Q2 - Trump Triumphs & Starmer Stutters
The Great Rotation Continues & UK Equities Remain Attractive
Q2 2025 was bookended by two critical events—Liberation Day on April 4th and the US bombing of Iran's nuclear facilities on June 21st. Risk assets fell sharply after the former but recovered quickly and continued to rally further after the conclusion of the latter. The overall 5% rise of the S&P 500 year to date masks a 15% drawdown seen at its low on April 8th.
From their mid-April lows, the major equity indices have experienced the following recoveries: S&P 500, +24%; NASDAQ 100, +32%; FTSE 100, +15%; FTSE 250, +22%; and AIM 100, +23%. Adjusting for the 11% relative dollar decline to the pound over this period, the UK market's recovery has been respectable.
Over H1, in sterling terms, the S&P 500 was down 3%; the NASDAQ 100 was up 11%; the FTSE 100 was up 8%; the FTSE 250 was up 5%; and the AIM 100 was up 6%.
While there is a lot of noise around the new Trump administration and its policies, it is worth focusing on what can be discerned by its actions. Over the last three months, we have learnt that: Trump is serious about changing the nature of world trade and its tax policy; it has some pain points regarding bond yields, and its ability to fund its debt; but it is prepared to let the value of the dollar decline; it is more concerned about bond markets than equity markets; it prioritises tax cuts over spending cuts as the Big Beautiful Bill indicates an expansionist growth policy to outrun the fiscal deficit. Finally, geopolitically, while it seeks to retreat from the responsibility of paying for the West's defence, it remains selectively prepared to intervene militarily where necessary.
The fact that Trump managed to force through his Big Beautiful Bill with such a slim House majority was in stark contrast to the predicament of the Starmer government in the UK. While he has performed better than we might have expected in foreign policy, particularly in handling Trump, for example, his inability to get the UK’s fiscal position under control, despite his substantial parliamentary majority, is striking. His government is boxed in by his left-wing backbenchers on one side and the bond markets on the other.
Since Trump's return to the White House, the US 10-year Treasury yield has fallen by about 50 basis points. Whereas over Starmer’s first year in office, UK 10-year Gilt yields have risen by 50 bps. Perhaps that is not a fair comparison, but it is indicative, and one can’t help but feel that the UK government, just one year in, is the most incoherent and dysfunctional ever since the last one.
As we head into H2, Scott Bessent is now under pressure to issue well over $1 trillion of long-dated US Treasuries. He will need help from SLR extended bank balance sheets, stablecoin proliferation and people like his old buddy Stan Druckenmiller. Stand by, as the Treasury Secretary makes the big reveal of how he squares this circle, made more difficult after another strong jobs release that will make Jay Powell less keen to cut policy rates.
Bond markets continue to pose a challenge for the UK and US governments. Neither seems capable of reducing their fiscal deficits. However, Bessent seems more likely to stimulate growth than his British counterpart, who is more politically vulnerable and somewhat preoccupied with personal matters.
It has sometimes been said that Britain is becoming a health service with a nuclear deterrent attached. It would perhaps be more accurate to say that the state is becoming a combination of health service, benefit office and debt collection agency, with all other functions squeezed to compensate. To avoid this, we must fundamentally reconsider the role and reach of the state, while also taking serious steps toward radical, pro-growth reforms. Daniel Herring, Head of Economic & Fiscal Policy at the Centre for Policy Studies.
Regardless, the Great Rotation of capital out of the US into other markets, which we reported on in the Q1 update, grinds on. But it won't happen quickly. Surveys and improved liquidity suggest that European markets are regaining favour among global investors, a view supported by increasing M&A and primary deal activity across the UK market cap spectrum.
The gold price has remained broadly flat over Q2, indicating that the fear of trade war-induced financial market dislocation has decreased. However, precious metals and other scarce assets have remained at elevated levels as the fear of permanently higher structural inflation (currency debasement) has intensified, amid the tacit acceptance that the 2% inflation target is now unachievable, and failed attempts here and in the US to reign in government spending (DOGE in the US and welfare reform in the UK).
Following the recent ceasefire in the Middle East, however tenuous, suggests that the world has a sufficient supply of oil and dollars, both of which have weakened significantly—a positive development for global economic growth, particularly in Europe and among emerging markets.
Although their path have been volatile, both the US and UK 10-year bond yields are lower YTD. However, concerns about debasement and increased issuance have kept term premia high, and globally, yields on 20-year-plus bonds remain difficult to contain, forcing debt issuance to continue at the shorter end. So far, the impact of this trend has not spilt over into valuations of longer duration growth equities.
Indeed, with fiscal expansion in both the US and Europe, the latter heavily disguised as defence spending, a falling dollar, and lower energy prices, some frothy market signals have appeared. These include increased speculative SPAC issuance in the US and growing innovation among UK microcap companies experimenting with Bitcoin issuance strategies.
But the UK equity market remains attractive. Broker Peel Hunt estimates that in the first five months of this year, there were 30 bids for UK companies with a market capitalisation of over £100m, totalling a value of £25bn, with an average takeover premium of 43%. However, there was only one IPO, demonstrating not just the undervaluation of UK companies but also their increasing scarcity.
UK equities remain an attractive long-term asset class. However, in a de-globalising world with increasing fiscal dominance and elevated inflation, value remains preferable to growth, and scarce real assets are likely to remain better risk mitigants for equity portfolios than government bonds.
This was the market call weekly update I did earlier today with Gareth.