Stock Market & Economic Commentary - August 2025

“The market cycle will once more prove to be the human-nature cycle; its economic background will have changed, but not its basic character nor the consequences of its character.” – Benjamin Graham (1894-1976), British-born American financial analyst, economist, accountant, and investor, widely known as the “father of value investing”.

Lessons from Bridge

I don’t play Bridge, but a lot of my friends do. I am often intrigued by the fascinating stories of the game and how things can change quickly. It is easy to draw parallels with the stock market. Bridge and investing both teach you that a bad or good hand is not the end. Because it is not about the hand you are dealt; it’s how you play the game.

When the cards, or the markets, turn against you, it is easy to feel disheartened, but seasoned players know that resilience is the key. The next hand, or trade, can shift the balance in an instant.

The more experienced players also know that success rarely comes from short bursts of luck. A winning streak may feel like mastery, but both Bridge and the stock market have a way of humbling the overconfident. It can be dangerous to try to read too much into the numbers.

Most investors are sitting on nice gains this year and, as a result, are perhaps feeling overconfident. The FTSE has broken into new highs, and so has the US S&P 500, although not in pound terms because of a fall in the dollar. In Europe, the Euro Stoxx 50 recently broke a record that had stood for 24 years, which tells you something about the state of European markets over the last couple of decades.

But does any of this tell us about what may lie ahead? Some investors try to read the markets, looking for signals in the numbers, like Roman priests poring over the entrails of sacrificed sheep to tell the future – a practice known as haruspicy. There is a less gruesome form of divination that might have more appeal – observing the flight and behaviour of birds. That is ornithomancy for those of you who might be interested.

All of it is nonsense, of course.

Finomancy

But is it just as foolish to try to divine the future from the behaviour of financial markets? Let’s call it “finomancy”.

There are a few basic principles that are widely inferred by “finomancers”. When bond yields are low, specifically the gap between traditional and index-linked bonds, it suggests there will be little inflation ahead. When short-term bond yields are higher than medium-term yields, it allegedly warns us of an impending recession. And when equity markets rise, growth is expected. Let’s all party!

There may be more truth and meaning in these indicators than in the colour of sheep entrails or in the flight of birds, but we need to be careful. It is not that these things will happen, but that the market thinks they will.

The market is simply a reflection of the attitudes and moods of millions of participants. Some call it “the wisdom of the market”. But the market can be stupid sometimes. The problem is that the moods of its participants can swing violently.

Warren Buffett famously described the equity market through a character he called “Mr Market”.

Mr Market is manic; sometimes euphoric and sometimes depressed. Some investors think they have the best chance of making money when Mr Market is at either extremity. That is when it might be a good time to make big, long-term decisions.

Other investors believe that money can be made by going against the crowd. Take what the market ‘says’, and if your view is different, trade against it. The disgraced fund manager Neil Woodford, during his tenure at Invesco Perpetual, famously did exactly that when he avoided the worst effects of the 1990s dot-com bubble and the 2008 financial crisis. But when he tried similar tactics in 2018/2019, he failed miserably, and many investors in his Woodford Income Funds lost money. He became overconfident in his ability to beat the market by following a contrarian investment approach (for the record, the Clarion Portfolio Funds did not have any exposure to the Woodford funds, as we felt that he held too much in illiquid private equity).

However, back to the principles of “finomancy”. If you think inflation will be higher, buy index-linked gilts rather than conventional gilts. If you think that there are financial risks not priced in, avoid financials. If you think the AI boom is overhyped, underweight the largest of the big tech stocks. That still leaves a long list of reasonably priced shares in which to invest. Or just buy a global fund with a few strategic tweaks here and there, similar to the strategy used by Dimensional Fund Advisors. ‘Factor investing’ is what it is called. The Clarion Portfolio Funds have significant exposure to this type of investing with a slight tilt towards profitable companies, smaller companies and undervalued companies.

Most of the time, of course, markets chug along calmly – as at present. But there seems to be something odd about this current serenity. It is not that equity markets have risen, they do most of the time anyway, but that they have done so with very low volatility.

The “finomancers” tell us that volatility is what the market thinks about risk. Low volatility suggests the economic and political situation is stable. If you look at the volatility chart for this year, it has been calm apart from one big spike after Donald Trump’s so-called “Liberation Day” and another small blip on 1 August. Many investors who thought that tariffs flew in the face of economic sense and were bad for growth jettisoned shares only to see markets recover.

Is the market correct in thinking that current conditions are much more stable? Can we invest with confidence? Or is this unwarranted calm itself a form of extreme thinking?

When markets are subdued, neither hyped nor depressed, it can mean investors are sitting on the fence, waiting to make a big call. But some experienced investors think the opposite and that the current environment signifies that investor sentiment is favourable and that now is precisely the right time to make a big call.

The market is not telling us that the risks are low or that there is little to worry about; it is leaving us to express our own views through our investment approach.

