The 1982 Dire Straits song Industrial Disease paints a picture of social and economic problems that seem appropriate to the times in which we live. Included in the British band’s song is the thought-provoking line: “Two men say they’re Jesus, one of them must be wrong.”
Financial markets can also send out conflicting signals, just like the two rival seers in the Dire Straits track. For example, many equity markets are climbing to new all-time highs, suggesting that all is well in the world. On the other hand, 30-year bond yields in many of the same countries (which move in the opposite direction to bond prices) are trading in ranges higher than we’ve seen since the global financial crisis and subsequent euro sovereign debt crisis. In the UK, they’re even revisiting levels not seen since the 1990s.
Source: FactSet; data 2 Jan 2006 to 29 Aug 2025
The existence of conflicting signals from two different markets is a troubling conundrum for anyone building a portfolio for the long term.
Equities have continued their recovery from the lows made on ‘Liberation Day’, when US president Donald Trump unveiled his ‘reciprocal tariffs’. The average global tariff rate for goods exports to the US will rise to 17.4%, up from 2.4% last year, according to the widely quoted Budget Lab at Yale.
However, investors have come to terms with the reality – at least they now know what they’re dealing with.
The second-quarter results season for US corporate earnings was quite good. This suggested that companies are finding a way to cope with the prospect of having to import more expensive materials and products, although cutting other costs to maintain profits could lead to weakness elsewhere in the economy. We’re certainly seeing some evidence of slower employment growth in the US. This is exacerbated by a more restrictive immigration policy that’s part of the same America First mentality that made US President Donald Trump increase tariffs.
The political dimension
Politics remains a major factor for investors to consider. The policies with the most influence on global financial markets are those emanating from the White House.
We await the Supreme Court’s ruling on the legality of the tariffs imposed by Trump. This might hang on the interpretation of what constitutes a security threat. When announcing tariffs, the president cited the 1977 International Emergency Economic Powers Act, which allows the executive to take emergency action in response to threats.
The 31 August to 1 September international summit, hosted by China, will have done nothing to reduce Maga Republicans’ belief that their country is under threat. It was attended by the leaders of (among others) Russia, North Korea, Pakistan, Iran and, perhaps most worryingly, India.
Meanwhile, the 8 September loss of a confidence vote by French prime minister François Bayrou highlights governments’ difficulties faced in controlling their fiscal deficits. It echoes the climbdown by the UK’s Labour government over welfare reforms, although that was the result of a revolt from its own backbenchers rather than a recalcitrant opposition. Higher government spending in a world of higher interest rates leads to more tax revenue being spent on servicing the debt. This is a problem that UK chancellor Rachel Reeves will have to address in the Autumn Budget – most probably with higher taxes rather than spending cuts. The US hopes to use tariff revenues to offset spending increases from tax cuts. France doesn’t seem to want to change at all.
Source: IMF; net lending/borrowing (also referred as overall balance) as % of GDP; annual data from 2001 to 2024
Investors are demanding higher interest payments to account for the risk of runaway deficits. This can generate a vicious spiral, where the debt becomes more unsustainable, leading to even higher interest rates because debt service costs are higher. Letting the economy run hot and allowing inflation to remain high is one tempting solution by governments to a high debt burden. This is a threat that steers us towards a preference for fixed income assets with shorter maturity dates.
We also believe that increased geopolitical tension and the effects of climate change could raise the rate of inflation. At the very least, they could make it more volatile. For example, particularly bad harvests, which are more likely because of climate change, could suddenly push up commodity prices.
While we’re comfortable being fully invested in equities, current valuations don’t justify being overweight relative to other asset classes.
Turning the European supertanker
This is particularly the case for US equities, which trade at levels consistent with past market peaks, judged on several measures. And yet, betting heavily against the US is a mug’s game over the long term.
US companies remain the leaders in the current wave of technological innovation, backed by deep pools of capital and a never-say-die entrepreneurial spirit. We don’t subscribe to claims that the US equity market is in a bubble similar to the one that formed at the turn of the millennium. The leading companies are exceptionally profitable and generate strong cashflows from their operations, many of which are underpinned by regular subscriptions rather than unpredictable one-off purchases. Rather than relying on debt, as in the first internet boom, they’re using that cash to invest in the future.
We continue to see attractive prospects for European equities. This might be akin to turning round the proverbial supertanker and some investors will become impatient with how long it takes. But there does seem to be, finally, a recognition by national governments that attitudes to regulation need to soften. There’s also a growing sense that innovation requires more support. Much of this change in thinking stemmed from a report last year by Mario Draghi, ex-president of the European Central Bank and former Italian premier. Germany is leading the way with a €1trn fiscal stimulus package, although it’s one of the few countries whose finances allow it to be so generous.
Other governments will need to make more unpalatable decisions to rejuvenate growth, boost productive capacity and improve public finances.
John Wyn-Evans is head of market analysis at Rathbones. The views expressed above should not be taken as investment advice.