Investment Update - February 2025
*all returns in local currency terms
Overview
There is an old City of London expression; “markets climb the wall of worry” and looking at returns against the backdrop of events, this certainly held true through January. Markets gyrated as they contended with wildfires in LA, a revelation in the AI space from China’s Deep Seek and, of course a flurry of executive orders from newly invested President Trump, as well as his employing tariffs like a western six-shooter. So, it was reassuring to see equity markets’ resilience. However, it was European markets that surprised most, as one would expect that a region with a high trade surplus with the US is particularly vulnerable to increased tariffs. However, a settling down of the pollical impasse in France and continued cutting of interest rates by the European central bank provided a stronger impetus for markets there.
Given that higher US tariffs and the increasing threat of this developing into a trade war has the potential to add to inflationary pressures, bond markets’ subdued performance was somewhat surprising. Yields having initially spiked upwards reversed direction as the month went on, as the picture for tariffs became increasingly difficult to predict. Consequently, this coupled with strong equity market performance meant all portfolios had a decent start to the year.
United States
As mentioned previously, President Trump’s edicts and continued weaponisation of tariffs caused some sector gyrations, but it could be argued that it was a previously little-known AI start up, Deep Seek, that had a greater influence, particularly on the ‘Magnificent 7’ stocks, notably Nvidia. Deep Seek claimed to have developed an AI model that was considerably cheaper and required less resources than industry incumbents such as Chat GPT. The prospect of a market disrupter in the AI space caused stocks that had previously benefited from the AI trade to reverse, with Nvidia finishing the month over 10% down. There is some question about the impact of Deep Seek’s claims on the industry and required infrastructure spending, but this didn’t stop the Magnificent 7 as a group declining slightly over the month while the wider market went up. Indeed, reassuringly, returns from the wider market broadened out beyond technology related stocks once again, including smaller companies.
Equity market resilience in the face of political uncertainty can possibly be explained by the continued strength of the US economy, both in absolute terms and relative to the rest of the world. US GDP numbers released during January showed the economy growing by 3.2%, whilst the ISM Manufacturing PMI index registered 50.9 percent in January, 1.7 percentage points higher than the seasonally adjusted 49.2 percent recorded in December (PMI is an indicator of business confidence, with a reading of over 50 seen as positive). Meanwhile the jobs market still seems strong and business confidence is high (in somewhat of a contrast to the UK). This backs up the US Federal Reserve’s decision to keep rates on hold for the time being.
America has circa $10 trillion of debt to be refinanced during 2025. The newly appointed Secretary to the Treasury, Scott Bessent, has yet to announce how this will be funded. It is likely to be with more short-dated Treasury Bills, but as yet we do not know. The impact to bond markets and ongoing liquidity is important. The US 10-year Treasury ended the month yielding 4.56%.
Europe
Fourth quarter GDP across the Eurozone was zero, which generated further impetus for the ECB to cut interest rates again in January to 2.75%, the lowest level since the beginning of 2023. Within these GDP numbers, Germany’s economy contracted by 0.2%, as it continues to struggle with the challenges to its manufacturing sector and continued political upheaval. On the other hand, France’s new Prime Minister, Francois Bayrou, managed to survive a no confidence vote and finally get a budget through the National Assembly. However, the fiscal deficit cutting package was watered down from €60bn to €50bn. Additionally, it seems 90% of this will come from increased taxes rather than spending cuts. With one of the largest fiscal deficits in the EU, this feels like a bit of a sticking plaster over a deeprooted problem. Regardless, the French equity market rallied during the month, echoing the regions other markets, doubtless buoyed by the prospect of lower borrowing rates throughout the year.
