Investment Outlook Q2 2025: Politics recalibrated

Key observations: 

Economic outlook  

• Market pain before gain was the title of our March 2025 outlook, presaging the dramatic falls and rises.
• The second quarter of 2025 continued to see high volatility and a wide range of economic, policy and market scenarios.
• Politics in the US have been recalibrated to defer tariffs following the unsettling of equity and bond markets.
• While there are some modest signs of slowing in economies post the April tariff disruptions, we are expecting the stimulus from the US tax and stimulus Bill will underpin the US economy.  Europe has agreed to increase defense and infrastructure spending which will provide a boost to Europe, while China gradually increases their own stimulus efforts.
• Inflation continues to surprise on the downside in most countries, with some slight rebound expected by the year-end.
• Labour markets have weakened slightly in the US but is generally resilient in Australia and globally.
• Money flows continue to rebalance out of the US as the US dollar weakens from a peak in early 2025. Overall net liquidity is slightly negative but expected to pick up on the back of government stimulus efforts.
• Policy continues to have a rate cut bias with the Reserve Bank of Australia (RBA) and Federal Reserve (Fed) both expected to cut two more times before the end of the year. Overall, most developed market central banks have been cutting cash rates with more to come.

Market Scenarios for 2025  

• Under our base case for the year in aggregate we see equity markets ending the year on a positive given the rebound from the April US tariff disruptions and geopolitical events (US bombing Iranian nuclear facilities, followed by a contained Iranian retaliation, leading to a ceasefire between Israel and Iran).  We note the limited impact of this on markets and a short-term spike in oil prices. While there is still some political uncertainty, we expect more positive stimulus, deregulation, and contained tariff and geopolitical developments, which will support more positive equity markets with some moderate volatility into year end.
• The playbook to take early corrective action by the US administration, and being willing to risk a recession, has moderated based on the reaction of equity and bond markets to the disruption. The TACO (Trump Always Chickens Out) trade, an acronym that gained prominence in May 2025 after many threats and reversals,  has been embraced; however, we see evidence for committed action and pressure for more tariff deals.  Risks to the downside exist as bond markets may react at some point to further uncertainty and very high debt loads.
• On the positive scenarios, we see a clear shift in the US to stimulate the economy and to move forward on deregulation.  We see examples such as the bank Supplementary Leverage Ratio and positive bank stress tests providing headway for banks to increase lending. These positive policies are now the focus to ensure they are implemented with effect in time for the political campaigning season for the late 2026 mid-term elections.
• In the EU, a broad agreement has been made to increase defense and associated infrastructure spending to 5% of GDP for all but Spain. From levels that sat in the 2% area, this provides a significant boost that will last for years, and add other countries to the impact of Germany’s proposed major defense and infrastructure stimulus step up by Germany under their new coalition government.
• Credit markets continue to be extremely well supported following the spread widening and subsequent contraction in April and May.
• Our central case of overall positive equities for the year was challenged last quarter, however we expected at least one meaningful correction this year and these periods of correction are normal within a well-functioning market.
• Downside scenarios we are on the lookout to include business and consumer sentiment translating into worsening retail spending, corporate capital investment and hiring, and downward revisions in company earnings.
• On the upside, when we see a new Fed chair being announced, it’s likely the new chair will cut more than the current Fed chair (Powell retires in early 2026 but remains on the Fed Board of Governors until 2028).

Long-term themes for the next few years  

• Geopolitical and political policy volatility is the new normal and has to be factored into investment analysis.
• Climate change costs continue to rise, particularly with rising demands from data centers and AI.
• ESG as an investment theme fades with ESG labelling being removed or downgraded.
• High government debt loads have an impact on regular, typically four-year refinancing cycles.
• Technology curves converge and accelerate with merging AI, blockchain, hyperscale data and compute.
• Popular themes and narratives interact, creating waves of cheap vs expensive thematic investing opportunities.
• Generational disruption and challenges to traditional institutions from a more polarised society. 

Anecdotes that intersect the long-term view with right now

• US bombing of Iran nuclear facilities highlights geopolitical shocks and recoveries for markets.
• Gold continued to be supported as the net central bank announced buying intentions for reserve asset portfolios.
• Announced during the recent NATO meeting, defense spending in Europe was agreed to move to 5% of the EU countries' GDP.
• Copper price above $10,000 a ton, supporting intended energy and data center infrastructure investments. 

 

Tactical Asset Allocation 

 

Factor	Rationale
Fundamental – Neutral	US soft economic data is mixed, and hard data is weakening slightly while inflation remains subdued. While there is potential for a downswing from here, there is also a potential for recovery from a low base. There appears to be more willingness to look through erratic tariff policy and focus on stimulus measures from the recently passed view.  Elsewhere, we see positives of a low for the European economies and companies, while China’s GDP is strong and inflation remains very weak. We see challenges to fundamental earnings for Australian companies, which still have a negative trend of analyst earnings revisions versus global companies, with the MSCI World index earnings beginning to rise from a trough low.
Valuation – Moderately Negative	MSCI World multiples have risen with the rebound from lows and, albeit above historical averages, the change in mix of global companies with more growth and technology in the MSCI World index can justify a higher valuation multiple compared to Australian equity index.  Credit spreads have returned to relatively low levels after spiking up during the tariff disruption period.  The US Fed is likely to cut more this year with markets pricing in two cuts for the remainder of 2025 and another three for 2026. The RBA is likely to cut rates two more times before the end of 2025, and possibly another cut by mid-2026.
Technical – Neutral	Sentiment is bullish for retail investors who have had strong positive flows into equities and fixed income  Equity positioning is a mix of neutral and some selective underweight with institutions. Market breadth has improved as the recovery in equity markets has broadened beyond mega-cap tech with equity market performance strong.  Relative performance has been mixed across the US, Europe, China and Australia, while Momentum has been strong with a rotation towards Growth and away from the Value style. Some Cyclicals have lagged, but should catch up as market breadth and company earnings growth revisions come through. A weaker USD trend appears to be in place which should be positive for monetary liquidity, growing off a slightly restricted base.
Overall view for growth asset classes.	The markets have rebounded from the depths of tariff and geopolitical shocks, and while momentum has continued, we appear to be in a phase of ‘climbing a wall of worry’. This is expected to be a continued grinding up trend with occasional shocks and pullbacks. Reluctant institutional and bearish holdouts will likely allocate back to equity and growth assets as there are opportunities on pullbacks and as additional hard economic data and company reporting come through. Sentiment has been relatively subdued across the world, with some emerging signs of recovery in US business sentiment and some emerging positive signs from Australian businesses.  Within our model portfolios, we added back growth asset classes to a smaller overall underweight in June, allocating to Global equities where we see more positive signals than Australia. This is based on our nuanced Fundamental view, with some slight negatives on valuation and a neutral view on Technicals. We are open to adjusting this position on further volatility and as evidence changes from our slightly conservative positioning on a tactical timeframe.

 

 

This information is general in nature and is provided by Partners Wealth Group. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.