A backdrop of uncertainty isn’t causing disruption… so far

Roger Montgomery | Montgomery Investments 

If I had told you, last year, 2025 would bring with it a mercurial US president who would spark a global Trade War, that Israel would expand its war with Palestine to Iran, the U.S. would bomb Iran, and US Treasury Bond rates would remain elevated, I suspect you would have predicted a stock market sell-off, and perhaps a material one.

So, it’s surprising that even though gold, which is considered a safe-haven asset, is up 44 per cent over the last year, everything else is higher, too. The S&P500 has registered new all-time highs, the ASX200 is bubbling near its record, the NASDAQ has risen 12 per cent over the last year, the Small Ordinaries is up nearly eight per cent, and Bitcoin has surged 77 per cent.

While geopolitical conflicts such as Russia-Ukraine and Israel-Iran, rising U.S. debt (US$37 trillion), a cooling U.S. labour market, and tariff-related inflation fears paint a backdrop of uncertainty, investors are looking past the disruptions, classifying them as temporary.  Instead, investors are focusing on positive catalysts such as solid earnings growth, optimism around AI-related productivity enhancements and Fed rate cuts, and a de-escalation of Trump tariff-inspired conflicts.

Economy and Conflicts

It's worth looking at some of these influences in a little more detail because they may hold clues to investment conditions over the next twelve months. Indeed, the markets and geopolitics don’t care that Australian investors have entered a new financial year.  June 30 is just another day.

The stock market's record highs in 2025 are despite, or perhaps due to, U.S. economic softness.  US final Q1 GDP declined 0.5 per cent, weaker than the 0.2 per cent decline expected.  Meanwhile Consumption grew by just 0.5 per cent against expectations of a 1.2 per cent growth.  For Q2 2025, the estimated (year-over-year) earnings growth rate for the S&P 500 was 4.9 per cent, down from 9.3 per cent in March, but importantly, the percentage of S&P 500 companies issuing negative earnings guidance for the second quarter was less than average.

Meanwhile, fears of an escalation of the fighting in the Middle East have abated, as have concerns about a broader conflict disrupting oil supplies or global trade, and this has boosted investor risk appetite, contributing to the rallies in the major stock market indices.

Elsewhere, Trump’s backflip on the aggressive tariff policies of April 2025, which triggered a sharp market sell-off, has calmed investors.  

Optimism for AI profits

At the same time, the excitement reserved for the Magnificent Seven companies has morphed into optimism about artificial intelligence (AI), overwhelming any broader economic concerns, and fuelling significant gains in stocks, such as Nvidia and Broadcom. Indeed, the PHLX Semiconductor Index (SOX), which had been tracking sideways for almost a year, was up 27% in the last quarter alone.

While the father of AI and the recipient of the 2024 Nobel Prize in Physics, Geoffrey Hinton continues to warn of the imminent dangers of humans losing the title of most intelligent beings on Earth, investors continue to fund, fuel and cheerlead the biggest and smallest names in the sector.

Despite the U.S. Federal Reserve’s 550-basis-point rate hikes since 2022, which should have pressured valuations, many of the most innovative company stocks continue to register record highs, presumably fueled by materially faster-than-average earnings growth expectations. In fact, conservative estimates for the aggregate forward free cash flow of Meta, Amazon, Nvidia, Google and OpenAI sit at a 24 per cent compound annual growth rate, despite heavy R&D investments that amounts to about 22 per cent of sales, or triple the S&P 500 median company.

It's also worth pointing out that, unlike traditional business models, these innovators grow more profitable as they scale, leveraging network effects where data improves algorithms, attracting more users and generating further data. This self-reinforcing cycle drives super-exponential cash flows, positioning firms like Nvidia and Meta as ecosystem builders, not just product sellers. And geopolitically, their dominance in strategic assets like AI and semiconductors shields them from the possibility of aggressive antitrust scrutiny.  What U.S. regulator, under Trump, is going to weaken these technology champions or threaten their global leadership over rivals, particularly from China.

Of course, valuation concerns persist, but a two-stage discounted cash flow model suggests many of the market’s leading companies may not be overvalued. The thinking is that these firms’ operational strength and innovation-driven ecosystems make them structural economic drivers, rather than mere economic passengers.

Where to invest?

There are clear arguments for owning last year’s leaders in 2025 and perhaps beyond, but what’s on the horizon that could potentially prove supportive or a speedbump?  And are there other asset classes to be considered for diversification?

For Australian investors, the banks have benefited from a partial unwinding of U.S. Exceptionalism.  The idea there may be safer places to invest than the U.S., has inspired international equity fund managers to seek safe havens in other jurisdictions. And a bank is a great business to own if you live on an island!

On the downside, our big resource companies remain tied to the economic vagaries of China, and that country is facing deepening deflation, with consumer prices dropping 0.1 per cent year-on-year in May 2025, marking the fourth consecutive monthly decline, and producer prices falling 3.3 per cent, the steepest since mid-2023. Persistent deflation is dangerous because it can turn into a structural low-growth trap, driven by weak consumer demand and state-driven industrial overcapacity. Suppressed wages, a weak yuan, and a consumption-heavy tax system limit household spending, while the property market collapse, with 70% of household wealth tied to real estate, exacerbates the slowdown. Overproduction in sectors like solar and electric vehicles fuels a deflationary loop as producers slash prices to clear inventory.

