Investing in a post‑globalisation world

The year 2025 was always going to be one of change, but the speed and extent of developments have taken almost everybody by surprise. The full impact of trade policy shifts have yet to unfold, but it is clear that the global trading system is being reconfigured before our eyes, with profound implications for financial markets.

We are undergoing a process of deglobalization. This will negatively impact the global economy, with the key protagonists, the U.S. and China, hit hardest. It is also a key factor in our outlook for equity, fixed income, and asset allocation investing through the rest of 2025.

The threat of tariffs has brought forward changes in equity markets that had already begun to occur prior to November’s U.S. presidential election. The spread of earnings growth between the “Magnificent Seven” group of mega‑cap tech stocks and the rest of the U.S. stock market will likely continue to diminish, fueling a period of less concentrated markets and more varied market leadership. We expect this broadening of the opportunity set to include non‑U.S. stocks as well.

In bond markets, massive German fiscal expansion, in combination with the U.S. tariff policies, has triggered a global regime change. Higher‑trend inflation—most notably in the U.S.—and a heightened risk of a sharp growth slowdown are pushing developed market sovereign bond yields higher, eroding the quality of developed market sovereign bonds. However, corporate bonds are heading into the difficult period ahead with meaningfully higher overall credit quality than in the past.

The market environment has led our Asset Allocation Committee to favor inflation protected bonds and real assets, such as real estate and commodities, to offset inflation risk. Given the likelihood of continued geopolitical volatility, we are focusing heavily on valuations and continue to favor value stocks over growth stocks. We also modestly favor non‑U.S. stocks.

Volatility is elevated, and policy is changeable. We are ready to respond as clarity over tariffs emerges over the coming months. The most important thing is to acknowledge that in the less globalized world ahead, the range and mix of investment opportunities will be different from those to which we have been accustomed. Successfully adjusting to this new reality will demand heightened vigilance, a willingness to let go of old assumptions, and an ability to take decisive action when required.

Trump’s tariffs will hit the U.S. economy hardest in the near term

The Trump administration’s tariffs—combined with any retaliatory measures from U.S. trading partners—will, if implemented, deliver a supply shock to the U.S. and a demand shock for the rest of the world. The severity of these shocks will depend on the outcome of ongoing trade negotiations and legal challenges. However, it seems certain that the world’s two largest economies, China and the U.S., will experience lower economic growth than projected at the beginning of the year—and the ramifications of this will be felt across the globe irrespective of any individual trade deals struck.

The U.S. faces downside risks to the growth outlook even as higher reciprocal tariffs with China and other trading partners have been paused. Businesses face rising input costs, which would squeeze profit margins and force some firms to reduce investment spending. Tariffs on consumer goods will likely reduce real purchasing power and slow consumer spending, which accounts for more than 70% of U.S. gross domestic product. Any further downward pressure on the U.S. dollar could exacerbate upside risks to inflation.

The U.S. labor market has remained resilient so far, but recent data confirm that it has transitioned from exceptionally tight in 2022–2023 to more balanced now. This implies a thinner cushion for the labor market than at any point in the post‑pandemic period. In the event of a large and persistent shock to economic activity, a pickup in the pace of layoffs would push up the unemployment rate.

The U.S. Federal Reserve (Fed) is in a difficult position as it balances the risk of tariff‑fueled inflation with supporting a weakening economy. This tension will likely linger through 2025. President Donald Trump has been leaning heavily on the Fed to cut rates, but the Fed’s independence remains intact for now. For the remainder of the year, we expect the focus to be on deregulation and fiscal measures such as tax cuts, which could deliver a boost for U.S. growth. We will monitor these developments closely as they would pose upside risks to both the growth and inflation outlooks.

China’s more focused trade war gives it more options

As the main target for U.S. tariffs, China also faces economic headwinds in the second half of the year, albeit different in nature and probably less severe than those the U.S. faces. Although negotiations between the two countries have resulted in lower tariffs, those currently in place will still have a major impact on U.S.‑China trade.

One advantage China has is that while the U.S. is busy fighting a trade war with almost every country in the world, it is only fighting one against the U.S. As such, China will likely seek to reship many of its goods through other countries with lower tariffs. If this happens at scale, it will mitigate the growth and deflationary pressures China faces, although it may not be enough to prevent a growth slowdown. We expect Beijing to use a combination of monetary and fiscal stimulus to offset the drag on growth from tariffs, but any such measures will be taken sequentially and in response to data rather than being rolled out all at once.

