Asset allocation update How we're thinking about markets...

The major economies continue to see positive economic growth; however, growth rates are slowing. In the US, economic growth is back to trend levels and is widely expected to slow further from here as higher tariffs work their way through the system.[1] Cracks in the economy can already be seen in the US labour market. In the other major developed economies, growth rates are stalling, having recovered through 2024. Expectations are for a continuation of this trend – slowing GDP growth, but not to recessionary levels. 

The picture is mixed on inflation. Headline CPI has been rising for the last four months in the US and is forecast to be over 3% by the end of 2025. Tariffs are expected to send inflation higher in the short term, but the impact should be temporary. The UK is also experiencing rising inflation. UK headline CPI is almost twice the Bank of England’s 2% target.[2] In Europe, inflation has been at or below target for the last 3 months but has the potential to start moving up again as we move towards the end of the year.[3] Japan has had a much needed reduction in inflation, and China is still battling with outright deflation. 

Source: Saltus, Trading Economics

Second quarter corporate earnings results were robust. Corporates remain in good shape, supported by steady consumer demand, rising wages, and solid macroeconomic conditions. Once again, the standout performer was the US technology sector, particularly the firms at the heart of the AI narrative. Looking forward, analysts expect 7.8% earnings growth for global equities over 2025. Regionally, Asia ex-Japan earnings are forecast to grow quickest over the next 12 months, at 17%, whilst the UK, Japan and Europe have more subdued forecasts at 5.8%, 4.4%, and 5.6% respectively. These regions all trade in line with their long term averages on a price to earnings multiple, whereas the US remains overvalued (this consensus on earnings and valuation data is derived from Bloomberg).

Market Themes

Going for gold

Gold has continued its strong run, recently reaching a record high of over $3,500 per ounce.[6] The upward trajectory for the gold price started in 2022 following Russia’s invasion of Ukraine. The current upward trend began in 2022, following Russia’s invasion of Ukraine. In response to the invasion, the US and its allies froze the international reserves of Russia’s central bank. This move prompted other central banks, particularly those less aligned with the US, to reassess their reserve strategies. Many began shifting a significant portion of their reserves into gold and have since been consistent, price-insensitive buyers, helping to put a floor under the gold price. At the time of the invasion, gold accounted for 9% of global international reserves; today, that figure has risen to 15%.

More recently, Trump’s attempts to rewire the world’s geopolitical order and America’s relationship with its key trading partners has been unsettling, and therefore bullish for gold. As have his attempts to coerce the Fed into lowering interest rates whilst the US debt position is under serious scrutiny. As the dollar has weakened, gold (priced in dollars) becomes cheaper for international investors, two of the largest being Chinese and Indian savers. Chinese savers have been moving from property to gold as an alternative safe asset since the Chinese property bubble burst, and Indian savers are becoming wealthier and storing more of their wealth in gold.

Will this rally last? It would seem like investors are confident that it will – evident in the recent performance of gold mining stocks. Whilst miners were initially slow to respond to rising gold prices, largely due to the long lead times required to ramp up production, their share prices are now starting to reflect expectations of sustained higher gold prices. We share this view. Many of the factors supporting gold, particularly central bank buying and geopolitical uncertainty, are unlikely to fade soon. As a result, we maintain an active position in both gold and gold mining stocks.

Ballooning borrowing costs

Fiscal concerns are everywhere it seems, but most acute here in the UK. Government long term borrowing costs (30 year bond yields) are back where they were in the late-90s, and the UK now pays more to raise medium and long term finance than any other country in the G7.[7] This is a hard pill to swallow given that government debt to GDP is still below 100% in the UK, compared to the US, Italy, France and Japan all comfortably in triple figures. The UK government deficit is on track to decline by 1% of GDP, in contrast to the US, where borrowing is expected to remain at an unsustainably high level – above 6% of GDP – for the foreseeable future.

So why, then, are borrowing costs so much higher here than elsewhere? Some UK specific reasons stand out. First, the rise in 30-year government bond yields may reflect a sharp drop in demand from defined benefit pension funds, which no longer need to hold long-dated gilts in large quantities. Second, is the obsession with the Office for Budget Responsibility’s (OBR) twice yearly review of Britain’s fiscal rules. These reviews often trigger headlines about black holes in the public finances and speculation about tax rises, creating recurring uncertainty. Third, the fiscal rules themselves are binary and depend on long term forecasts – stretching five years ahead – that are often unreliable. Finally, lingering market scepticism from the Liz Truss episode may also be contributing.

