Barclays London Cross-Asset Strategy Head: Diversified investments, selective stock selection, and focusing on high-quality targets are key responses to the second half of the year.

Barclays UK London Cross Asset Strategy Manager Dorothy Decker stated in a research report that despite global stock markets rebounding nearly 20% from the April lows, policy uncertainty, headwinds in earnings, and high valuations still pose challenges. The bank expects a global stock annualized return rate of 6.5% over the next 10 years, but emphasizes the need for defensive allocations and options strategies to hedge risks, particularly to diversify concentration risk in US technology stocks. The first half of 2025 highlighted the fragility of investor confidence and the speed of market narrative changes. While recession risks have eased and growth has significantly slowed, stock valuations remain high. In this context, continuing investment is reasonable, but actively managing risk is equally important. Diversification, stock selection, and focus on quality assets will be key to navigating the rest of the year. Barclays' main points are as follows: This year, the speed at which policy shocks arrive is concerning, and so is the volatility in the stock market. In addition, there have been many changes at the industry and regional levels. Focus on quality assets and selective assets seems critical for investors. In the first half of 2025, global stock markets experienced volatile fluctuations. At the beginning of the year, market optimism was high due to strong economic growth, lower inflation data, and expectations of rate cuts. However, the situation took a turn for the worse in April when the US government unexpectedly implemented aggressive tariff policies, reigniting concerns about an economic recession, leading to a brief but intense global stock market sell-off. However, the market later made a strong recovery. The temporary pause in tariffs and easing trade rhetoric accelerated the rebound. By the end of May, global stock markets regained lost ground, rising significantly from the nearly 20% low point in April, approaching the February high. Nevertheless, this apparent recovery masks industry rotation, policy uncertainties, and the fact that the second half of the year will bring a more complicated investment environment. From momentum trading to rotation: changing market dynamics Underneath this year's headline market performance, significant sector rotation has occurred. Funds have flowed out of the most crowded trades of the year (especially US large tech stocks and assets centered around the US), towards more diversified market sectors and international markets. This rotation reflects a reevaluation of the US exceptionalism narrative and whether a few tech giants can maintain significantly higher-than-average profit growth. While these trends are not likely to reverse entirely, if the profit growth and valuation gap between the US stock market (especially large tech stocks) and other global stock markets further narrows, it could have a significant impact on global capital allocation. Recession risk: reduced but not eliminated The easing of trade tensions has alleviated some of the worst-case scenarios for global growth. However, recession risks still exist. There is still uncertainty about the final structure and implementation of proposed tariffs. Currently, the average actual US tariff is expected to be 14%, much lower than the initial forecast of 23%, which limits the impact, but also leaves little room for an unexpected upside. Meanwhile, policy uncertainty is putting pressure on companies' confidence and investment plans. Therefore, investors should expect future economic growth to be weak, with the possibility of a technical recession. Importantly, private sector balance sheets are still healthy, and central banks have room to cut rates. Even if currently resilient hard economic data deteriorates, this will cushion downside risks, although it cannot prevent market volatility. Valuation concerns and earnings headwinds After the recent rebound, stock valuations remain high, especially in the US stock market. The current valuation multiples are not consistent with expectations of slowing growth, rising inflation risk, and continued political uncertainty. At the same time, earnings expectations have been revised downwards. Currently, the global earnings growth rate for 2025 is expected to be 8%, down from the initial 12% at the beginning of the year. Earnings forecasts for 2026 are still at 13%, but in a globally decelerating economy, achieving this target may prove challenging. Yield, fiscal concerns, and market disconnect In this context, the resilience of global stock markets across different markets is also worth noting. In fact, oil prices have softened, precious metals have outperformed industrial metals - these are developments typically associated with economic slowdown. In contrast, the recent relative strength of the stock market compared to the bond market seems to diverge from the improved economic environment, highlighting a significant disconnect in market narratives. In other words, while the stock market anticipates a broad bull market in the second half of the year, the bond market takes a more cautious view of the current environment. Part of the reason for this is the increasing concerns about the long-term sustainability of the US fiscal imbalance. As a result, rising US (and global) yields may require stronger growth to match, or problems may arise. How this disconnect is eventually resolved will be crucial to the market's next phase. Therefore, the bank does not have a positive outlook on stock market index levels. Continued investment, but with selected assets It is important that short-term volatility not distract investors from the bigger picture. According to the bank's updated capital market assumptions, the bank expects