After the dramas of April, the S&P had ‘the best May for 30 years’ according to the headlines - although of course the cruelty of market maths means that it is basically flat year to date. Both Gold and the $ were essentially unchanged over the month, although year to date their fortunes are very different, with Gold up over 25%, while the dollar is down close to 10%. The latter is particularly important for international investors and is the main driving force behind the increased focus on diversification - one of our key themes for 2025.
During May, the media narrative switched to bonds - in part because they did badly as the 30 year yield went above 5% - and it’s a reality that the majority of the media is always looking for an anti Trump spin. (This is not to be partisan, but to acknowledge that the broad information set is often skewed).
The long end took fright at the Big Beautiful Bill, which while containing little that was new (much of it is simply making permanent previous Trump regime tax cuts), likely served as a reminder that while DOGE can identify waste and corruption, the Budget remains controlled by the House and the Pork Barrel still rules.
Importantly, however, the majority of the deficit is funded in notes and bills, ie below 10 years, which as the chart shows is little changed from a year ago at 10years and between 50 and 100bp lower further up the curve. As such the cost of funding is going to be down rather than up on last year.
Short Term Uncertainties - Team Trump (still)
The biggest uncertainty for markets remains Team Trump policies, although we would argue that they are largely consistent and that the bigger uncertainty is created by the ‘analysis’ around them, which tends to focus on what people think Trump should do, or what they would do if they were in charge.
Equally, a lot of the ‘soft data’ on the US has become so politically skewed as to be virtually meaningless. Take for example the Michigan Consumer Sentiment Survey, which is either great or terrible depending on whom you ask. (The same applies for questions on growth, inflation etc).
Our view remains that the Tariffs will not be abandoned, neither because the establishment economists don’t like them, nor because ‘the markets disapprove’. This is not a government where the Mainstream Media have any influence (and thus give an early indication of policy). Trump’s tariffs (in our view) are there as part of a ‘corporate restructure’ of the US.
In particular, tariffs can allow so called external revenue to allow what is effectively a blended form of consumption and corporate tax to replace income tax for the 90%. This would be political dynamite and very difficult to reverse. Trump has stated he wants zero income tax for anyone earning less than $150k, which would require around $600bn in tariff revenue. Anyone looking at his announcements needs to take this (heavily) into account.
Medium Term Risks -Diversification
Over the last two years, according to Goldmans, over $300bn a year came into the US equity markets from overseas investors as a perfect storm of risk-seeking and risk-aversion led to a barbell of US short term debt and US long term growth (tech equities) for Family offices, Sovereign Wealth Funds and institutional Investors.
Foreigners poured hundred of billions into a barbell of Notes and Nvidia. No longer.
Since March, over $60bn has gone the other way and, we would suggest, this is just the start. Moreover, the wake-up call that the barbell was actually generating different types of risk - specifically Concentration Risk, Correlation Risk and Currency Risk - is something that is now difficult to ignore, which means that the inflows will, at best slow and, more likely, reverse further.
As we discussed last month, the Buy on Dip has come from US retail - who arguably are right to do so - but, as we have seen with other index-weight driven multiple expansions (at the stock as well as the market level), the passive momentum flows work in both directions.
Active US Retail has bought the dip, but we suspect passive international index trackers will sell the rally
If we were fully bought into the conspiracy rather than cockup theory , we would say that clearing international rent seekers out of your equity markets and allowing domestic savers to buy in at a 20% discount is part of a Great Reset plan. We doubt that Team Trump is quite so crafty, but the net effect is the same and as we noted in our recent commentary (Active Not Passive), there appears to be a clear shift in policy.
Team Trump are happy for Petro $ to be recycled back into the US economy, but not into US Capital Markets. “Don’t recycle your $s into our securities markets, invest in our infrastructure, build factories or co-invest with US companies.
Cut out the middle men” seems to be the view, one supported by the latest revelations in the FT and elsewhere that that ‘The Big Beautiful Bill’ contains a hidden ‘time Bomb’ in section 899 that allows the US to increase income tax and/or withholding tax on foreign holders of US securities - that may or may not include Treasuries. It may come to nothing, but markets will move to hedge the risk.
Otherwise, the biggest medium term risk is getting caught in a Bear Trap. Experience of multi year bear markets, like Japan in the 1990s and US tech in the early 2000s is that there are some great tradeable rallies, but that is all they are; trades. Institutional investors are very wary of getting caught in a bear squeeze.
As such we would expect to see selling of rallies in the US and steady reallocation to international markets with, likely, a strong home bias, something that favour China and Japan in particular, given their large trade surpluses and high savings ratios.
Long Term Themes - New Themes, New Markets
We see the recent sell off as not only a warning, but an opportunity to refocus. While broadly seeing a rotation to ‘value’, usually defined to include financials and energy, we are looking at ‘New Energy’, especially Nuclear, and New Finance, which brings us back to the FinTech area, as well as all the infrastructure surrounding it.
As previously discussed, we see one of the biggest growth areas in Finance being the excess savings in Asia, where the savings ratios are so high, mainly because the returns on capital are so low. In Japan that is down to the low interest rates - something now changing, while in China there is still too much in Housing, Gold and Cash.
With the rotation away from the US and US$ assets generally, we see opportunities not only in domestic financial markets, but also in the users of that capital- manufacturing and consumption. Hence we see the opportunity to expand beyond the sector thematics like European financials and Defence, to incorporate more geographic exposure in emerging Europe - notably areas like Greece and Poland which are sector exposed, but are also halfway between the EU and ‘normal’ emerging markets and will likely benefit from capital reallocation.
So too with China, where the US has made it clear that the near $1trn a year trade surplus in not welcome. New manufacturing and New Consumption are themes that are emerging from the prospect of this capital being recycled. Here, we suspect that many ‘home team’ companies like the former SOEs will be favoured - as well as being part of a wider move to build a broad based capital market structure - something we see as potentially beneficial to Hong Kong as well.
Please note, none of this is to be considered investment advice. Please do your own research and speak to a financial advisor.
*Betteridge’s law of headlines states that for any Headline that ends in a question mark, the answer is No.
Good read!!