The UK government could take immediate steps to shift market focus away from short-term concerns and toward its relatively strong fiscal position. One option would be to reduce the issuance of long-term debt. UK gilts currently have an average maturity of 14 years—twice the average of other advanced economies – which may no longer be necessary given changing investor demand. The government could also scale back fiscal forecasting to once a year, aligning with IMF recommendations. The current twice-yearly cycle often fuels unnecessary and damaging speculation. If tax increases are required in the November Budget to meet fiscal rules by 2030, their implementation could be delayed – especially if they’re not needed in the near term – giving the economy space to grow. Ultimately, markets won’t ignore the UK’s stronger fiscal position forever, but credibility will depend on the government showing that its commitment to sound public finances is lasting.

Equities

Over the summer of 2024, we gradually reduced our US equity exposure. The region had already delivered strong performance, but the outlook was becoming more uncertain – particularly after Joe Biden withdrew from the presidential race, increasing the likelihood of a return to power for a more emboldened Donald Trump. This continued into the first part of 2025, as we saw more attractive opportunities in non-US stock markets, notably Japan, Europe and Emerging Markets. During the stock market volatility in February, March and April, this relative underweight to the US worked well as the rest of the world performed strongly compared to the US.

Over the last few months, we have been reassessing the outlook for the US stock market now we have more certainty over trade policy, and the administration’s objectives for the US financial system. The US administration wants lower interest rates, a lower oil price (and lower inflation with it), and more oversight of its critical businesses. If it achieves these aims, without damaging the economy or the credibility of key US institutions, this is positive for the stock market, especially if the AI theme continues to fulfil expectations.

As a result, the committee decided to marginally increase our exposure to US equities, funded by a reduction in our global equity allocation. This adjustment aims to bring greater balance between US and non-US equities, correcting what had been a tilt in favour of the rest of the world. Within the increased US allocation, the committee also began a gradual shift away from broad-based exposure toward a more targeted approach – focusing on the largest technology companies and strengthening our position in smaller US companies. The result is a more focused, higher-conviction US equity portfolio.

Elsewhere in equities, the committee decided to increase the sensitivity of our Emerging Market exposure, without changing the overall level. This is to ensure that portfolios benefit fully from the positive drivers of Emerging Market equities, namely cheap valuations, high earnings growth, and a weakening dollar. The rest of the equity book will remain unchanged. The other notable regional exposure is an overweight to Japan.

Bonds

We maintain a relatively low exposure to government bonds given debt concerns in several developed markets, combined with sticky inflation. Where we do have exposure, we are keeping our duration (interest-rate sensitivity) low to reflect these concerns. In our US government debt exposure, we only have inflation-protected bonds, which have performed well recently, given the inflationary dynamics of the US economy.

The committee decided to sell our European government bond exposure completely. Whilst these bonds have performed well since we acquired them, growing concerns over the fiscal positions of France – and more recently Germany, due to significant fiscal stimulus – led to this decision.

The proceeds of these sales will be used to fund a small top up of our Emerging Market debt position. We like this asset class given higher yields in Emerging Markets, less debt sustainability issues, and tailwinds from a weaker dollar and looser monetary policy. We will also buy a position in short-dated gilts – effectively a cash position – as we wait for more clarity on The Budget in November, and more importantly, the bond market’s appraisal of this.

Alternatives and Currency

Within our diversified alternatives exposure, the committee decided to increase our copper allocation. There has been a high level of volatility in the copper price lately given US tariff flip-flopping on the metal. Now there is more certainty on the tariff level, the price has settled down, and we are taking this opportunity to bolster our existing structural position. We have a positive view on copper given the long term demand dynamics, combined with the lack of investment in new supply. This exposure may also offer protection should we have a reflationary episode, where other parts of the portfolio may struggle.

Elsewhere in the alternatives book, we are reducing our exposure slightly to equity long/short funds where we have lower conviction in the specific strategies.

Within currencies, the only change of note is an increase to Emerging Market currencies given the increase in our Emerging Market debt position. Our largest non-sterling active currency exposure is to the Japanese yen, given the diversification benefit on offer. The Japanese yen tends to appreciate in times of market stress, giving the portfolio an element of downside protection.