The rest of the world, meanwhile, is betting on potential U.S. Federal Reserve rate cuts in 2025, encouraged by Fed Chair Jerome Powell's cautious but flexible stance on monetary policy. The market is perhaps also optimistic about Trump appointing a new Fed chair who might kowtow to his desire for lower rates immediately.

The thing is, it’s not all about rates.  It’s liquidity that will ultimately fuel further gains in the biggest companies.  Without liquidity, asset prices can’t keep rising.  The money has to come from somewhere. 

Michael Howell, a global liquidity strategist, believes a significant decline in liquidity is likely in 2026 and 2027 due to a looming "debt maturity wall," where a massive volume of debt, estimated at US$33 trillion annually, requires refinancing, absorbing liquidity from public markets.

If he’s right, the development could strain financial systems, potentially leading to market volatility or even a crisis as debt refinancing competes for limited capital. Consequently, central banks, particularly the Federal Reserve and the People's Bank of China, will have to support markets by injecting liquidity to facilitate debt rollovers. That means countering any liquidity drain with measures like quantitative easing.  Public markets could face heightened instability and asset price declines unless central banks reinstate their support.

That’s why a growing number of investors and their advisers are turning to private credit for diversification away from public markets, along with reliable monthly cash income and attractive returns.  Already, more than $25 billion has been invested locally, but Australian investors are well behind their US and European counterparts.  Of course, not all private credit funds are the same, and I’d suggest investigating those funds, like ours, without exposure to property developers and construction, those with shorter average duration in the portfolio, monthly income rather than quarterly and a portfolio diversified across thousands of smaller loans rather than a handful of very large loans, especially to property developers.

It’s also true that prolonged trade friction could raise inflation and slow growth, with the OECD projecting U.S. GDP growth dropping to 1.6% in 2025 from 2.8% in 2024, the S&P 500’s forward P/E ratio is near all-time highs, suggesting limited upside if earnings growth slows and any renewed conflict or unexpected geopolitical policy shifts could disrupt the support investors are currently enjoying.

What counts.

In my previously contributed articles for Nabtrade, I have outlined the three fundamental requirements for the market to go up.  One requires, 1) positive economic growth (it can be anaemic but it needs to be positive), 2) Disinflation (which is consumer prices rising but at a slowing rate), and 3) rising liquidity.

Provided those three preconditions are in place, equity markets should be ok.  Trump of course, is a wildcard, and he will continue to create environments that produce volatility.  Something that some investors just don’t like, and some retirees just don’t need.

After two very good years in markets – the S&P500 was up by more than 20 per cent in both 2023 and 2024 – history suggests it’s unlikely we’ll have a third double-digit gain in the stock market.  But who knows, the market registered three consecutive very high double-digit returns in the 1980s, and it can happen again. 

But since the early 1900s, the worst drawdowns in equity markets during a presidential term have occurred under Republican presidents.  Trump is a Republican.

On balance, I think we should expect single-digit returns from equities along with heightened volatility. So, modest returns with a high risk of intermittent losses seems is my current conclusion.

The stock market’s strength this far reflects a combination of economic resilience, sector-specific momentum (especially AI), and expectations of policy support, which currently overshadow global challenges. However, high valuations along with Trumps unpredictability, and unresolved risks suggest some caution for investors is warranted. Finally, always consider diversifying and aligning your investments with your risk appetite – be honest about how much risk or how big a drawdown you can tolerate.  I think the next twelve to eighteen months will see market conditions shift rapidly and frequently.

All prices and analysis at 27 June 2025.  This information has been prepared by Montgomery Investment Management Pty Ltd ABN 73 139 161 701 AFSL 354 564. The content is distributed by WealthHub Securities Limited (WSL) (ABN 83 089 718 249)(AFSL No. 230704). WSL is a Market Participant under the ASIC Market Integrity Rules and a wholly owned subsidiary of National Australia Bank Limited (ABN 12 004 044 937)(AFSL No. 230686) (NAB). NAB doesn’t guarantee its subsidiaries’ obligations or performance, or the products or services its subsidiaries offer.  This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice.  Past performance is not a reliable indicator of future performance.  Any comments, suggestions or views presented do not reflect the views of WSL and/or NAB.  Subject to any terms implied by law and which cannot be excluded, neither WSL nor NAB shall be liable for any errors, omissions, defects or misrepresentations in the information or general advice including any third party sourced data (including by reasons of negligence, negligent misstatement or otherwise) or for any loss or damage (whether direct or indirect) suffered by persons who use or rely on the general advice or information. If any law prohibits the exclusion of such liability, WSL and NAB limit its liability to the re-supply of the information, provided that such limitation is permitted by law and is fair and reasonable. For more information, please click here.