Market euphoria

The behaviour of equity markets during this extraordinary year has been close to matching the dictionary definition of levitation. The Trump trade war, spiralling fiscal deficits and public debt, geopolitical risks, the dismantling of the post-war international order, and declining global growth prospects, all have failed to hold back the magical rebound after investors’ panic in April over Donald Trump’s erratic on-off tariff tantrum.

Applying the yardstick that investment sage Warren Buffett regards as the best single measure of market valuation, stock market capitalisation relative to GDP, US equities are at historic record levels. The UK market has lagged behind the US on the GDP ratio, but the FTSE 100 has now ventured into record high territory, while other developed world markets have proved surprisingly resilient. In the face of another Trump deadline on 1 August, battle-hardened investors suffered from only a modest fit of the vapours rather than abject capitulation. How then to explain the growing insouciance of investors?

At one level, this defiance has been about the “Taco” phenomenon (short for “Trump always chickens out”), the abbreviation which explains investor willingness to shrug off Trump’s bizarre threats. More specifically, equity markets are pricing an assumption that tariff threats will eventually be watered down. Meanwhile, the bond markets are pricing a belief that Trump will not actually execute debt-expanding measures, causing investors to spurn US Treasuries.

But at a more fundamental level, markets are preoccupied with the next stage of the digital revolution. Nobody really knows how AI will affect the world, but there is a perception that it will utterly transform labour and capital, revolutionise the nature of work and even redefine what it means to be human, thus providing rocket fuel for corporate profits and equity market valuations. Or so the techno optimists think, oblivious to the daunting potential cost implications.

This is the stuff of incipient bubble euphoria. Optimism about such revolutionary changes spurs excessive risk-taking and borrowing as herd behaviour drives an accelerating stock market bandwagon.

All this makes nonsense of the efficient market hypothesis, which broadly asserts that the market is always correctly priced. More plausibly, economists seek to rationalise speculative behaviour by relating asset prices to risk, which they equate with volatility.

Fomo or FoL

But this definition of risk is not particularly helpful to mere mortals. The old Wall Street adage that markets are driven by fear and greed may be nearer the mark – at least when it comes to fear. Investors don’t fear volatility as such; what they fear is the possibility of permanent loss or ‘FoL’.

But a different kind of fear is at work at the moment, fear of missing out, or Fomo.

This term emerged in the mid-2000s, used by clinicians to describe young people, bombarded with social media images of their peers, who became anxious that everyone else was having more fun than they were. The clinical view of Fomo readily migrates to the stock market context.

Consider Isaac Newton, the astronomer, physicist and Master of the Mint and the South Sea Bubble. The historian Charles Kindleberger recounts in his book Manias, Panics and Crashes how Newton sold shares in the South Sea Company at a 100% profit of £7,000 only to be infected months later by mania as he observed the stunning profits earned by others. He re-entered the market at the top for a larger amount and lost £20,000, about £3.6 million in today’s money.

There are signs that the intellectual climate is changing in relation to risk. This is reflected in a recent paper by Edward Macquarie from the Leavey School of Business at Santa Clara University. He suggests that Fomo and FoL are dominant emotional drivers for investment behaviour.

Fomo becomes palpable when a narrative of revolutionary change takes hold, as with dot coms and AI. Stocks with low valuation multiples and small market caps may be shunned by investors who fear they are missing some seemingly low-risk, super innovative sure thing. One factor that can inspire the syndrome is a worry that a window in the markets may be closing, shrinking profitable investment opportunities.

How then should investors counteract these overwhelming fearful instincts? Firstly, identify where we stand in the recurring oscillation between FoL and Fomo. Try to assess the risks of a down wave in the future grinding transition from Fomo to FoL.

That means avoiding concentration risk, especially in AI and supporting tech; avoiding overvaluation specifically in US mega cap stocks; and avoiding exposure to long-duration government debt. There is no free lunch in the investment world, which means that portfolio diversification is vital, particularly in these challenging and uncertain times.

As with Bridge, it is not the hand you are dealt, it is how you play the game. Play the long game

Please click here to access the Clarion Investment Diary for August which provides a snapshot commentary of recent economic and political events and full details of the Clarion Portfolio Funds.

As always, we thank you for your continued support and we look forward to updating you regularly throughout 2025. Please get in touch if you have any questions.

Keith W Thompson CIP; Dip FA

Clarion Group Chairman

August 2025

Risk Warnings

Any investment performance figures referred to relate to past performance which is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments, and the income arising from them, can go down as well as up and is not guaranteed, which means that you may not get back what you invested. Unless indicated otherwise, performance figures are stated in British Pounds. Where performance figures are stated in other currencies, changes in exchange rates may also cause an investment to fluctuate in value.

The content of this article does not constitute financial advice and you may wish to seek professional advice based on your individual circumstances before making any financial decisions.

Stock Market & Economic Commentary – August 2025