Climbing the wall of worry

With a turbulent second quarter behind us, Head of Market Analysis Janet Mui examines how its challenges provided valuable insights into market behaviour and long-term investment strategies.

The phrase “climbing the wall of worry” captures the paradox that stocks can rise through challenges. In Q2 2025, investors were confronted with a trio of “walls” – a trade war, a real war, and a tech arms race driven by AI. While these factors rattled market sentiment, the markets ultimately rose to new heights once again.

So, what are the implications? In this insight, we’ll consider how investors responded to each of these challenges, what was learned, and where we go from here.

Trade wars and tacos

Q2 began with fears of a global trade war as President Trump unveiled a host of reciprocal tariffs in the White House’s Rose Garden. The event was anything but rosy…  

Global stocks plummeted and were on the verge of a bear market, as both friends and foes of the U.S. were hit with tariff rates so high they seemed incomprehensible. These actions catalysed a cascading series of concerns about supply chains, inflation, corporate margins, and the consequences of retaliatory measures. The tariffs with China alone escalated to a point that threatened to paralyse trade between the two superpowers, with potentially dire consequences for the world economy.

Following sharp falls for stocks, bonds, and the U.S. dollar in response to these shocks, President Trump made a series of unexpected U-turns before announcing a 90-day pause in reciprocal tariffs. Following this, negotiations continued, deadlines were extended, and rhetoric continued to soften throughout the quarter. Markets have coined this pattern TACO (Trump Always Chickens Out). This is perhaps due to economic pragmatism and market pressure but may have been his plan all along, that is, escalate to de-escalate.

As this view took hold, sentiment stabilised, and stocks rebounded to record highs towards the end of Q2. This is something that President Trump can claim victory for. As Sun Tzu wrote in the The Art of War, “The greatest victory is that which requires no battle”.

The takeaway from TACO is that President Trump’s threats may be more bark than bite. We can be reasonably confident that the escalation/de-escalation pattern will reappear as negotiations intensify, with uncertainty lingering over the shape and size of the final trade deals. This volatility will be unnerving but often presents good opportunities, as we learnt from the market rebound in Q2.

Real war in the Gulf

Q2 saw a concerning rise in geopolitical tensions. The sudden escalation of hostilities between Iran and Israel sent shockwaves throughout the world. As for markets, the threat of a wider conflict in the Middle East, a key oil-producing region, sparked a sharp rally in oil prices and reignited concerns about higher inflation, compounded by tariffs.

Ultimately, a ceasefire was quickly brokered by President Trump that brought an end to the “12-Day War”. Oil prices slumped to levels even lower than they were at the war’s outset. Overall, the market’s reaction to the conflict was swift but largely confined to the oil market. Why was this the case? Partly because the U.S. is now a major oil producer, reducing global dependence on OPEC. Worries about losing Iranian oil supplies were eased by the reality that other producers could step in to meet the demand. Confidence was further bolstered by a broad consensus among analysts that the Strait of Hormuz would remain open due to the mutual, vested interests of oil producers and exporters in the region.

Looking back, events followed a pattern that has become all-too familiar: escalation followed by de-escalation. A more sanguine and considered attitude began to emerge; geopolitical risks are a fact of life, and while diplomacy may be imperfect, it still works. The lesson learnt is that risks tend to fade after initial shocks, and knee-jerk reactions to new crises tend not to persist in the longer-term. For investors, it’s important to stay calm amid what appears to be a highly unstable world and avoid overreacting to every headline.

Techwars: The AI arms race accelerates

While trade and geopolitical risks come and go, the third “wall” in Q2 wasn’t about traditional conflict. The AI arms race is very much a strategic battle amongst sovereigns and corporates, with significant implications for our futures.

Events during Q2 only served to intensify questions about the contest between the U.S. and China for technological dominance. The release of DeepSeek – a Chinese-developed AI model – highlighted how quickly China is advancing in AI innovations and capabilities. This has further amplified concerns about the erosion of U.S. tech dominance at a time when the market’s confidence in U.S. exceptionalism is already fragile.

These AI tensions are closely linked to the broader U.S.-China trade conflicts, particularly around semiconductors. This has led to export restrictions on high-end semiconductors from the U.S., reciprocated by export restrictions on rare earths by China. However, in a notable improvement in trade negotiations, the two superpowers agreed on both a trade framework and ongoing dialogue towards the end of Q2. This is welcoming news for investors looking for signs of a more conciliatory tone.

Investors should not mistake this truce for a complete resolution, though. The AI race is likely to accelerate, not ease, and the ever-increasing strategic importance of tech means this U.S.-China rivalry is far from over and tensions may well resurface. That said, both countries understand that they cannot decouple, and recognise the need to learn to coexist.

Elsewhere in tech, the private sector showed no signs of slowing down in Q2, with many flagship AI deals being announced. Saudi Arabia’s Sovereign AI initiative and Meta’s $14 billion investment in Scale AI are just two of the more visible examples.

Across the board, big tech companies have spared no expense in building their AI infrastructure and capabilities – further evidence that AI is far from just a passing trend. Instead, it represents a global shift that will profoundly impact how we work, innovate, and invest.

The arrival of Deepseek, the intensification of connected trade conflicts, and the fiercely competitive nature of the sector only serve to reinforce the scale and urgency of AI investment. The stakes are high, and we believe this will remain an important theme for many quarters to come.

Looking ahead

As some key macro risks have faded, attention has turned to the question of what’s next? President Trump’s apparent unpredictability suggests it would be unwise to assume trade tensions won’t escalate again. We may well see the pattern of aggression followed by compromise, concessions, deals, and agreements.

As for inflation, the broad direction of travel continues to improve. Markets are increasingly confident that the Federal Reserve and the Bank of England will cut rates a further two times before the end of 2025. This assumes, of course, that the data continues to be satisfactory and that there will be no further, unexpected shocks. Additionally, the European Central Bank will be able to adopt a more stable approach now that 2% inflation in the Eurozone has been achieved.

In this environment, we remain modestly pro-risk. We continue to favour quality equities while keeping exposure diversified across regions. We also see interesting opportunities in Europe excluding UK equities, supported by Germany’s commitment to embrace a more expansionary fiscal stance. The rise in defence and infrastructure investment over the next decade could also benefit local industrial supply chains and change the growth narrative across the region.

Regarding fixed income, we are neutral overall, with a preference for high-quality sovereign bonds over credit. We maintain a modest overweight allocation to gold as a hedge, and view gold purchases by global central banks as a form of secular support.

Walls can be climbed

Every quarter brings some new walls. In Q2, there was no shortage of fear, but markets climbed the wall of worry. We still believe that staying calm, diversified, and invested is essential for building portfolio resilience during these times of heightened uncertainty – and, ultimately, achieving long-term success.

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The value of investments, and any income from them, can fall and you may get back less than you invested. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.