No region unaffected by battle of the heavyweights

Despite being lowered from the levels previously threatened, the U.S.’s tariffs on China will still impact the eurozone in several ways: First, because weaker growth will reduce China’s demand for European exports; second, because Chinese manufacturers seeking to redirect their exports away from the U.S. will provide more intense competition for European exporters in other markets; and third, because a surge of Chinese imports will contribute to goods disinflation within the eurozone itself.

Combined with the direct impact of the eurozone’s own trade tensions with the U.S., these secondary impacts from China will likely contribute to slowing growth in Europe in the second half of the year. Inflation should continue to decline in the near term, and while Germany’s debt brake reform will eventually provide a boost to the eurozone economy, this may take some time to materialize. Negotiated wage growth in the eurozone is expected to continue falling, giving the European Central Bank further latitude to cut rates—and we expect it to do so several times before inflation risks rise again in 2026.

Deflationary pressure in China is also likely to spill over into other emerging markets (EMs) as Chinese goods are redirected to other countries in the region, lowering prices. Weaker global growth and lower commodity prices may bring further disinflationary pressures in EMs, with commodity producers likely to remain under pressure. Given the uncertainty, most EM central banks will be cautious and wait for the data to tell them what to do next—although the weaker U.S. dollar will give some of them more room to cut rates without risking a currency sell‑off or inflation spike.

Equity markets to broaden further

An expanding opportunity set in stock markets was on its way before Donald Trump was elected U.S. president; the trade policies he has implemented since taking up office have merely sped up the process. This expansion of investable stocks will take place both within the U.S. market and abroad. We are returning to an environment in which more sectors and regions can work—one demanding diversification and favoring active management.

Broadening market leadership has already begun to occur: Many overseas stock markets have outperformed their U.S. counterparts this year. This expansion of leadership should continue in the second half of the year. Although the Trump administration’s tax cut and deregulation agenda will deliver a boost to the U.S. economy, this will likely be balanced out in the near term by ongoing uncertainty over tariffs and their impact on U.S. consumers and businesses.

At the same time, the era in which the “Magnificent Seven” group of mega‑cap tech stocks dominated the S&P 500, and by extension helped U.S. stocks to dominate the world, could be transitioning to a new phase where a broader cross‑section of stocks outperform. The spread of earnings growth between technology stocks and the rest of the S&P 500 has been narrowing, and we expect this to continue (Figure 2). The emergence of start‑ups such as China’s DeepSeek are showing that AI innovation is no longer concentrated in a handful of trillion‑dollar companies.

As U.S. inflation remains higher for longer, value stocks—which historically have outperformed growth stocks in inflationary environments—are expected to become more competitive again. Value sectors such as energy, materials, and industrials historically have performed well during inflationary periods.

India and Argentina stand out among emerging markets

Opportunities for regional diversification are likely to come mainly in EM countries. Of these, India looks well positioned after two terms under Prime Minister Narendra Modi have delivered solid economic growth, reforms, and investment. With its large, domestically driven economy, India is more insulated from tariff‑related volatility than many of its rivals and has sufficient critical mass—measured in economic scale, infrastructure, digital adoption, and the expansion of the middle class—to continue its growth path. While Indian stock valuations remain elevated, the market’s resilience and strong economic fundamentals should not be underestimated if buying opportunities occur.

Argentina continues to catch the eye amid ongoing reforms under President Javier Milei. His administration’s efforts to balance the budget and control inflation have helped to transform Argentina’s economic prospects, which have been further boosted by a USD 20 billion loan from the International Monetary Fund. The risk premium associated with Argentine stocks means they remain attractively valued, offering discounts compared with some of their regional peers.

Indonesian and Saudi Arabian stocks are also expected to perform well as part of a broader tilt toward international equities. However, some other countries, notably Vietnam, face a somewhat more challenging period ahead as they navigate U.S.‑China tensions.

European stocks are attractively valued

Outside of emerging markets, European stocks have outperformed U.S. stocks this year and appear well placed to continue doing so. European equities are trading at lower price‑to‑earnings ratios than their U.S. counterparts and are more likely to benefit from a central bank rate cut. Germany’s decision to end its longstanding debt brake will enable increased investment and defense spending, while the prospect of reduced trade with the U.S. might persuade the European Union to introduce much‑needed reforms.

