Never before have we been asked about the perils of the US equity and the US dollar concentration by our charity clients as much as in 2025. With US policies grabbing the headlines throughout the year, many trustees were keen to understand how exposed they are to US-specific risks and what they could do to diversify that risk in a cost-effective way.
It’s no surprise that the events across the pond dominated macro discussions with clients. The UK budget, the European fiscal boost and the new leadership in Japan were overshadowed by the world’s biggest economy, given the impact that the current US administration is having on global markets and politics. To determine the potential impact on markets and, more importantly, our clients’ investments, we follow our tried and tested approach of combining the analysis of macro fundamentals, risks on the horizon, valuations and sentiment.
Macro fundamentals
President Trump’s tariffs remain a central theme, alongside an increasingly active foreign policy, whether that’s in the Middle East or more recently in Asia. Tariffs remain at the highest since the 1930s at 17-18%, according to Yale Budget Lab. However, the true effect of that on the US is likely to be lower as companies could find ways to avoid tariffs or find new substitutes.
It’s also still unclear whether tariffs are good or bad for the US given limited retaliation from others and the potential to spend all that new tariff revenue. US growth still appears to be solid, with a surprisingly strong Q3 GDP growth at around 4% (annualised) (AtlantaFed GDPNow), even if some slowdown is expected. The main driver of that strength has been AI-related spending, which has been a really large contributor. For example, in the second quarter of 2025, it was over 1.5% of annualised GDP growth (Bloomberg and L&G).
Alongside the AI spending, US consumers remain resilient, the savings rate remains around 5% and unemployment remains low at around 4%, still around the lowest since the 1960s, according to the Bureau of Economic Analysis. Investors also take comfort in the fact that the Federal Reserve (or Fed) still has plenty of space to cut interest rates should they need to. With the tariffs effect appearing to be gradual, with limited shock impact on spending or wage demands, investors expect a couple more cuts by the middle of next year, which could support spending in 2026.
What about the risks?
While there are many reasons for optimism, we remain laser-focused on risk management. With so much good news around, we as a team always challenge ourselves to map out alternative scenarios to stress test our portfolios against, so that we do not lose sight of potential risks.
One of these risks could arise in company earnings. Some were disproportionally impacted by both the One Big Beautiful Bill and, on top of that, real incomes did not grow very fast despite lower net migration into the US. There was an expectation that lower immigration would reduce the availability of lower income workers, which could benefit current US workers. However, for now we are seeing evidence of rising stress. Auto delinquencies are up to about 5%, similar to the peaks in 2008 and 2009, and student loan delinquencies are at the highest on record, at around 13% (New York Fed Household Debt and Credit Report).
Secondly, we carefully monitor for signs of the Fed independence being eroded as we go into the new year. In our assessment, the odds of Lisa Cook, one of the board members, being indicted by year end remain low. However, next year will see the change in the Senate approval process which could make it easier for President Trump to fill new spaces on the Fed board with his preferred appointees.
Valuations and market sentiment
Before we dive into portfolio implications, we also need to consider market sentiment and valuations to decipher how markets currently interpret the balance of risks and fundamentals, and how much could already be priced in.
On the equity side, volatility remains very contained with the VIX index (the common barometer of market nervousness) around 17, states Bloomberg, while valuations are high against the long term and most of the last five years. Similarly, investment grade credit spreads are very low – some of the lowest for the last 25 years. Finally, when we look at the sentiment towards equities, we do see it elevated but not in any way extreme. Hence, it would probably be premature to claim that there is excessively high optimism among investors at the moment.
Putting it all together
So what does this mean for our portfolios? After such a great year for markets, we are looking at forward return potential and taking a breather, targeting a better entry level for equities. As mentioned above, the potential catalysts for investors’ appetite for equities to weaken could be tariff changes, any high-profile credit defaults or another government shutdown.
On the credit side, when valuations are so tight, in good times we believe the asset class would have limited upside relative to government bonds. However, in bad times, one could still see a very considerable sell-off in corporate bonds. So we are faced with an asymmetric set of returns which gives us confidence in owning less.
Within our more cautious stance on equity and credit, we look for value opportunities within alternatives and have been adding to UK infrastructure investment trusts. In our view, UK prospects are similar to the rest of Europe and yet these types of assets are currently trading at attractive valuations – in part due to negative sentiment surrounding UK assets and partly due to technical reasons as there have been some forced sellers as defined benefit schemes mature.
Are we out of the inflationary woods?
Once we have covered the growth angle, the most common next topic of our client discussions is inflation and rightly so given how important it is for charities and endowments to seek real returns on their investments. So how worried should we be about inflation?
It is interesting that it did not really receive very much attention in 2025, even though unemployment remains at relatively low levels, with some upward wage pressure. US wage inflation and services inflation remain at around 4% and 3.5% respectively, according to the Bureau of Labor Statistics.
One of the things that has helped has been the subdued oil price, which has been at its lowest level since 2020. Artificial Intelligence (AI) is also expected to put downward pressure on inflation, with the potential to drive costs down across large areas of economies. However, we remain wary that while inflation might be receiving few headlines, it would not take much for it to re-emerge as a theme. It is an important risk to consider for us as multi-asset investors because when inflation does pick up, equities and bonds tend to go up and down together, with an impact on potential diversification benefits.
In our portfolios, where we do own inflation-linked exposure, we focus it mainly in the US as that’s where we see the greatest risks from tariffs and low immigration, with US Customs and Border Protection figures revealing that border encounters are down over 90% from their peak, and 10-year real yields in the 1.5-2.0% range, which looks attractive in our view. Pension scheme demand in the UK means that inflation pricing is higher than in similar foreign markets. We also keep our bond exposure globally diversified. We currently have more exposure to Japan and Australia than we would normally do in our long-term asset allocation, to diversify away from the main three markets: the US, Eurozone and UK.
‘Prediction is very difficult, especially if it’s about the future’ – Niels Bohr
At the turn of the year, it is tempting to engage in all kinds of fortune telling. Fun fact for you: in Poland we do it on the eve of Andrzej’s name day, in late November, when every Andrzej is gifted with special clairvoyance powers just for that one special night (or so the custom says…).
Yet experience teaches us that when it comes to financial markets, making short-term macro predictions is challenging to say the least. Our preferred approach is to balance a number of different factors together, from fundamentals to risks, and stick to our mantra of “prepare rather than predict”. Rather than spending all day fine-tuning our predictions, we aim to make sure our clients’ investments can seek to withstand a number of possible scenarios ahead and embrace regional diversification in portfolios.
Charity Finance wishes to thank L&G for its support with this article
