Webinar Q3 Market outlook webinar - One big, beautiful update

Good morning, everyone. Thanks for joining me today. Sorry to start a minute or two late. We had some slight technical issues in the background, but they've now been resolved. I'm Anthony McDonald. For those of you who haven't joined these webinars before, I'm the Head of Portfolio Management at Aegon UK.

We've had a bit of a roller coaster first half and a bit of 2025 in terms of policy and markets, particularly stemming of course from President Trump in the US and given his dominance really of the last six months across so many facets. I've shamelessly plagiarised his ‘One Big, Beautiful Bill’ entitling this update ‘One Big, Beautiful Update.’ Hopefully, as with the bill, it will prove to be clearly his policy priorities and high rhetoric remain dominant as we look into the second half of this year.

So over the next 30 to 40 minutes, I'm going to get to grips with some of the key developments we've seen, their impact and what we think they mean for investment risks and opportunities from here. That's all captured in the learning objectives, which I'll pop on the screen quickly now. And as always, there'll be plenty of time for questions at the end, so please do use the Q&A button on your screen to ask any questions you might have. I'll answer them depending on how they fit in, either as we go through or more likely at the end of the session. And importantly, we'll also share the CPD certificate link in that Q&A section towards the end of the webinar, so do please look out for that. And do, as I said, please do send through questions. It's always good to focus on the areas of particular interest.

I do always like to start with a reminder, a quick reminder of our approach to investing. I do think it kind of it frames the way we look at markets and events and so it's important to give that context upfront and our approach is rooted in a long-term valuation-based philosophy. We do think that long-term approach to investing your clients money is an edge that we have compared to short term traders and is anchored by that valuation analysis. We do believe, linked to that, that for many reasons markets can and do absolutely trade expensive or cheap to a reasonable estimate of their fair value. Think cycles of behavioural cycles of greed and fear.
Or just the technical reasons. Different market participants have different reasons for operating in markets. Like I said, there may be short term traders, there may be some desire to hedge particular risks in certain portfolios. They all push markets around in the short term and it's only over longer term that we feel fundamental analysis can come to bear.

To put colour on it this time, I've included here one of our preferred equity valuation indicators on this slide. This is the cyclically adjusted P/E of difference.
Market indices across the UK, Europe, US, Japan, emerging markets and Pacific. Cyclically adjusted P/E (CAPE) made payments by the Shiller PE effectively smooths the long-term earnings, the earnings denominator to a long-term earnings average on the denominator to create a more, stable attempted cyclically adjusted measure than a than a spot price to earnings ratio. We like it because we find it's historically correlated well with long term future returns, if not necessary returns over the next month or two months or - 3 months but over the next 5-10 years. We find that markets that start off very expensive on this kind of ratio are associated with weaker future performance, long-term future performance than those that start off cheap. And what we can see here is the green bar, the current CAPE for all these markets and then the yellow dot is the median over the last around 20 years or so and
clearly the first point to make is all these equity regions are trading at least a little bit above their median, their average cyclic adjusted P over time. So none of these regional blocks look screamingly cheap.

But we do find that kind of the there's quite a big kind of fuzzy range around the median where the long-term kind of signal is weaker. What we really look for is markets that either look very cheap or markets that look very expensive as very, very clear valuation signals. And here you can see the US market, look how far that green bar extends over the yellow dot. That's telling you that the current cyclically adjusted P of the US market is considerably higher than its long-term average. That would typically be associated with lower returns over the next 10 years, all else being equal, so that that gives us a signal to go away and do our own analysis on the context within which that valuation metric is sitting and even after our further work on that economic context, it does contribute to why we have a negative view on the US.
So that's philosophically the way we think about investing and putting together valuation signals with our deeper analysis and what I'll do now is I'll move to a kind of more shorter term take on some of that context that that signals sitting within.

You can see this chart shows that very quickly the recent backdrop to this quarterly update. This is just the Q2 performance across the kind of main asset classes and you can see kind of which we sorted by quarterly performance kind of all the left-hand assets from Pacific equity down to, through the different regions showed that the equity markets enjoyed a strong quarter. You know, as we'll remember, they'd initially swooned pretty hard in response to President Trump's Liberation Day reciprocal tariffs at the start of the quarter. You know that was early April.
It feels like longer ago in some ways, but as you as most of you all know, those additional tariffs were swiftly postponed. The focus moved to trade deals. We'll talk about that more in due course, and that enabled a strong recovery from global equity markets generally.

