Q2 2025 Financial Market Update

KEY POINTS

• Share markets bounced back strongly over the June quarter, despite renewed tensions in the Middle East and ongoing U.S. tariff policy uncertainty.
• The U.S. dollar continued to weaken with the Euro appreciating.
• Bond yields moved lower, as expectations of a U.S. cash interest rate cut firmed.

SHARE MARKETS BOUNCE BACK FROM TARIFF CONCERNS

Following a very sharp sell-off in early April in response to the “Liberation Day” tariff announcements, global equity markets bounced back strongly over the remainder of the June quarter. Hopes that a pause in the tariff program would allow a much more moderate negotiated outcome buoyed markets. Also adding to investor confidence was the expected passing of the “One Big Beautiful Bill Act” through the U.S. Senate. This legislation provides a source of fiscal stimulus to the U.S. economy and is seen to lower the probability of a recession in the near term. The S&P 500 Index slightly outperformed the global average with a gain of 10.9%. European markets were also well supported, particularly during the period of heightened concern over the U.S. tariff program. Similarly, the Japanese market gained strong support, with the Nikkei Index rallying 13.8%.

Gains on emerging markets were also solid but trailed those on developed markets. Uncertainty over the impact of the very significant tariff rates announced by the U.S. on Chinese imports detracted support from the Chinese share market, which recorded a modest gain of 2.4%.

There were further tensions and military activity in the Middle East last quarter, with both Israel and the U.S. striking nuclear facilities in Iran. Although this activity had minimal impact on share markets, there was significant volatility in the oil price. After falling early in the quarter, the oil price jumped 7.1% in the month of June. This spike in the oil price was initially prompted by fears that Iran could take action to close the Straits of Hormuz, which cater for 20% of total global oil trade.

With the quarter being one of high volatility, the more defensive sectors of the equity market performed well. This led to gains to gains for global infrastructure stocks, which advanced by 6.7%. Over the past 12 months, infrastructure has been the best performed of the major asset classes, posting a return of 23.7%. Listed property has also been well supported, assisted by the outlook for lower interest rates.

AUSTRALIAN EQUITIES MATCH GLOBAL RALLY

Australian equities performed closely in line with the global average over the June quarter, with the S&P ASX 200 Index rising 9.5%. Consistent with the strong global support for the sector, technology stocks were the strongest performers, rising by 28.4% over the quarter. Financial stocks also made a solid contribution, with CBA (up 22.4%) hitting new record highs. For the 2024/25 financial year as a whole, CBA gained 49.8%, which compares to an average of 17.8% for the other 3 major banks.  

Despite oil prices falling over the quarter, the energy sector advanced nearly 10%, with a takeover bid for Santos (up 15.0%) adding support. Other resource stocks were less impressive, with a 7.8% decline in the iron ore price, and a rising $A, leading to a decline in earnings expectations across a number of mining stocks.

INTEREST RATES CONTINUE TO DECLINE

Interest rates continued to decline across the globe. Australia’s cash interest rate was reduced from 4.10% to 3.85% following the Reserve Bank’s May Board meeting. The lower rate follows a reversion in Australia’s inflation back towards the RBA’s long term 2% to 3% target.  Expectations remain strong that monetary policy will continue to be eased around the globe.

Despite the potential inflationary threat from tariffs and increasing concern over the size of the U.S. budget deficit, longer term yields in the U.S. finished the quarter largely unchanged, after rising in April. 10-year U.S. Treasury Bond yields rose by just 0.01% over the quarter to 4.24%. There was more downward momentum in Australian yields, with the 10-year government bond rate dropping from 4.38% to 4.18% over the quarter.

The $US was on a downward trend last quarter, enabling the $A to appreciate from U.S. 62.8 cents to U.S. 65.5 cents. The $A was also 0.7% stronger against the Yen but declined 3.6% relative to the Euro. The Euro has been the best supported of the major currencies, having appreciated 12.7% against the $US since the end of December. This is despite cash rates declining in Europe over this period. As such, the Euro appears to have taken on a “safe haven” type status, potentially providing investors with some diversification away from U.S. policy risks and uncertainties.

CONSIDERATIONS FOR INVESTORS

The 2024/25 financial year was another lucrative period for investors, with double digit returns on equities, and fixed interest benchmarks delivering a margin of more than 1% above cash. Underpinning the positive results on financial markets was the success achieved by policy makers in bringing inflation back towards target levels, without forcing economies into a recession. Complementing this positive economic backdrop was the ongoing advancement in artificial intelligence, where evidence of the technology’s monumental potential to transform and improve business processes and models continues to build.

Notwithstanding the healthy asset class returns over the year as a whole, there were certainly periods of heightened concern experienced. The periods of negative return were triggered primarily by a focus on two alternative sources of risk. Firstly, the risk that bond yields would remain elevated, and that central banks would not be as accommodative as hoped in cutting cash rates, was a major focus of bond and equity markets in the sell-off experienced late in 2024. Secondly, and more recently, the policy uncertainty originating from the new U.S. administration, and the risk that the tariff program will materially weaken economic growth, caused a significant sell-off on share markets over February, March, and early April.

Although financial markets finished the financial year on a very positive trend, it is notable that both risks identified above remain in play. Some form of resolution around the uncertainty over the U.S. tariff program may be delivered relatively shortly, although the actual economic impact of the tariffs will take months to asses. Bond markets too remain vulnerable, with inflation uncertainty stemming from both the U.S. tariff program and oil prices. In addition, the further expansion in the U.S. government deficit, which is being baked in by the “One Big Beautiful Bill Act”, may present challenges as investors will need to be convinced to buy more bonds at current yields to fund the U.S. deficit if a steeper yield curve (and capital loss on bonds) is to be avoided.

Admittedly, the risks discussed above are somewhat U.S. centric and for Australian investors may provide less of a source of direct concern. However, whilst there may be less inflation, policy and economic downturn risks in Australia in the year ahead, it could be argued there is more equity valuation risk here. Australia’s share market rally has matched that of the global average over the past 12 months, despite earnings growth prospects for the majority of our large companies being quite muted in comparison. This has seen price to earnings ratios for selected larger blue-chip companies reach particularly high levels, which adds to the potential for correction should market sentiment deteriorate.

Therefore, in looking ahead to the 2025/26 financial year, a more cautious approach to share markets may be warranted, with particular focus around managing exposures to the U.S. (and the $US) and the more expensive areas of the Australian equity market. Pockets of attractiveness in risk adjusted valuations do remain, with smaller companies (both globally and domestically), global listed property and emerging markets all trading below historical norms in terms of relative valuation. Australian bonds, offering a yield above the cash rate, also offer an attractive return without the same risks accompanying their U.S. counterparts.

Important Information

The following indexes are used to report asset class performance: ASX S&P 200 Index, MSCI World Index ex Australia net AUD TR (composite of 50% hedged and 50% unhedged), FTSE EPRA/NAREIT Developed REITs Index Net TRI AUD Hedged, Bloomberg AusBond Composite 0 Yr Index, Barclays Global Aggregate ($A Hedged), Bloomberg AusBond Bank Bill Index, S&P ASX 300 A-REIT (Sector) TR Index AUD, S&P Global Infrastructure NR Index (AUD Hedged).