United Kingdom
The UK equity market faces headwinds, as fiscal concerns and a weak macroeconomic environment dampen prospects. Despite strong trading updates from major retailers, rising payroll costs and subdued consumer sentiment weigh on the outlook. Industry analysts project FTSE 100 earnings growth of 6% for 2025, trailing the broader European market’s 8%. Despite this, UK equities delivered a strong January performance, albeit restricted to the currency sensitive FTSE 100. The UK bond market remained volatile, with 10-year Gilt yields hitting 4.70% and 30-year yields peaking at 5.45% before retreating on softer data. The UK’s fiscal position remained under significant strain as borrowing rose to £17.8 billion in December, marking the highest level for the month in four years. The total deficit for the fiscal year stands at £129.9 billion, exceeding the Office for Budget Responsibility’s (OBR) forecast, with surging debt costs compounding fiscal pressures. This raises concerns over a potential breach of fiscal rules when reviewed in March. Chancellor of the Exchequer Rachel Reeves is maintaining a focus on growth, defending her tax policies as essential for stability. Mrs Reeves has signalled readiness to announce new fiscal measures in March if needed, emphasising careful monitoring of bond market moves. Meanwhile, trade optimism grows as the UK seeks sector-specific carve-outs in potential US trade negotiations, avoiding panic despite fiscal and trade challenges.
Japan
The Bank of Japan’s decision to raise interest rates to their highest level for 17 years generated barely a ripple in markets – unlike the 10% stock market ‘flash crash’ it caused when it surprised the markets with a rate increase in July. On that occasion, we saw the yen appreciate markedly, however this time the move was well telegraphed and currency traders seem to favour the dollar at present, which probably help alleviate any upward pressure on the yen. Inflation is clearly not temporary and seems to be driven domestically rather than being imported. Japanese bond yields have been rising steadily to reflect this and it seems likely that we will see further rate increases later this year. How this higher interest rate environment sits with an economy experiencing low economic growth and a large fiscal deficit remains to be seen, as does the impact of a potentially stronger yen on Japanese exporters.
Asia and Emerging Markets
Aside from Korea, Taiwan and Australia, most Asian markets declined over the month. India’s stock market, one of the best performers in Asia for most of 2024, continues to slide in line with the economy, which is suffering from low growth rates, high unemployment, inflation and low levels of consumer spending.
China’s position remains broadly unchanged – dealing with strategic difficulties of colossal national debt and a shrinking population. The need to export cheap manufactured goods remains acute and likewise remains a broadly successful approach. Tariffs will become a hurdle for the vast US economy where China enjoys a $2 trillion surplus today. A ramping up of exports to other markets, notably those in Asia has been notable. Chinese equities have drifted sideways since October 2024, interest rates have been cut to 3.1% and the Yuan is losing value in what could be a planned approach to managing tariffs, since the 10% depreciation since September already compensate US importers for a tariff level of equal proportion.
Outlook
Whilst the US equity market has been the main driver of returns for investors for the last few years, it has come at the price of expanding valuations and reduced diversification. So, it is good to note the continued broadening of returns away from the Magnificent 7. With enormous uncertainty over tariffs and which areas of the US and global economy will be impacted, either positively or negatively, the importance of having a portfolio that is globally diversified is certainly greater in this environment. There will clearly be both winners and losers, both by geography, sector and company. The same applies to fixed interest markets, where a flexible approach to managing duration (sensitivity to interest rates) will be important, particularly due to the uncertainty over tariffs’ inflationary impact. It will also be just as important to manage credit risk, given certain markets such as High Yield are priced to perfection at present. Although Elon Musk’s approach to reducing government spending through the Department of Government Expenditure (DOGE) may seem unorthodox, a reduction in the budget deficit is to be welcomed, provided it doesn’t end up with unintended consequences.
Rockhold Asset Management, with contribution from Alpha Beta Partners, Marlborough and LGT, February 2025.
Disclaimer: This document is issued by Journey Invest Limited. Its content is for your general information purposes only and does not constitute investment advice. The commentary is intended to provide you with a general overview of the economic and investment landscape. It is not an offer to purchase or sell any particular asset and it does not contain all of the information which an investor may require in order to make an investment decision. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article.
Past performance is not a reliable indicator of future results. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances. Your capital is at risk and the value of investments, as well as the income from them, can go down as well as up and you may not recover the amount of your original investment.