One area to monitor is the fluid situation with tariffs, as shown in the U.S.’s decision on May 23 to impose a 50% rate on European Union goods only to postpone it a few days later. The size, scope, and speed of tariff implementation could bring further volatility for both U.S. and European stocks.

Finally, while Japan has been hit harder than Europe by Trump’s tariffs given its greater dependence on exports to the U.S., Japanese stocks appear undervalued compared with historical norms and global peers. Japan’s strong underlying fundamentals—including a robust corporate sector, high savings rates, ongoing corporate governance reforms, and the return of positive inflation—remain in place and will be supportive, particularly if it strikes a favorable trade deal with the U.S.

As equity market leadership becomes less concentrated, the mix of opportunities will likely broaden across sectors and countries. Successfully navigating this environment will require diversification^[1] and a renewed focus on identifying high‑quality companies. A broader market provides more opportunities, but it also brings additional risk.

 

^[1] Diversification cannot assure a profit or protect against loss in a declining market.

 

Bonds with credit risk may outperform government debt

Already this year, two events have occurred that have broken historical precedent and shifted the global fixed income landscape. The massive German fiscal expansion and the Trump administration’s tariffs have resulted in a weaker outlook for developed market sovereign bonds and a stronger one for credit and some emerging markets. More recently, rising anxiety over the U.S.’s fiscal position led to a sell‑off in U.S. Treasuries.

The combination of recent events has triggered a global regime change. One of the most conspicuous symptoms of this is that above‑target inflation in some developed markets looks here to stay. The inflation outlook is particularly downbeat for the U.S., where we expect the tariff‑induced supply shock to produce a material bump higher in prices despite lower oil prices offsetting some of the upward pressure in the short term. With inflation currently running at an elevated 2.5%–3.0%, it is difficult to see it reaching the Federal Reserve’s 2% target over the next few years.

The likelihood of a global recession—with the U.S. leading the downturn—has also increased. Even if President Trump lowers tariffs from their current levels or abandons them entirely, there will be lingering damage as the uncertainty of the on‑again, off‑again trade levies at varying levels has damaged corporate and consumer confidence. Instead of a traditional recession, what may transpire—especially in the U.S.—is a longer period of subpar growth with both higher unemployment and higher inflation.

Higher inflation to keep Fed on hold despite slowing growth

The mix of structurally higher inflation and the higher probability of a steep downturn in growth means that the Fed’s monetary policy is essentially on hold for the time being. Outside the U.S., where inflationary pressure is somewhat lower, other developed market central banks have more room to lower rates.

In the short term, we expect continued volatility as fixed income markets work through the implications of regime change. Over the longer term, European growth, driven by Germany’s aggressive fiscal expansion, should recover relatively quickly. Global inflation is likely to push higher amid supply problems stemming from the trade war. We expect to see higher yields as investors anticipate the erosion of developed market sovereign bond values by inflation.

Improved overall quality to bolster corporate credit

This outlook does not bode well for high‑quality global sovereigns over the long term. However, the picture is a little different for fixed income sectors with credit risk. As of late May, credit spreads^[2] have narrowed to near‑record lows after the sell‑off in April’s turbulence, so they could certainly widen further in the near term. However, corporate bond markets—both investment grade and high yield—are going into this economic downturn with meaningfully higher overall credit quality than in the past.

One‑third of the non‑investment‑grade bond market is secured,^[3] or backed by collateral that goes to the bondholder in the event of default. In another indication of higher credit quality and recession resistance, the amount of non‑energy cyclical sector exposure in the Bloomberg U.S. High Yield 2% Issuer Cap Index was about eight percentage points lower as of March 31, 2025, than 10 years earlier. From a broader point of view, the average credit rating of the non‑investment‑grade index was higher as of the end of March than it was 10 years ago.

That said, some of the weaker high yield issuers in sectors dependent on consumer spending could default as tariffs slash their profit margins. Prior to the early April tariff announcements, our high yield credit analyst team anticipated a 2025 U.S. default rate of about 5%.^[1] We now think it could drift higher but doubt that it will reach the 7%–8% level experienced following the onset of the pandemic in 2020.

High yield and select emerging market bonds offer meaningful diversification

Shorter‑maturity investment‑grade corporate bonds should hold up better than longer‑maturity corporates in an environment of increasing long‑term government yields. In the high yield market, shorter‑maturity bonds with early refinancings ahead of maturity dates are also potentially attractive.

