We remain selectively optimistic
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Looking through the noise, we remain selectively optimistic for asset prices as high levels of government spending continue to support economic growth and corporate earnings.
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The path ahead is likely to remain bumpy as politics stay in focus, trade deals are negotiated, and geopolitical tensions persist.
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In equities, we expect European stocks can continue to outperform as increased government spending catalyses an inflection in growth, while low interest rates provide reassurance for borrowers.
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In bonds, the backdrop favours attractive yields offered by short-dated bonds, across the credit spectrum, over long-dated government bonds.
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Portfolio construction and careful selection of diversifying assets, such as gold, is key.
Values accurate as of 30 June, 2026
2025 H1 Review
Politics took centre stage for investors during the first half of 2025, causing ripples through financial markets. While we anticipated more volatility this year, as described in our year ahead publication, the scale of moves has been larger than expected. Moreover, significant currency moves have materially impacted returns for UK investors and are reinforcing the importance of having a comprehensive approach to asset allocation.
The start of the year proved a worrying time for investors. The emergence of Chinese AI company, Deepseek, with its low-cost AI capabilities, catalysed concerns about US chipmakers which have made huge price gains over recent years. The outcome for leading chipmaker Nvidia was the biggest single day loss in market value for an individual stock in the history of US markets. Stocks recovered quickly but nervous investors were then faced with many challenges from the new US administration. President Trump signalled significant recalibrations to global trade and defence relationships. Sweeping increases to import tariffs announced at the beginning of April had the potential to cause enormous disruption for businesses globally and triggered a sharp downturn in stocks. Tariff rhetoric escalated quickly with rates applied to China rising to as much as 145%. The creation of the US Department of Government Efficiency (DOGE), with the aim of reducing government costs, also worried investors due to the potential for lower spending and job losses.
Despite all the hurdles, stocks regained ground quickly over the second quarter. Tariff rhetoric softened with a 90-day pause enacted for most countries, and a truce was struck with China, bringing tariffs down to a more sensible 30%. Realisation that DOGE was unable to achieve its anticipated cost reductions, and its ultimate demise, provided additional support to markets. Much of government spending, for example on healthcare, social security and defence, remains very difficult to curtail. Attention swiftly turned from spending cuts to the tax cuts incorporated in President Trump’s ‘Big, Beautiful Bill’. Overall, it seems likely that US fiscal spending will remain elevated, as it has been for several years, providing further support to consumers and, as a result, corporate earnings.
In Germany, encouraged by the US pulling back from global security arrangements, leaders have committed to increased government spending. After decades of cautious budgeting, this is likely to be the biggest increase in German fiscal spending for more than a generation. This propelled German stocks to a new all-time high in the first half of 2025, further helped by the European Central Bank cutting rates by 1.0%, providing reassurance for borrowers. UK stocks also posted strong gains, buoyed by the UK becoming the first major economy to secure a new trade agreement with the US.
Despite the turbulence caused by policymakers, corporate earnings held up well over the first quarter of the year. Earnings growth remained robust, with widespread positive surprises and better-than-expected net profit margins. However, some caution is warranted as many companies elected to withdraw their full-year guidance amidst growing discomfort with the uncertain landscape. This is a key area to monitor as the year progresses as a lack of clarity over tariffs and other government policies makes it difficult for businesses to plan and invest.
In the face of many challenges and volatility, asset prices displayed stunning resilience over the first half of the year, reinforcing the importance of staying invested despite dramatic headlines and intramonth market drawdowns. There were notable divergences between and within asset classes. US stocks rose 6%, whilst the US dollar fell 10% against Sterling as investors reduced, from historically high levels, allocations to US assets amidst political volatility. This resulted in a small loss for UK investors. Performance from other regions was more favourable, with stocks in Europe up 8% and UK 7%. Bond markets produced small positive returns, with dispersion between regions, maturities and sectors. Commodities and listed infrastructure delivered modest gains, with lower volatility than most regional stock markets. Meanwhile, gold surged, building further on a strong 2024. Central banks have been increasing allocations due to its role as a safe-haven asset and a hedge against inflation, as well as to diversify their holdings away from being so reliant on US dollar assets. The dispersion of returns and volatility between assets emphasises the importance of careful and granular portfolio construction.
2025 H2 Outlook
Looking ahead, we believe that there are some aspects of the current environment which mirror that of recent years, and provide broad support to assets, but there are also important changes to consider when building portfolios. Government spending is very high, as it has been for a few years, and central banks remain biased towards rate cuts, rather than hikes. Nonetheless, uncertainty lingers over trade policy, geopolitics and the impact of high government spending on bond issuance and prices.
As described previously, many areas of government spending are very difficult to cut – such as healthcare, social security and defence – because it is politically unviable. Ageing populations, with higher demands on healthcare services, and geopolitical tensions, which underpin the need for defence, add further to the pressure. These high levels of government spending support jobs and wages and, therefore, corporate earnings and stocks. Indeed, wage growth remains high in the US, UK and Europe. However, elevated spending means there will be more issuance of government bonds, putting downward pressure on bond prices and upward pressure on bond yields. There may be some offset though as central banks seek to keep interest rates low. However, the pace of cuts is expected to be slow, as they assess the possible impact of tariffs, and other policy changes, on inflation. In any case, there is not a great fear of rate rises as was the case a couple of years ago. In addition, with President Trump vigorously encouraging the Federal Reserve to cut rates, it seems likely that, when the post of committee Chair is renewed in 2026, the successor will be an individual that is inclined towards cutting rates. This stance encourages consumers and businesses to borrow and invest, in turn helping jobs, spending and corporate earnings.