If we then step back more broadly, you know you can see from the fact that the vast majority of these bars are positive that it was a good quarter generally for multi-asset investing in terms of delivering positive returns to investors. You know those equity gains accompanied by smaller positive performance from corporate and government bond markets, helped by interest rates continuing to fall in a number of areas, including the UK and the eurozone. I suppose the other key element of recent performance this year that's been notable has been weakness in the US dollar. You know, that's really interesting. Plenty of theories around tariff policy suggested that the dollar should strengthen to help offset the impact of tariffs in the US.
Clearly so far that hasn't happened. Investors seem to be more focused on general policy risks, policy uncertainty, a slowdown that we saw in in US growth. It was negative for the first quarter of the year and those factors seem to have weighed on what ostensibly looks like a relatively expensive currency so far this year, we'll talk a bit more about that in due course, but we are thinking about what that means for the outlook for currencies generally from here.

So with that general backdrop, starting to think about what we've seen in the last quarter or so, I thought it would be a useful thing to have a bit of a media review of the of the investment themes that we set out around six months ago, a good way to frame the progress we've seen broadly over the course of this year and then to think about these critical areas looking forwards, you know at the start of the year. What we're looking for, you can see in this slide, you know there were some investor concerns about the risk of resurgent inflation. We felt interest rates could generally continue to fall further over the course of the year, kind of linked to that. But further we thought that there was the case for further policy support from China, authorities continuing to address economic fragilities and we were a bit contrarian in the setting out the longer-term case for UK investment opportunities where we saw areas of increasingly compelling value, we've been speaking about that over the course of the last six months, particularly gilts and kind of mid-cap equities and then at the end they're clearly less contrarian, but you know as with everyone else, we absolutely expected President Trump's policy platform and his unorthodox approach to implementing this policy platform to have a huge impact on both sentiment and economic developments. And what I've done here is, you know, a very quick review of each of those areas really showing that most of these themes, as we'll know, are absolutely on track as we look into the second half of the year.

Central banks across the world absolutely continue to be biased towards lower interest rates. Clearly, the US Federal Reserve has been on hold this year, linked to some of the potential inflationary pressures from the Trump policy platform we've been talking about but outside there we see cuts in the UK, eurozone, Canada, Sweden, Australia, Mexico, India, loads of others. Outside the US really we're seeing a world that's primarily on a path to lower interest rates. Looking to the second half of the year, we think that can continue to some degree. We think the UK is likely to lead the way among the major central banks, they've been a bit slower than the regions like the European Central Bank to bring the interest rate down and we do think the combination of some economic growth risks and indications that inflation may start to fall again will give the Bank of England the ability an impetus to keep going in the second-half of the year. So we still think the kind of 2025 move to kind of lower interest rates is absolutely on track.

What about China? Well, again, we saw unexpected rate cuts in May, again showing the authorities intent to provide support that the economy seems to need.
On top of that, the credit impulse, the kind of the rate of credit moving into the economy has historically been quite a good support for economic growth and that's improved in recent months. So partly we think as local governments have front loaded some of their 2025 bond issuance and again we think that provides a kind of a more conducive policy backdrop for the Chinese economy.

Here in the UK it was a slightly challenging start for domestic assets. You know we had we had those early year concerns around debt sustainability, the chancellor’s fiscal headroom to fiscal rules that comes up from time to time in the news and so there was a bit of early underperformance from the pound and gilt to the mid-caps kind of altogether, but we saw a really strong recovery actually from sterling you know amid that general weaker dollar trade we've been talking about and from the mid-caps in the second quarter of the year. And if we step back, the gilt yields have been you know we put range-trading there I mean really bouncing around for some months now and we think that kind of while they bounce around, we're being paid a pretty attractive income while we wait for any clearer direction there, which we think may come with any Bank of England move to kind of lower interest rates at a faster pace than expected.

