Against the odds, US stockmarkets have staged an astonishing recovery in recent months, helping the States-heavy MSCI World index to enjoy a leap of 11.6% in the last quarter alone – the dizzying backdrop of tariffs, trade deals, geopolitical uncertainty and less-than-predictable policymaking from the Trump administration notwithstanding.
The big question facing asset allocators and other professional investors over the remainder of 2025, then, is whether this optimism will spread to other more unloved parts of the global stockmarket – China, smaller companies, the UK, to name just three – or whether renewed tariff strife and weakening economic data will prompt a retrenchment.
The second quarter of 2025 was bookended by the imposition of tariffs by Donald Trump. Having introduced a wide-reaching array of import taxes at the start of April, he then announced a three-month pause amid volatile stock and bond markets. That pause has now expired and, while some countries have agreed trade deals with the US – the UK included – many major economies have not.
The market appears to have concluded the US president will always back down in the face of turmoil – and taken some reassurance from that – yet it still it feels like a fragile truce. Trump clearly enjoys using tariffs as a bargaining chip – for example, at the start of July, he was busy threatening the ‘BRICS’ nations of Brazil, Russia, India, China and South Africa with higher tariffs over “anti-American” policies, after they condemned US tariffs and military attacks on Iran. It appears unlikely he will back away from this favoured part of his policy agenda any time soon.
While markets have shaken off this threat, market leadership has changed in 2025 and the MSCI Europe excluding UK index is still around 13% ahead of the US-dominated MSCI World benchmark over the year to date. Furthermore, there has indeed been a revival in those unloved areas, such as China, smaller companies and the UK, amid signs investors may finally be falling out of love with the US markets, in spite of their revival.
The bond markets
The US economy remains surprisingly untouched by the tariff turmoil, with the much-anticipated spike in inflation yet to materialise. Headline CPI increased 0.1% in May and 2.4% over the past year while core inflation was similarly well-behaved. “These softer-than-anticipated readings are a signal that inflation is not yet rising at a notable pace in the wake of recently enacted tariffs,” notes Carter Griffin, global investment strategist at JP Morgan.
This has helped keep bond markets in check. Indeed, where there has been pain, it has been felt most by the US dollar, which is down over 10% since the start of the year and 6% in the past quarter alone, according to MarketWatch data.
“Investors have not only had cause to back away from the US, they have also had an increasingly compelling reason to look at other markets.
The dollar and US treasuries can no longer be seen as safe havens, which has implications for broader equity markets.”
Most investors are still cautious on the dollar, believing it could drop further still – for example, Simon Evan Cook, head of the Downing Fox range of multi-asset funds, has pared back his exposure from 50% to just 5%. The long end of the US bond market has also been fragile, although this has been a phenomenon across financial markets and not just the US.
As things stand, few foresee a catastrophic ‘Liz Truss’ moment for the US bond market. “Some of the recent handwringing, scare mongering and market moves to a weaker dollar have no doubt been generated from positional unwind,” says David Roberts, head of fixed income at Nedgroup. “Certainly, news that Trump would spend, spend, spend or the US would run a big deficit should have come as a surprise to no-one.”
For his part, Benjamin Melman, global chief investment officer at Edmond de Rothschild, says: “If the US bond market does not stage a rebellion – one cannot exclude a few tensions among non-resident investors, already highly exposed to the dollar and increasingly concerned over the currency – markets generally have the capacity to see beyond the trough that lies ahead of us today.
“This pattern works, however, if the world moves on and leaves protectionism behind – which is possible but far from certain. As of now, we understand talks with China could drag out and are looking tricky with Europe. As a result, as we enter the second half of the year, we are maintaining our slight dollar and equity underweight – via US equities – particularly as duration and the dollar no longer shield portfolios from risks the way they used to.”
This is an important point – and one that all investors will need to contemplate in the second half of the year. While there may not be a catastrophe in the offing, the assumptions on which a lot of portfolios have been based are weakening. The dollar and US treasuries can no longer be seen as safe havens, which has implications for broader equity markets.
Beyond the US
Investors have not only had cause to back away from the US, they have also had an increasingly compelling reason to look at other markets – for example, the self-sustaining narrative that has emerged around Europe. Germany’s incoming Chancellor, Friedrich Merz, has already put a major public investment package in place, focusing on defence and infrastructure and corporate tax cuts. He has also supported a more assertive position on international affairs, including Ukraine.
The expectation remains this should feed into the rest of Europe. “European stocks are outperforming their US counterparts, benefiting from lower valuations and potential advantages from central bank rate cuts and increased government spending,” points out Jennifer O’Hara Martin, a portfolio specialist in global equity at T Rowe Price. Although Europe’s outperformance tailed off over the last quarter, it is still well ahead of the US for the year to date.
By sector, in a higher inflation environment, value stocks in energy, materials and industrials – even financials – may be poised for a comeback.”
Fund flows have also begun to shift in favour of Europe. The last round of Calastone data showed investors wavering on US exposure, while active fund managers have also started to back away from US companies. They must now factor a declining dollar into their calculations – once a tailwind for non-US investors, this now appears to be blowing the opposite way.
According to O’Hara Martin, the opportunities outside the US are plentiful. “Japan’s strong fundamentals and undervalued stocks offer promising prospects,” she says. “In emerging markets, opportunities may arise from select countries, such as Argentina, India, Indonesia and Saudi Arabia. Each of these countries is leveraging reforms, demographic advantages and sectoral growth to offer compelling opportunities for global investors.
“By sector, meanwhile, in a higher inflation environment, value stocks in energy, materials and industrials – even financials – may be poised for a comeback.” This could also favour UK or European markets, which tend to have more in these types of sectors than the US, which is focused on higher-growth markets such as technology.
Smallcap revival?
Another question mark hovers over the long-awaited smallcap revival. In theory, smaller companies should be in a sweet spot now – usually more domestic in focus, they ought to be relatively insulated against the tariff chaos. Equally, they have not yet seen any discernible benefit from falling interest rates, which would normally create a better environment for small businesses. Across the UK and Europe, they remain at historic discounts to their larger counterparts.
Over the second quarter, there have been signs of recovery in this space – for example, the FTSE 250 index rose more than 17% during the period as investors belatedly started to recognise the value to be had here. At the same time, the MSCI Europe Small Cap index was up 20% – almost double the 11.6% of the MSCI World.
Investors in the asset class believe this trend has further to run – for example, Simon Murphy, manager of the VT Tyndall UK Equity Unconstrained fund, says there is still “tremendous value” in this part of the market and sees a “generational opportunity”. Certainly, the magnitude of underperformance in recent years has been significant and the unwinding of that weakness could have further to run.
The US economy and stockmarket could go either way over the coming quarter but there are signs investors are tiring of this unpredictability. The weakness of the dollar adds another dimension to their decision-making. The recovery in the US market looks fragile, and the move out of the US into other regions appears to be building momentum. Europe has been the early favourite, but there is now a question on whether investors will be brave enough to move to higher-risk options such as China, or even smaller companies in the second half of 2025.