The pattern of high government spending and supportive central banks is a familiar one from recent years. However, there have been some notable changes in global relationships since President Trump took office which are also important to consider when building multi-asset portfolios. Global trade has been impacted by actions to raise tariffs, and the flip flop nature of policy brings uncertainty. Moreover, geopolitical risks have the potential to impact the economic outlook. Conflicts in the Middle East and Ukraine fuel regional instability with impacts on energy and food prices. Beyond traditional warfare, cyberattacks are becoming more frequent and severe. These risks emphasise that the future path of possible outcomes is wide, and this thinking is embedded within our asset allocation as we begin the second half of the year.
Top Three Investment Risks
Tariff policy
Uncertainty lingers with respect to US trade policy, its potential to deter or delay investment decisions and any inflationary impact.
Bond market turmoil
Ongoing high levels of fiscal spending has the potential to push up long-dated bond yields and weigh on equities globally.
Geopolitics & cyberattacks
There are many pockets of tension across the globe which could escalate further and cyberattacks are becoming more frequent.
North Capital portfolio positioning:
We have a neutral stance between defensive and growth assets but are very focused on specific allocations within each area which we believe will enhance portfolio returns and bring resilience. Within fixed income, we are underweight sovereign bonds in favour of active short-dated bond funds across the credit spectrum. We expect this increased allocation to short-dated bonds will smooth the return profile and reduce risk in an environment in which long-dated bonds are vulnerable to rising levels of government spending and investors being more reluctant to lend to governments for long horizons. In addition, we expect short-dated bonds can outperform if the market narrative shifts towards speculation over the next Federal Reserve Chair.
Within growth assets, we are overweight European stocks, funded from our allocation to real assets. The tone from politicians in Europe is encouraging with German authorities having agreed to increase spending on defence and infrastructure. This comes on top of already low unemployment, improved consumer sentiment and a supportive stance from the European Central Bank. For the US, many uncertainties remain, but we have moved global equities, which are dominated by the US, back to neutral (from underweight) as some drivers have turned more favourable in the near term. Evidence points to high levels of government spending continuing and, in addition, the US is home to a large share of the world’s most innovative companies and, so far, corporate earnings have remained strong. This shift has been funded by moving to an underweight position in commodities after good gains over the first half of the year. We are overweight gold as we believe it brings valuable diversification to multi-asset portfolios, especially in the current environment where we expect diversification from traditional bonds will be less reliable than many investors have historically become accustomed to.
We are neutral overall risk.
We are neutral defensive assets, with a focus on specific allocations.
We are underweight fixed income relative to real return.
Our bias remains to short duration bonds and tactical funds.
We are underweight Fixed Income relative to Real Return.
Our bias remains to short duration bonds.
Elevated cash rates provide support to short-dated bonds while longer duration bonds are less attractive due to inflation risks and a heavy supply of bonds. We have a preference towards active funds, because ongoing fluctuations in the market narrative provides ample opportunities for strong managers, as well as short-dated high yield and high-quality asset backed funds with attractive yields.
Defensive real return assets offer good value as real yields (nominal bond yield
minus the expected inflation rate) are positive, presenting value to investors.
Inflation-linked bonds are attractive as inflation pricing remains subdued relative to persistent wage growth pressures and rising trade tariffs.
We are neutral growth assets.
We are overweight equities relative to real assets.
The US has agreed trade deals with the UK and, more importantly, China. This greatly reduces uncertainty for businesses and consumers and should support sentiment following a challenging period. In addition, the focus has moved from spending cuts via the Department of Government Efficiency to tax cuts incorporated into Trump’s ‘Big, Beautiful Bill’. This means that US fiscal spending is likely to remain elevated and provide an ongoing support to the economy and earnings. Therefore, we are overweight equities relative to real assets. Meanwhile, fiscal spending is expected to increase sharply in Europe as Germany is embarking on greater defence and infrastructure spending – a change that we view as favourable for European stocks and the currency. Within global equities we expect earnings growth can broaden selectively across sectors and regions, providing an environment in which strong, active managers can add value. We hold selective exposure to high quality active managers within our global and emerging markets exposure.
We are underweight real assets relative to equities.
Real assets offer attractive diversification within a multi-asset portfolio and are, therefore, good for smoothing returns over the long-term. We have an overweight allocation to gold as we believe that its limited supply and low correlation to traditional assets makes it attractive, while the desire for central banks to diversify their reserves away from US assets, because of heightened global uncertainties, should continue to underpin demand. We are underweight broad commodities at present as we believe equities offer a potential greater return.
North Capital portfolio positioning:
Continued
We retain neutral allocations to UK, Japan and emerging market equities. In the UK, valuations have increased over recent months but remain attractive compared to other regions. However, with inflation above target again, it could be more difficult for the Bank of England to offer support via rate cuts. As such, we view risks as balanced going forward. In Japan, corporate reforms are helping to make companies more profitable, thus creating a compelling option for global investors. Meanwhile, the return of inflation brings risks of rate hikes as well as currency and stock market volatility which are undesirable. Emerging market returns for UK investors can be significantly influenced by currency moves.
A weak US dollar is typically advantageous for emerging markets due to their reliance on dollar debt which becomes easier to repay. Following a sharp US dollar depreciation over recent months, this leads us, in the absence of other significant catalysts, to a neutral view on emerging market stocks. We hold selective exposure to high quality active managers within our global and emerging market allocations as we believe there are an abundance of investment opportunities within and between regions.