And last but no means least, you know, I've mentioned President Trump a few times. He's obviously come in, upended really established U.S. policy, global relationships, unilaterally setting tariff rates that we haven't seen for decades, implementing policies that look to be significantly slowing immigration levels in the country and passing that One Big, Beautiful Bill Act, which is meaningful fiscal legislation. Well, actually it's pretty quickly as we saw eight years ago addressed his main campaign priorities. And we do think it's reasonable now for kind of the initial high level of policy uncertainty to be fading. That's probably helped the recent rebounding in stocks and riskier assets more generally but we do also think that policy blitz has ushered in quite profound changes, many of which could stay in place for quite some years and that's a theme I'm going to go back to in due course as we think about the impact of those policy shifts and the degree to which they may be fully understood, discounted by markets at this stage.

So think about that concept of discounted by markets it's a bit nebulous, but you know it links to the starting point I set out where you know our philosophy is very much kind of anchored in analysis of the valuations, you know effectively the amount we're paying for different assets and the degree to which we think that offers value or not and we saw when we looked at the US equity, the CAPE bar chart at the start of this session, the US equities look to us to be evaluations that have previously only been seen in the in the dotcom and post COVID bubbles. You know, to us that's an expensive starting point and actually it'd be similar for something like investment grade corporate bond spreads where the premium for lending to those corporates over governments is back down to pre-2008 levels.

The way we think about that is against that backdrop of profound policy change or what we think is profound policy change and the impact of which we really don't think has yet been fully seen in economies and then hence through to markets. We do think there is a particular risk for paying up for those parts of the market that are very expensive. It may well be that the winners of the next decade are not the same as the assets that proved to be the winners of the past 10 to 15 years certainly that risk when we hit moments of change.

So I want you to think about tariffs in a bit more detail, just to bring that point to life a little first, I suppose, before we go into the nuts and bolts of this of this timeline, a bit of broader context.
The US effective tariff rates, you know, different people calculate it slightly differently depending on kind of trade relations to step share. But you know it broadly looks to have been below 5% for the best part of the last 50 years and actually much lower than that for most of the 2000s. And so if we stick to the very high level, a trade policy that looks to set a minimum 10% baseline tariff and enhancements by country or sector on top of that is a big deal. It takes trade policy to somewhere that hasn't been seen in decades, in fact, the best part of the last 100 years. So that's the kind of the big context that I think is important to bear in mind. And then this timeline tries to then try to capture really how unstable that tariff policy has been so far this year. You know, we've had, as we all know, this rolling mix of threats of postponements of deals and I split it really into three main parts. The first part, you know, the first phase of this timeline is up until Liberation Day, where we had these kind of ongoing, seemingly scattergun tariff announcements against Mexico, Canada, China, high levels of uncertainty of where it would all end up, but the threatened effective tariff rates from the US on imports were clearly rising fast and that phase peaked with those reciprocal tariffs that President Trump announced on the 9th of April in that in that kind of strange rose garden press conference. And then from then to kind of late June, early July, we had the kind of period of detente really, I suppose, where the high reciprocal tariffs had been postponed. The administration was or at least seemed to be clearly in deal making phase. You know that was illustrated well by the UK/US trade deal in early May, subsequent truce between US and China and uncertainty, you know, faded quite considerably because the worst-case outcomes looked to being curtailed. You know that those liberation, their reciprocal tariffs were postponed and negotiations were in place. Signs from them suggested that for much of the world that kind of that the baseline 10% plus a bit was turning into a kind of a likely landing zone I suppose and then kind of more recently this month we've seen that kind of the quicker kind of deals being reached, you know Indonesia, Philippines, a whole host of them with a wide range of countries where the tariff rates are below those original and reciprocal levels, but quite high kind of generally if you see 10% as the baseline, you know we're looking really in the 15 to 20% range for the eurozones, the Japan's, the Indonesia's, the Philippines. And so this becomes a phase where that that US effective tariff rate has actually been grinding back up again as these deals add on to the on to the baseline and so you know even before then we were at those kinds of generationally high levels and now if anything that's just pushing back at pushing up a bit further.