Within the non‑investment‑grade market, we modestly favor bonds over bank loans because loans are generally trading at higher prices currently, giving them less price appreciation potential. Also, loans—which have floating rate coupons that adjust in lockstep with short‑term interest rates—are exposed to spreads widening in a recession at the same time that coupons are dropping if the Fed is forced to cut rates.

In international markets, bonds from emerging markets that are less exposed to the tariff war—particularly those in Latin America and Eastern Europe—could hold up surprisingly well, providing attractive opportunities for yield and diversification. Another advantage of emerging market exposure is that some higher‑quality emerging market sovereigns have been less volatile than developed market government bonds, including U.S. Treasuries.

Inflation protection and equity diversification to drive asset allocation

While we anticipated a deglobalization process following the pandemic‑induced supply chain snarls in 2020, the threat of tariffs has brought globalization under attack. Countries and companies are scrambling to reduce their exposure to tariffs, greatly accelerating the deglobalization trend. This process will have significant implications for asset allocation as some previously favored assets become less attractive and others show more potential.

One thing is clear—the Federal Reserve will stick to its data‑dependent approach, avoiding forward guidance, and continue to assiduously avoid any messaging that could be interpreted as political. Fed policymakers know that lower rates are not a cure for uncertainty, so we do not expect a “Fed put” in the form of an interest rate cut over the near term. We see little chance that the central bank will lower rates until a major increase in the unemployment rate shows that a recession is obviously imminent.

The Fed is also reluctant to cut rates because of the risk that tariffs will pressure inflation higher. We are mindful of this possibility and favor exposure to inflation protected bonds and real assets like real estate and commodities as tools to help offset inflation risk. Our Asset Allocation Committee (AAC) holds an underweight position in longer‑term U.S. Treasuries as they could underperform amid resurgent inflation. Additionally, Treasuries face growing scrutiny from foreign investors due to concerns about fiscal sustainability and economic policy uncertainty.

Growth stock valuations remain elevated

In times of rapid geopolitical change, we tend to lean more heavily than usual on asset class valuations. Even after the concentrated selling pressure on growth stocks and value’s relative outperformance in early 2025, value equities appear to provide more valuation support than growth.

In artificial intelligence, the tremendous advantages of being on the right side of change, as illustrated during the shifts toward digital media, online retail, and cloud computing, appear to have flattened out. As a result, the tech giants are spending heavily on AI to try to ensure they maintain their positions on the leading edge of technology. We believe this spending will profitable over the longer term, but time horizon is important. These innovative firms could see their valuations challenged over the near term by flattening returns on equity while their capital expenditures are elevated (Figure 4).

Trade war to dampen traditional U.S. equity advantage in a downturn

In a typical economic growth downturn or recession, we would expect U.S. equities to hold up better than international stocks. But we believe the underlying dynamics of this year’s slump may be different, leading us to modestly favor non‑U.S. shares.

One factor working against U.S. equities is the inflationary pressure from tariffs that will keep the Fed on hold unless a recession is inevitable. Outside the U.S. (and Japan, where the Bank of Japan has been gradually raising rates), central banks have more leeway to lower rates—and mortgage rates are more responsive to cuts, so the benefits flow through the economy faster.

Finally, the recent landmark decision by Germany to loosen its debt brake on defense spending and create a EUR 500 billion infrastructure fund is a dramatic change after more than a decade of austerity measures. This pivot could eventually provide a much‑needed fiscal boost to the European economy, which has been operating below capacity for most of the past 15 years, supporting the Continent’s equity markets.

All of these factors, combined with the sizable weighting of the mega‑cap tech firms in growth stock indexes, led the AAC to a relative underweight to U.S. growth equities.

Corporate governance reforms continue to support Japanese equities

Japan still stands out among international equity markets because of its positive momentum toward stronger corporate governance. The country’s steady progress toward a healthy level of inflation and domestic consumption should also support its stock market. While exports are a major driver of Japan’s economy, making it particularly sensitive to U.S. tariffs, Japan appears motivated to negotiate with the Trump administration to lower tariffs.

Key takeaway

Our Asset Allocation Committee holds underweight positions in both long-term U.S. Treasuries and U.S. stocks.

 

 

 

 

^[1] Default estimate includes both traditional defaults and distressed exchanges. If a distressed exchange is deemed likely for an issuer, we consider all the securities of that issuer within the index to be in default. Actual outcomes may differ materially from estimates.

 

^[2] Credit spreads measure the additional yield that investors demand for holding a bond with credit risk over a similar‑maturity, high‑quality government security.

^[3] Source: J.P. Morgan.