With tariffs back in focus and all eyes on bonds on both sides of the Atlantic, equities are being squeezed by rising bond yields, high valuations and moderating earnings growth.
Tom Stevenson, Investment Director, Fidelity International has shared his latest insights into what’s driving markets this week and why investors would be well placed to bolster their defences as he comments:
“The focus on the bond market continued through last week as investors weighed up the impact of proposed tax cuts and a soaring debt burden in the US, higher fiscal spending in Europe, stubborn inflation, and pressures on the UK government’s fiscal rules.
“Yields on government bonds issued by both the US and UK governments have soared to levels last seen before the financial crisis. The 30-year gilt yield approached a 27-year high at the end of last week, closing at 5.48% on Friday. The benchmark 10-year gilt yield has also risen more than in any other G7 country other than Japan over the past year.
“In part this is a domestic concern. Investors are worried that the government will be forced to cut public spending further or to raise taxes in order to meet the Chancellor’s rule of balancing day-to-day spending with revenues by 2030. But the British government is being squeezed by what’s happening across the Atlantic too.
US debt and ratings pressure
“US Treasuries have also sold off this year in response to concerns about trade tariffs and big tax cuts. The 30-year Treasury yield rose above 5% last week as investors assessed the so-called ‘Big Beautiful Bill’ that could add over $3trn of debt to the US government’s already large stock of borrowings, taking the debt to GDP ratio from around 100% to 125% over the next decade.
“The prospect of higher borrowing and unsustainable debt servicing costs led Moody’s to downgrade the US’s triple-A credit rating. Debt interest payments – already at $880bn a year – are set to rise further.
“That could create a vicious spiral unless the US Treasury reduces borrowing or benefits from lower market rates. But rates may rise further if investors demand higher yields to compensate for default risk and inflation erosion.
“For years, the US has lived beyond its means thanks to strong global demand for its debt. But confidence is beginning to wane, with investors seeking to diversify away from America.
UK faces headwinds
“The global bond sell-off has impacted the UK but gilts are under pressure for home-grown reasons too. Sluggish economic growth and rising borrowing costs are making it harder to meet already-stretched fiscal rules.
Tariffs back in focus
“Last week, Donald Trump announced a 50% tariff on EU imports from 1 June, citing stalled trade talks. While short-lived, it did initially represent an escalation of the simmering transatlantic trade dispute. European markets rebounded in relief on Monday, recovering losses from the end of the previous week.
Equities under pressure
“Where does all this leave the stock market? Having come close to quickly unwinding a 20% drop since the start of April, the market paused for breath last week as rising bond yields made shares look relatively less attractive to investors. Equities look to be trading within a range underpinned at the bottom by the US government’s apparent willingness to ease back on tariffs if the market falls too far and to ratchet up the pressure if it approaches the February high again.
“After two strong years of rising valuations and decent earnings growth, a more subdued year always looked likely in 2025. And now a sideways drift is starting to look like a best-case scenario.
“Where stock markets go from here will depend on three factors: earnings, valuations and bond yields. Earnings growth has moderated but appears stable in the mid-to-high single digits – down from low double digits earlier this year, but still supportive.
“Second, valuations. After the rebound from the March low, US shares remain quite highly valued on around 21 times expected earnings. Third, and probably most importantly, shares will be influenced by bond yields.
“Long term bond yields are a key driver for equities now with buyers of shares likely to be less willing to pay up for equities when they can receive a relatively risk-free return of over 5% from government bonds. Were valuations to fall by 3 or 4 points that could equate to a 15-20% fall in share prices. That makes the range from about 4,800 to 6,000 for the S&P 500 look like the trading channel for the foreseeable future.
“The shorter-term bull market from the 2022 lows may be over. The more interesting question is whether the 15-year bull run that began after the financial crisis has also ended. The answer to that won’t be clear for some time.
“In the meantime, investors will need to bolster their defences by putting their eggs in a wide variety of baskets. If bonds and shares start to become more correlated then geographic diversification and a spread of assets to include gold, hard assets like property and commodities, plus cash and even maybe some bitcoin (hitting new highs) looks sensible.”
