importantly, what is anticipated will happen. This year, in essence, there have been two key drivers. Firstly, even though tariffs are bad for economic growth, inflation, company profits and employment, they are not as bad as worst expectations. So, even though they are a negative, there is some relief over their scale, Secondly, equity markets are made up of individual companies, the larger they are, the bigger impact they have on equity market indices, such as the S&P 500 Index. The giant US technology and communications companies that have been a key driver of equity markets have just, in most cases carried on doing so. Nvidia, the largest company in the world, is up virtually 30% this year, to the end of August, Microsoft is up over 20%, Meta, some 26%, Broadcom 28%. Not all of them have joined in the party, Amazon is only up around 4%.

The key driver of this has been the explosion in demand for products that are related to AI, and the shares of companies that are major beneficiaries of it. These companies’ share prices have been a polarising debate amongst investors for years now. The naysayers compare them to the DotCom boom and bust at the turn of the century, the advocates talk of a new paradigm, the truth lies somewhere between the two. Their share prices may be too high for now, but there is no doubt the world is changing quickly. Personally, I am more on the side of the advocates.

Please remember, equity markets are enormous, and I am just using examples to make my points.

Bond markets are wide and varied as well, from the lowest risk bond issued by developed country governments, such as the US or UK, to the highest risk issued by small, new companies in emerging markets. But it is the first of those that has hit the headlines and I’ll focus on that. Whilst longer maturity bonds, such as 30 years, are riskier, as more can happen before repayment, no one really believes the UK government won’t repay their debt. But they are sensitive and are indictive of how investors around the world view the UK economy. There are real world ramifications; it means the government has to pay a higher level of interest to borrow money, which means they have less to spend or need to raise taxes or borrow more.

That is not an appetising cocktail and is exactly where we are at presently. You will be reading as much as I am about the fiscal problems the UK faces and what the Chancellor maybe lining up for the Budget. The top line and the bottom line are that the government has a very high level of debt and significant spending plans that are unlikely to be reduced, therefore it needs to both raise taxes and borrow more in the face of a stagnant economy. It is a backdrop that will make investors averse to risk in key parts of the bond market.

Without wishing to scaremonger and just point out one interesting feature of the UK economy, we are seeing lots of stories relating to potential taxation of the housing market, possible wealth taxes, Capital Gains Tax (CGT) on main residence, higher local taxes, National Insurance on buy-to-let amongst others. None of which are positive for house prices. It is such an important element of the economy, the real estate company Savills recently stated that the “value of all homes across the UK now stands at £9.10 trillion (£9,100,000,000,000)”, which is “now more than 3.5 times the annual GDP of the UK”, GDP being Gross Domestic Product, or the total value of goods and services produced by an economy. That’s a big number!

Play time is over, back to the economics classroom.

That’s all very well, but what is coming up?

I need to make an admission first of all, I have been surprised by how well economies have held up given the real and imagined threat of the US trade tariffs. It has been hugely unsettling for governments, companies and individuals, with planning for the future particularly difficult.

The US economy has remained very resilient, although not all the data points in the same direction, there are legitimate concerns over the jobs market and inflation is stickier than most people expected and hoped, meaning the central bank has been reticent to cut interest rates, in spite of immense pressure from the President. Maybe I shouldn’t be surprised though, I have been a long term advocate of the flexibility, resilience and entrepreneurial nature of the US.

Meanwhile, Europe has been boosted by the relaxing of fiscal rules to allow much higher spending on defence and infrastructure, with moderating inflation allowing interest rates to be cut. Whilst the economy isn’t booming, it isn’t bust either and there is room for optimism over the long term. China has taken the brunt of US tariff pressures, but has adapted by selling more finished goods and components to countries other than the US, The world’s second largest economy, which is a key player in global trade, is doing OK.

I think I’ve said enough about the UK already.

Onto the next subject; the outlook for financial markets.

We have equity markets at or near all time highs in many regions, the long end (30 years) of the UK government bond yields at levels not seen this millennium; you would think that something has to give, You may well be correct!

But for now, most market indicators suggest things are “OK”. However, there is little doubt that equity markets look expensive by long term historical comparison, some more than others. To me, that does throw up an interesting question; what historical time period should we be comparing them to? The world, economies, industry, technology, society, investment and financial markets continuously evolve, although at times it is revolution rather than evolution, a good example being the industrial revolution. We should ask ourselves, when deciding if equity markets are cheap or expensive, whether 20 years or 5 years of history is more relevant, given the technology revolution we are living through. The world is very different now to 20 years ago.

Notwithstanding that intellectual debate, on most measures equity markets do look somewhat expensive. But, that can remain the case or company profits can grow faster than expected, which will make valuations cheaper, and there has been evidence of that over the summer, particularly from the giant technology companies.

Within all that there are areas that look much better value, such as the UK, and within most regions, smaller companies look better value than larger companies.

It’s a similar picture in bond markets. Long dated government bonds offer much better returns than they did at the start of the year, but have notable risk associated. Meanwhile, high quality bonds issued by companies that mature in the near term offer better returns for reasonable risk. There are always opportunities available to investors who are willing to look within markets rather than at them.

There are always gems around for those expert enough to understand them, a good example is commercial real estate in Europe, such as; selected office space in major cities, warehouses and logistics, which will benefit from all the upcoming infrastructure spending, and residential housing in Germany. We can find companies that will prosper from that. Another example would be infrastructure companies in the US, those that benefit from the huge demand for energy resulting from the need for data centres as AI explodes all around us.

The bell rings.

It’s a big world and we can find lots of opportunities. However, given the uncertainties that we face, caution is appropriate and I don’t think now is the time to be taking too much risk.

This has ended up being much longer than I intended, but it’s been a while and there’s lots to cover. I’ll make sure I’m back with more thoughts before half term.