healthy returns from global stocks over the next 10 years, including dividends, with an annualized return rate of 6.5%. However, heightened macroeconomic and policy uncertainty means a greater focus on selected assets, risk management, and diversification is needed. In this situation, options-based strategies can help mitigate downside risk, balance portfolios, and address the kind of intense market volatility seen in April. "Given the expected policy rate declines and slowing growth, the bank still prefers defensive sectors." Diversification more important than ever Concentration risk in the stock market has become a key challenge for investors. US stocks make up nearly two-thirds of the MSCI global index by market capitalization. The tech sector alone accounts for a quarter of the global index, and the "magnificent 7" stocks - Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla - make up nearly a third of the S&P 500 index. This imbalance exposes many portfolios to limited macroeconomic outcomes and industry dynamics. A wider geographic and sector allocation can help mitigate these risks while uncovering overlooked opportunities. This strategy has been effective this year as US stocks have underperformed other regions. Concerns about fiscal deficits, policy uncertainty, and the trajectory of the US dollar may continue to support this trend in the short term. Regional outlook: opportunities outside the US Given this, from a valuation perspective, two markets are particularly attractive: the UK and emerging markets. They trade at a slight discount to historical averages (based on expected P/E ratios), compared to US stocks with a significant historical discount. (1) UK: The FTSE 100 index has lower exposure to US-dominated tech stocks, allowing for diversification. Its defensive sector arrangement is expected to benefit from a broader market rebound, and the relatively high dividend yield is attractive to income-oriented investors. (2) Emerging markets: Emerging markets are expected to benefit from a weakening US dollar, cyclical shifts (including supply chain shifts, digitization, and AI adoption). As a whole, they trade at a significant historical discount compared to US stocks. While significant country-specific differences exist, selective stock picking and active management are crucial because specific countries still face risks (such as US tariffs, commodity prices, political risks, and currency fluctuations). Market sentiment may still be weak, but any credible policy stimulus from China can have a significant impact, as China accounts for 27% of the MSCI Emerging Markets Index. (3) Eurozone situation: For the Eurozone, its excellent performance relative to the US this year seems to have exceeded fundamentals. Therefore, a period of consolidation may occur in the short term. In the bank's view, Eurozone stocks may still be attractive beyond this range, benefiting from German fiscal plans, relative valuations, and capital allocation outside the US. (4) Japanese market dynamics: With the volatility of the yen and the search for alternatives to US treasuries, Japan has attracted attention recently. The Nikkei index has a high weight on cyclical sectors (such as industrial and non-essential consumer goods), which could drive upside if global growth exceeds expectations. However, this market remains challenging and requires careful management of currency fluctuations. "The first half of 2025 highlighted the fragility of investor confidence and the speed of market narrative changes... but stock valuations remain high." Industry focus: favor defensive sectors, but not exclusively Given expectations of rate cuts and slowing growth, the bank still prefers defensive sectors over cyclical sectors. Defensive sectors have historically outperformed cyclicals throughout the economic cycle in the past 50 years. This aligns with central bank rate cuts in response to economic weakness. Utilities and essential consumer goods: The bank believes that despite significant revaluations this year, these sectors still offer value, especially in Europe, providing higher dividend yields. Additionally, due to conservative profit expectations, they have less downside potential. Healthcare: After recent valuation adjustments, this sector appears more attractive, especially in Europe, as concerns about US drug pricing and tariffs seem overblown. Energy: To achieve diversification, investors can seek targeted exposure to deep-value cyclical sectors. Energy stocks have performed well in this regard, as they trade at a significant historical discount and offer industry-leading dividend yields - 4.3% globally and 5.8% in Europe (based on the MSCI index). Stock selection: prioritize quality stocks and pricing power In the current environment, there is no reason for the bank to deviate from its focus on quality companies. In the current backdrop, strong balance sheets, earnings visibility, pricing power, and stable profit margins are desirable traits, especially in more challenging times. However, stock selection is crucial as many such stocks are currently trading at significant premiums. Long-term growth themes: leading over cyclical Another way to "filter out the noise" is to adopt a longer-term investment approach, following structural themes. These themes are often less sensitive to economic cycles and have weaker correlations with short-term market fluctuations. At this juncture, two main themes stand out: European defense: As European countries seek to reduce their dependence on US security guarantees and increase defense spending, this sector will benefit. The long-standing underinvestment issue is currently being addressed. Artificial intelligence: After a recent sell-off, valuations of selected AI-related stocks have become more attractive. Long-term prospects remain enticing, especially for companies with defensible intellectual property and scalable platforms.