Of course it's been well received by markets. Again we think that's because you know the uncertainties faded, the worst-case outcomes look to have been avoided. But kind of looking into the second half of this year, we can't help but be a little bit cautious on the policy reality, which is, you know, we've had a big trade dislocation that remains in place and kind of a change in kind of multi decade trade policy from the US. We think that brings with it amongst other things, well lots of risks, dislocations bring risks and have impacts that can't necessarily be fully foreseen, but that includes earnings risk, inflation risk. At a time when some markets in the US, particularly some markets in the world, particularly US equities, look to be at valuations that have been previously associated with bubbles. And so you know, we put all that together and we think it's not a time for investors to be to be greedy with their riskier assets.

Clearly, of course, other elements of Trump's policy platform have the potential to be to be a bit more supportive for the economy. You know, I'm thinking particularly of the One Big, Beautiful Bill, the extension and the kind of addition of tax cuts that looks like he provides some modest fiscal stimulus ahead of the midterm elections next year. So it's absolutely important not to be too one-sided, too negative on the outlook that there are lots of moving parts here and how they’re put together is close to a bit unprecedented. But we do think that that tricky tariff implementation phase will come first and more generally that the Trump policy platform poses some price risks. That does lead us to be a bit careful on the outlook for US government bonds. But if we kind of turn a bit closer to home thinking about the kind of UK opportunities theme, we do see some what we think are some pretty compelling opportunities in the UK.

This slide you can see a couple of indications and I could have chosen from any number of measures that the jobs markets turned quite soft. On the left-hand side we can see the unemployment rates, it troughed down close to 3.5% in early 2022.
We're up towards 4.7% now you know that's quite a quite a trend that's emerged of rising unemployment, a little bit concerning for the economy. On the right-hand side again you can see the flip side of that which is the payrolled employees. And you see, you know that peaked in early 2024 and it's been rolling down ever since. It's again a bit concerning and it's not the sharp kind of fall you see in the recession, but it's unusual for the kind of payrolled economies and employees in the country or really any country to kind of to kind of just keep on falling month on month and quarter on quarter, normally not a sign of an incredibly healthy jobs market. And so it does look to us that's indicative of an economy that may be just in a bit of a difficult place.

We think high interest rates are one reason for that and we do think that you know, especially with the government continuing to talk to and try to emphasise fiscal discipline, that there is room for the Bank of England to start moving faster on lower interest rates in the second-half of the year and you know elements like the stronger sterling we've seen some falls in the wholesale gas prices may may also help contribute to a lower inflation impetus that helps give that the central bank confidence to do that. We think that would be good for gilts. Gilt yields are higher than most other main development bond markets and we do think that the combination of the economic outlook and the kind of potential interest rate response is an opportunity for that market. It's not as ever a one-way opportunity. The main risk here is clearly political the potential for a loss of fiscal discipline whether that's at some level, the government giving up on its fiscal rules or as we saw with welfare bills trying struggling to put through the measures that they feel they need to put through to meet them. Our view is that you know the example of this trust and then those couple of smaller scares we've seen this year absolutely help focus political minds on the limitations to that course of action. And so while we're monitoring their words and actions very closely, we do think that kind of gilt yields more than capture the kind of the probability of that of that more difficult outcome.

As a slight aside, we do also think that on a long-term view UK mid-caps remain an attractive opportunity. Clearly a kind of some economic risks create some short-term challenges there important to size positions carefully but it does look like a very cheap part of the market at a time when we've seen many other equity markets look quite expensive compared to history. Real income growth is still positive for now. The economic outlook isn't one-sided and if the Bank of England does deliver those rate cuts that we've been talking about, then it may very well be that we can have a bit of a virtuous circle for UK assets more generally.

So here I've called this slide balancing risk and opportunity. How do we put all those thoughts together in portfolio strategy? You know, a lot of these themes I've touched on a little bit as we've gone through. You should expect us to remain true to our long-term valuation driven approach. We think that does keep your clients on the right side of long term opportunity and risk in the market. And we do also think that it's an approach that might be particularly well suited to the environment we're in. You know this links to the US and performance compared to markets like the Europe and UK that we've seen so far this year at a time of change. We talked about the profound change in the US approach to global trade, for example, new winners and losers often emerge. You know, a noisy process. It takes time for directions to become clear, but there is a particular vulnerability for those expensive assets that may be priced for a continuation of the of the previous environment.
You know US equities where I've spoken already performed well for a prolonged period, now looking expensive to us, any bump in the road and that may may just be a US growth slowdown which judging by the first quarter data may start to come through this year could be a real challenge for relative performance.

