A clear divergence between equity optimism and bond market caution points to the need for diversity and long term thinking, says Darius McDermott, managing director of Chelsea Financial Services.
Markets in 2025 have continued to demonstrate a remarkable ability to adapt. Despite political shocks, fluctuating interest rate expectations, and uncertain global growth, equity markets have remained resilient, reminding investors that volatility does not equate to weakness, but rather to repricing and recalibration.
The return of Donald Trump to the White House and the subsequent introduction of sweeping tariffs unsettled global markets earlier this year. Risk assets sold off sharply, and uncertainty around the scope and implementation of the tariffs weighed on sentiment. Yet, as has often been the case, initial pessimism gave way to pragmatism. By late September, the MSCI World Index had gained 26% since early April*, underlining the market’s ability to absorb shocks and move forward.
Volatility as a constant
Market volatility remains a defining feature of 2025, yet the current backdrop presents an interesting paradox. Despite ongoing geopolitical tension, diverging central bank policies, and fiscal pressures in both the US and UK, the volatility index (VIX) has remained surprisingly muted compared to the higher levels seen earlier this year.
Consider past examples. In the 12 months following the 2016 Brexit referendum sell off, the FTSE 100 returned around 25%**, and global equities delivered almost 50% in the 12 months following the peak of the Covid-19 pandemic panic***. In both cases, investors who stayed invested captured the recovery; those who de-risked too early missed significant upside.
The lesson is clear: volatility creates dispersion and dispersion creates opportunity.
Mixed signals
Equity valuations remain elevated, with US indices once again reaching record levels. On the surface, this may suggest a world free of risk. However, a closer look at the cross-asset picture tells a more nuanced story.
Credit spreads in both the investment-grade and high-yield markets have tightened considerably, indicating confidence in corporate balance sheets. Yet, at the same time, gold prices are at record highs and long-duration government bond yields are rising. A signal that the market is expressing concern about the ability of the UK and US governments to balance their books.
This divergence between equity optimism and bond market caution underscores the importance of selectivity. Not all sectors or geographies will benefit equally from the current environment.
What this tells me, is that diversification remains the most effective tool for any portfolio. While AI-fuelled US tech continues to be the leader in equity markets, other opportunities exist, like Europe and Japan, which have also had strong years thus far. At a sector level, healthcare remains under-appreciated, offering both defensive characteristics and long-term growth potential.
Meanwhile, UK mid and small-cap sectors appear undervalued relative to large caps, with potential catalysts including rate cuts and renewed domestic investment flows. China has also had a strong recovery in the past 12 months – albeit from a very low level.
Balancing caution with conviction
It is tempting for investors to become cautious when markets reach new highs. However, historical analysis suggests that such moments are more often a sign of momentum than exhaustion. According to Schroders, the US market has been at an all-time high in roughly 31% of months since 1926, and 12-month forward returns following those highs have typically outperformed the long-run average^. The data reinforces the case for discipline. Market peaks rarely signal an immediate downturn, rather they reflect accumulated strength and investor confidence.
As we move into the final quarter of 2025, investors face a complex but constructive backdrop. In this environment, diversification, quality, and flexibility are the key principles. The resilience seen across global markets this year suggests that the cycle still has room to run. Much like past periods of uncertainty, the ability to stay invested, rather than attempt to time inflection points, will be what distinguishes long-term success.
*Source: FE Analytics, total returns in pounds sterling, 8 April 2025 to 30 September 2025
**Source: FE Analytics, total returns in pounds sterling, 24 June 2016 to 23 June 2017
***Source: FE Analytics, total returns in pounds sterling, 16 March 2020 to 16 March 2021
^Source: Schroders, 21 July 2025
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
Main image: karla-hernandez-LrlyZzX6Sws-unsplash
