Momentum and growth

Tariff bonanza (sort of) 

We will soon know what President Donald Trump decides to do after the 90-day delay to reciprocal tariffs first announced on 2 April. Meanwhile, according to US Treasury data, as much as $100bn in customs excise revenue has been raised this year. Most of that has been generated since April. The Yale Budget Lab estimates the effective tariff rate for the US is currently around 15%, the highest since the 1930s. The revenue collected under the tariff regime is paid at the point of entry by companies importing goods into the US. However, the final cost burden is shared between the purchaser of the imported goods and the final consumer. On an annualised basis, tariff revenue so far is equivalent to about 1% of US personal spending. It is a relatively small, but still a meaningful, transfer of wealth from the household and corporate sectors to the government. It will not move the dial much on the budget deficit, but it underscores the impact on real incomes from a protectionist trade stance.

Prices moving up? 

Price index details suggest tariffs will impact import prices. The durable goods portion of both the producer price and personal consumption deflator reports have shown higher year-on-year inflation in recent months. June’s Institute for Supply Management (ISM) index showed the prices paid index edged higher to 69.7 from 69.5. This means that a sizeable majority of procurement officers at corporates are seeing higher prices for the inputs they need. The import index rebounded to 47.4 in June from 39.9 in May, but at that level the message is that import growth remains negative. The comments from respondents to the ISM survey clearly articulated the negative effects of tariffs on prices and procurement decisions.

But markets at new highs 

Not that markets care. Equities keep reaching new highs and bonds, despite concerns about fiscal policy and a negative reaction to the June non-farm payroll data, are at levels that are not causing a problem for equity markets. The Federal Reserve (Fed) is on hold, but markets still think that it will cut rates this autumn. For now, the well-established trading range for US Treasuries and other government bonds remains in place.

The gap between the earnings yield for the S&P 500 index (the inverse of the price-earnings ratio) and the 10-year Treasury yield is about 0.25%, based on the consensus forecast for earnings-per-share growth over the coming 12 months. That earnings-yield gap has gone through a massive round-trip from the days of the dot.com bubble at the end of the 1990s (when it went negative), to a peak of over 6% in 2011, to being near to zero again today. The simple conclusion is that equities are hugely expensive relative to bonds. The more daring conclusion would be that prospective returns from stocks are lower than they are for bonds.  The counter is that earnings growth is still very strong, and this should sustain returns. The big risk is a recession occurs when income growth slows; and you need income for spending (think both household and corporate); you need spending for revenue, and you need revenue for profits.

The bearish scenario 

After reaching an all-time high in early 2000, the S&P 500 index fell almost 50% and took around six years for it to recover back to that 2000 level. The net return of Treasuries over that period was higher than the net return for the stock market. Today, the continuation of US equity outperformance relies on there being no meaningful cyclical correction which would undermine earnings and, at the same time, see interest rates fall. According to the National Bureau of Economic Research, and ignoring the COVID-19 mini-recession, the US has expanded for 192 months – a stretch of economic growth that exceeds those seen in the 1980s, 1990s, 2000s and 2010s. You might think a recession was due. The fact that we have not had one shows how resilient the US economy is – so why wouldn’t stock markets keep on delivering?

European momentum slowing 

International markets are not expensive, but they have not had the same voracity of economic expansion either. Equity multiples are much lower in European and Asian markets. US exceptionalism has delivered strong wealth growth, but this has created more downside risks – especially with policy unpredictability and inflation risks. Market performance in June reflects the new bullish sentiment towards the US. American and technology-related Asian equity indices were, by far, the best performing markets last month. European markets lagged, although they remain ahead on a year-to-date basis. The suggestion from the European Central Bank, that it has cut interest rates enough, had an impact on investor sentiment. European bonds underperformed US and UK duration for the first time in a while.

Love the short linker 

It remains hard to have high convictions. The US stock market is one big momentum trade, supported by “buy-the-dip” sentiment and the ongoing enthusiasm around artificial intelligence (AI). Away from equities, short-duration inflation-linked bonds have been one of the standout asset classes in recent years, in terms of risk-adjusted returns. The beauty of short-duration bonds is they benefit from the inflation accrual, linked to a reference consumer price index, but have limited sensitivity to interest rate volatility. The total return, year-to-date, for the ICE Global one-to-five year Inflation Linked Bond index, was 7.5% in US dollar terms as at the end of June. In euro terms, with the dollar exchange rate hedged, the return was 2.95% - still well above the increase in the Eurozone Harmonised Index of Consumer Prices (1.6% to end May). It is an allocation that should perform in this period of tariff uncertainty. If inflation rises, inflation-linked bonds will benefit. If growth slows and the Fed cuts rates earlier, or more than expected, then there will be also a positive impact from lower nominal rates, and a reduced inflation break-even spread.

High yield cash flows resilient

In terms of riskier assets, a balance of equity and high yield allocation would capture the still positive cash-flow dynamics. Global high yield has registered strong returns – again using ICE indices, in US dollar terms the global high yield index’s total return was 6.9% to the end of June and, in euro-hedged terms, it was 3.4%. The fundamentals and market dynamics for high yield continue to drive positive returns and little is expected to change going forward – any recession in the US is going to be demand, rather than balance sheet, driven. US corporates will benefit from some of the tax provisions in the budget bill. The chart below plots the total return of short-duration inflation-linked bonds, US high yield and US technology stocks since the beginning of the year.

Barbell 

Investors all have their different risk budgets and time horizons. Short-duration inflation and high yield total return indices are at record highs, along with US growth stocks. Fixed income assets have clear cash-flow return characteristics – accrued inflation, rates and credit returns based on solid corporate fundamentals. Equity assets are much more subject to changes in expectations on whether super-revenue growth can be sustained over the medium term. There is no doubt that AI has the potential to change many things and that companies are spending billions to integrate AI into their operating models in the hope they will reap the benefit of higher productivity and profits. The question is whether the option of buying into it now, is at the right price. The equity risk premium in US stocks is so small, but the expected growth of earnings from technology stocks compensates. The long-duration growth equity versus short-duration fixed income cash-flow barbell remains an attractive core portfolio.

Paid to own fiscal risk 

Finally, the drama around UK Chancellor, Rachel Reeves, on 2 July highlighted how vulnerable UK government bonds are to any deterioration in the fiscal outlook. The 10-year gilt yield rose by 15 basis points (bp) and the 30-year by 19bp amid speculation that Reeves might be replaced by someone less committed to abiding by the fiscal rules. Subsequently, Prime Minister Keir Starmer confirmed that Reeves would remain in place and the government is committed to fiscal stability. The increase in yields was quickly reversed. However, investors are keenly aware that the problem for the current UK government is it cannot satisfy its own MPs, supporters and financial markets at the same time. That conundrum will continue to challenge Starmer and Reeves, keeping the gilt market at risk until further fiscal plans are unveiled in the autumn. The way forward might be to increase income taxes – a more efficient way to generate tax revenue than any of the other measures tried so far.

Long-term bond yields are higher in most markets compared to the start of the year. Fiscal risk premiums are evident in curves – generically, 30-year bond yields are some 80bp higher than swap rates. The US budget should pass soon, and the UK government has some reprieve until the Autumn Budget comes into focus. I would be happy owning 30-year bonds over the summer with the potential for rates cuts from the Fed and the Bank of England likely to be supportive.

Performance data/data sources: LSEG Workspace DataStream, ICE Data Services, Bloomberg, AXA IM, as of 3 July 2025, unless otherwise stated). Past performance should not be seen as a guide to future returns.