Market Review
The second quarter of 2025 was notably eventful, shaped by a series of significant geopolitical and economic developments. In the US, markets reacted to trade tariff announcements on so-called 'Liberation Day' and the loss of the country’s AAA sovereign credit rating. Tensions in the Middle East also escalated, with renewed conflict between Iran and Israel.
However, many of the risks stemming from these events began to subside towards the end of the quarter. For example, the US showed more leniency towards tariffs and began exploring trade deals with individual countries, including China, which had been most affected. This helped ease fears of a wider trade war. In the Middle East, tensions also began to calm after a ceasefire was agreed between Iran and Israel, which reduced the risk of further escalation. Meanwhile, the EU lifted sentiment with the announcement of a major fiscal stimulus focused on defence spending.
Risk assets were hit hard at the start of the quarter following the US tariff announcements but regained ground as conditions stabilised. Credit spreads finished the quarter marginally wider but remained firmly down year-to-date.
In Europe, investors resorted to the safety of fixed income allocation. Capital moved out of the US, where concerns were growing around the fiscal outlook and market stability. A fiscal package under discussion in the US Senate raised fears of higher deficits, putting pressure on longer-dated US Treasuries. As a result, long-term rates rose in the US but decreased in the rest of the world. Fixed income therefore delivered positive returns over the quarter, especially in short-duration and European holdings. In particular, sectors less affected by tariffs, such as property and financial services, outperformed. The export and automobile industries also delivered strong performance in the quarter after recovering from the initial price shock caused by the US tariff announcements.
The quarter saw several rate cuts, especially in Europe. The European Central Bank (ECB) cut rates twice, bringing them down to 2%. This reflected progress as inflation moves closer to target. The ECB now signals inflation is nearing desired levels. Meanwhile, the Bank of England (BoE) continued to deliver on one rate cut per quarter, as has been the case since last year. In contrast, the US Federal Reserve (Fed) paused its rate-cutting cycle as it assessed the impact of tariffs on inflation. Overall, US inflation has been slower to return to target compared to Europe.
Fund Activity
The fund’s returns were somewhat challenged by the strength of sterling compared to most developed currencies, driven by investors shifting assets from North America to Europe. The US dollar notably weakened, falling nearly 6% versus sterling over the quarter. Nevertheless, the fund’s overweight position in euros helped mitigate these effects and contributed positively to relative performance.
During the quarter, we focused on purchasing bonds less exposed to tariff impacts, including those from Australian toll road operator Transurban. We also bought subordinated bonds issued by the French Insurance Group AXA and the South American supranational entity CAF. We took profits from the sale of subordinated debts issued by the Dutch-based Rabobank and American-based JPMorgan. We also decided to exit our position in American entertainment company Warner Bros following its financial restructuring.
Outlook
We expect European markets to continue outperforming on the back of lower interest rates and ongoing fiscal stimulus, particularly in Germany. Conversely, the US economy is likely to slow compared to 2024, as the impact of tariffs weighs more heavily on domestic companies. Additionally, signs of stress are emerging in the US labour market, with rising job vacancies. Stricter immigration policies under the Trump administration have also contributed to a tighter labour supply.
Important Information
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice.
This document is issued for information only by Canada Life Asset Management. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available in the literature section.