So, I'd absolutely accept there's a lot of uncertainty about the kind of combined impact of Trump's trifecta policies across tariffs, taxes, immigration, you know, none of that. I don't think anybody knows for sure how it's going to kind of balance across inflation pressures, margin pressures, different impacts on different parts of the economy and in that world, we think it's right to keep the overall asset allocation relatively balanced, but within that to emphasise the cheaper markets and to build in defensive assets that we think can provide protection in difficult scenarios. And I've spoken to the gilts which we think can play a role there. And so as a result when we look at kind of our current views across different asset classes and as I said at the start, please do feel free to send in questions. I'd like to go in any direction that anybody would find of use. But if we look at our current views across the different asset classes, you can see that kind of that relatively balanced approach is captured in that neutral stance and global equities but within that we we're sharing that preference for what look to us to be the cheaper markets that the UK including the mid-caps in Japan and to kind of be a little bit kind of tilted away from the US that looks much more expensive to us.

Similarly in bonds you can see there the preference is primarily for the gilt. So I've set out the kind of economic and policy reasons why we think there is a good opportunity for gilts of on a medium to longer term view. The investment grade credit there are currently neutral. You know our conviction there is progressively fading as spreads tighten. You know, I've said that those corporate bond spreads over government bonds are at relatively tight levels compared to history and we do continue to focus quite carefully on making sure that the risk and return opportunity is right at this stage. That's primarily captured in holding a part of that in short dated credit where we think that the kind of yields, the spreads and the risks are a little bit more attractive than in the kind of the full curve of investment grade credit.

So very quick summary because obviously I balanced the opportunity and risk before as well. You know we think policy change is significant. We don't think it's well reflected in market valuations. We think that the US policy mix is likely to bring inflation pressures which helps play to our preference for gilts over treasuries.
We think a relatively balanced asset allocation is right for now, but we're alert to how the policy changes, particularly tariff policy, play through into economies in the second-half of the year and with a mind to the risks there we are incorporating offensive strategies to try to mitigate some of the downside risks.

So if I turn then to questions. I've got a couple in here if you if you just let me pick them up quickly.
Do you think the US is going to go into recession?
Yeah, that's a good question.
It's not our current base case. You know, a US recession would be associated with,
it's typically associated with pretty large equity losses. That would be an environment to be underweight equities. We wouldn't entirely rule it out either, you know, on the on the positive side of the ledger there's an economy that while slowing, has come into 2025 with pretty good momentum, you know a services and consumer sector that seems in decent health in aggregate and a policy mix, the one big beautiful bill act - like that should provide some support as we enter next year. On the flip side, we think some of the factors that supported the kind of post-COVID boom have entered reverse elements like the kind of excess savings, pent up savings that couldn't be spent during COVID, immigration to some degree, a general willingness to spend the relatively large proportion of incomes, a low savings rate. We think some of those factors have paused they're going to reverse student loans being repaid, and at the same time as I've said we do think that this tariff policy will have an economic impact globally, but you know clearly on the US where as things stand, it's starting to look as though the impact of tariffs is affected is being taken within the US rather than at the level of those countries and companies exporting to the US.

So if we put that all together, most likely the case looks to us to be a slow down from what would have looked before to be broadly above-trend growth to below-trend growth. You know, that's not a terrible position for the global economy generally. It can often lead to a slightly easier policy mix, I suppose one of the one of the big questions here is the degree to which that the inflationary risks hold the US back from delivering the kind of easier policy that might alleviate a downturn. So that’s a think about some of the kind of pros and cons around it, but our base case isn't a recession - that kind of a downturn in itself could have quite a significant impact on the kind of assets that outperform and underperform.

