Getting back on track: global markets deliver for investors in Q2

The impact of tariffs and trade policy continues to be a challenge for some regions and sectors, but the overall mood for equities was upbeat in the three months to July.

Bonds also had a positive quarter, as concerns about inflation and energy prices eased. Corporate bonds (which are issued by companies) generally did better than government bonds. 

Markets unaffected by Starmer drama

The US stock market continued to post new highs in early June as it cements its position as a global leader in innovation. Semiconductor and AI infrastructure companies led the way in the second quarter of the year, but communication services and consumer discretionary firms also had a strong quarter. 

While the Middle East conflict was a headwind for some parts of the market, investors chose to focus on the strength of earnings and the longer-term potential impact of innovation led growth, which we expect to continue and be very significant. Persistent strength from AI helped drive global equities to a return of ca. 14% for the quarter in GBP terms.

Back on these shores, the UK saw modest gains over the quarter, though it lagged other regions, UK equities delivered 3.4% in the quarter. Returns were weighed down by the market’s higher weighting towards defensive sectors, such as financials and healthcare, as well as energy stocks, which reversed some of the exceptionally strong performance delivered in the first quarter.

The resignation of the UK Prime Minister, Keir Starmer, had little impact on markets. Investors are instead focusing on inflation, interest rates and the UK’s fiscal credibility. It remains to be seen how the market will welcome Andy Burnham, if he is named the country’s new leader, as expected. 

The European Central Bank raised its base rate of interest, a move that had been widely expected, and Eurozone markets rallied over the quarter as consumer confidence bounced back alongside the de-escalation in the Middle East. European equities delivered 12.8% in GBP terms over the quarter, led by IT and financials. 

The recovery continues in Japan, supported by solid earnings, with companies in the region posting strong results and confident outlooks. The Bank of Japan raised interest rates as expected in June and with strong wage growth and rising inflation, there could be more hikes to come. Japanese equities returned 13.7% in the quarter in GBP terms.

But it was emerging market equities that were the surprise outperformer for the period, delivering a return of 23.8%. This was largely led by tech-heavy markets such as Taiwan and South Korea; performance across the region as a whole remains very mixed. 

Away from equities

It was a mixed picture in the bond market, with broad global bonds delivering a modest 1.3% return for the quarter.

Higher-yielding corporate bonds were stronger than other areas, delivering 3.7%. As investors become more confident, they are more willing to take on the risk of these bonds, which have a lower credit rating but higher yield compared to investment-grade corporate bonds. 

That risk-on attitude can also be seen in emerging market debt, which returned 3.5%. However, these bonds are still vulnerable to any changing expectations around interest rates or a shift in investor sentiment. 

It’s a key reason why diversification is so important within fixed income, and particularly during times of geopolitical uncertainty, when there is heightened volatility. 

Elsewhere, our infrastructure allocation had a solid quarter, delivering 4.1%. The sector - which includes companies that own and operate the likes of roads, rail and data centres - is another area feeling the benefits of the AI boom, as the demand for power and digital infrastructure continues to grow. 

Our view on the major asset classes

Equities

Overall, we are neutral on equities, although the easing of tensions in the Middle East in Q2 has improved the outlook. Large US tech companies continue to post strong results, which we expect to persist given the ongoing investment into AI by many firms. 

Over the medium-term, we see moderately better value in the US and Japan than elsewhere.

Government bonds

The easing of inflation as energy prices fell back saw UK gilt yields fall last quarter, but we see them being more attractive than Japanese or US government bonds over the next six months to two years.

The UK’s fiscal credibility is improving, while Japan grapples with balancing low rates and high inflation. Bonds can provide much-needed protection for portfolios, but investors must be selective.

Corporate bonds

On a three-to-five-year basis, we expect higher quality investment grade corporate bonds to deliver modestly better returns than government bonds. Higher yielding bonds may also bring stronger returns but will be more sensitive to market conditions. 

Yields look attractive and there generally looks to be a low risk of widespread defaults or credit rating downgrades. However, as more companies are expected to borrow more money to finance their investment in AI, this could be a risk for the sector. 

Real assets

We continue to believe that real assets, including infrastructure and real estate, bring diversification and can help to improve consistency of returns over time.

How have our portfolios evolved over the quarter?

As discussed at our last quarterly update, we continue to build portfolio exposure to the WTW Global Equity Diversified Index (GEDI) across our Central Investment Proposition. The aim is to build a more diversified, cost-effective core equity exposure across our portfolios.

Driven by our medium-term asset class views, we recently removed the overweight position to European equity from our MAF portfolios and distributed the proceeds across US and Japan. This reflects our lower growth expectations for Europe, given their reliance on imported energy - we no longer expect the region to outperform. For DFM/MPS clients, this change will be reflected at the upcoming portfolio rebalance in July. 

We have also increased the allocation to gold in our DFM and MAF portfolios, funded from Investment Grade Credit and taking advantage of the significant correction in the price since its peak in late February. Gold was introduced to these portfolios because of its ability to provide diversification at times of uncertainty and higher inflation. The metal often behaves differently from equities and bonds, bringing an extra source of diversification and resilience to portfolios during bouts of market volatility.