More questions here. Where on the curve are you overweight gilts? Yeah, that's a good question. We've actually got a position at the long end of the curve. We think that, you know, there is some sensitivity to general kind of long end steepening correlation around the US kind of, you know, you've got to manage the size of that position quite carefully. But we think that the yield there is very attractive. We think unlike in some of the other countries, there's actually quite a good premium for long data gilts over the rest of the curve. And we also think that the central bank is effectively, you know, on the side of that position.
In the kind of teeth of that kind of tariff liberation day dislocation, the central bank kind of postponed a long gilt auction. They previously cut long gilt issuance. There's now a lot of talk from the Bank of England about the degree to which their quantitative tightening policy and that was effectively contributing to a steeper curve, and that affecting the pastor of their interest rate policy, all that sounds to us as a central bank that is not particularly comfortable with the yield level at the long end of the curve. And we do think that there are some opportunities there, so broadly we like gilts across the curve and that includes the long end.

What is your view on small cap? I talked a little bit about UK mid-caps. Generally small cap equities globally look a little bit cheaper than larger cap equities. You know we'd be careful kind of country to country, region to region as to the make-up of that and the degree to which we felt like enough of an opportunity had emerged.
But we do think in the UK in particular, some of those mid and small cap valuations are really very, very cheap compared to other markets. And that's the kind of thing, you know, with our natural approach that we'd look to capitalize on.

Here's one, very topical one on the eurozone - following on from the EU tariff agreement, are you turning more positive on your exposure? That is a good question that links absolutely into the kind of bigger kind of picture frame I've been trying to set up about tariffs which is you know, the worst case scenario looks to be avoided because it's not a 25% tariff rate, but it is a 15% tariff rate, which is orders of magnitude bigger than what I hazard to guess any of us on this call have lived through. It's quite a lot more than the 10% plus sectors, or at least a bit more plus sectors that was in place before. So I'm not sure it necessarily does become a sudden moment of great excitement, you know. It plays into the bigger picture of more certainty can create some stability in assets because it kind of it stops that real kind of tail risk from taking place. But it's a certainty at a tariff level that we think will have
economic impact and dislocation that we're not sure have been fully grasped by many market participants.

Please do keep the questions coming in. We've got one more here on Japan. Any more, please put them out. I'm happy to keep going. Can you outline your positive Japan exposure? Has the recent political upheaval caused much concern? Yeah, that's another good question.
So Japan is broadly based in very big high level terms on that long term corporate change angle that has been broadly in place since the now late Shinzo Abe came to power in 2011, 2012 and kicked off a real long-term change in corporate culture around a more shareholder friendly focus. And that's come over time with various new shareholder codes, stock exchange initiatives effectively rewarding companies with high and or improving return on equity and we can see, we think we see if we step back over what's now quite a long period, that coming through in a kind of improved return on equity from the Japanese market in earnings growth that on some measures at times hasn't been far removed from countries like the US. We don't think that the market has effectively been fully rewarded for what we see as a profound and sustainable change in corporate culture to the benefit of shareholders.
We also think that again from the valuation point of view, the currency of the yen looks quite cheap and does provide another of those little kind of defensive exposures in the portfolio. So that's where the kind of Japanese position comes in obviously talking then about the short term. And the questioner here has rightly highlighted a bit of political upheaval with Ishiba-san not winning the election outright last year, back in the last year and then struggling in the upper house elections this year. Ultimately, we think that's likely to play to a little bit more fiscal stimulus as the main opposition party gets more say to allow the kind of government to continue functioning. That may pose particular risks to the bond market where yields have continued to rise, not necessarily day in, day out, but on a relatively steady basis over the last couple of years. Again, that plays to our preference for the UK government bond market over the overseas government bond market. You know, we expect it will create a little bit of volatility in Japanese equity markets, but we don't think it undermines the key kind of long term reason of holding them at a valuation level that looks reasonable to us.

Super. That's all the questions. So thank you everyone for your questions. It's great to have you all engaging and thanks more broadly for spending time with me this morning. Now this afternoon. The CPD link should be posted in the Q&A section so do make sure you download it and if you'd like any further information on our market views or investment solutions, please do visit our website.

Thanks again and have a good summer.