Last month’s forecast for higher market volatility duly arrived during February with the S&P 500 down 3% for the month. President Trump strode onto the geopolitical stage creating characteristic waves and setting markets on edge. What conclusions, if any, can we draw from a turbulent short month? We set out our views in the update which follows.
The first part of the of the year has seen international equities outperforming the mainstream American index. Tighter liquidity and higher bond yields tend to work on a lagged basis, pushing equities lower around 5-6 weeks after the fact. Added to which, geopolitics, weaker US consumer confidence, persistently sticky inflation printing at 0.3% for January, and a flash GDP report showing 2.5% year-on-year growth conspired to make for a more difficult month end. Interest rates are unlikely to be cut again until later this year. The VIX Volatility Index spiked to around 20, which tells us equity values can oscillate around 1% per trading session. We realise many investors find volatility somewhat trying. However, volatility is the price to be paid for higher real long-term returns. Our managers maintain risk within portfolios at levels set out.
The chart below shows PCE inflation in America – the Federal Reserve’s preferred measure of inflation.
Source: Bloomberg, 28 February 2025
In February we learned Scott Bessent, the new Secretary to the Treasury, intends to maintain a very similar policy to his predecessor. This means funding debt via short term Treasury Bills, rather than issuing coupon paying Treasury Bonds. Whilst perhaps subtle, this is good news for real asset prices, and will assist with the provision of liquidity and generate some yield curve control, holding US treasury yields lower. This is in line with the new administration’s plan to weaken the yield on 10-year stock, which today is sitting at 4.2% and is already lower than when the new administration took office. Of course, the added benefit of Treasury Bills not sitting on the Federal Reserve’s balance sheet, will not be lost to the Trump megaphone. The Q4 earnings season reported in robust fashion, with around 74% of S&P 500 companies beating forecasts. Although technology has struggled so far this year, being beaten by financials, we now see a resurgence in healthcare and energy sectors.
The parallels to Trump 1.0 in 2016 are evident. A higher dollar and higher bond yields on taking office, which are then pushed and massaged lower during the years which follow. Both outcomes offer stimulative support for trade, corporate America, and stock prices. A strategy to shrink the colossal US national debt appears to be unfolding – monetising US assets, including the military, appears to be one of the plans, as is cost cutting across the civil service. The Department for Government Efficiency (DOGE), headed by Elon Musk, has already reported savings of $155bn, according to official sources.
For us, the analogy of a new CEO at a large company bringing radical new ideas, and a new strong charismatic approach holds true. Under such circumstances, the company share price often fluctuates until such time as the market becomes accustomed to the modus operandi, the strategy can be validated, and results can be witnessed. This is broadly what has happened in the United States during February.
In Europe, the economic and political scene remains somewhat distressed. However, despite the apparent malaise, stocks in Germany (in particular) continued to do well, posting new all-time highs. The likelihood of rapidly expanding defence spending has stimulated stocks, such as, Rheinmettal and Airbus higher. As we have stated here in previous months, diversified earnings across a broad geography helps European stocks to perform differently than the pure domestic indicators might suggest. We continue to allocate to the region, as holding our nerve against a deteriorating economic backdrop has proven profitable.
Source: Bloomberg, 3 March 2025
Meanwhile, at home in the UK, we witnessed an uptick in inflationary pressure. As of February 2025, the UK economy is showing signs of slow growth, with the Bank of England revising its GDP growth forecast downwards to 0.75% for this year, which is significantly lower than previous predictions. This is attributed to a weakening labour market and a projected moderation in wage growth, despite recent highs. Inflation is expected to rise to 3.7% by quarter 3, before gradually easing back to the target rate. UK interest rates are expected to fall, albeit only very modestly, against the backdrop of higher inflation. We are reminded somewhat of 1970s style stagflation.
In Japan, stronger domestic consumer spending is likely a requirement to sustain its inflation target, and keep output growing. The good news is that consumer fundamentals have improved. The main impediment to stronger domestic consumer spending is inflation. Even with such strong contractual wage growth, headline inflation was even higher, at 3.6% year on year in December. Energy and fresh food prices have been rising quickly. Energy prices were up 10.1% to the end of 2024 positioning the Bank of Japan in a difficult position – cut rates to stimulate growth further and help real asset prices perform, and risk higher inflation, or maintain a tight monetary position. We suspect Mr Ueda and the BoJ will exercise caution, and any moves are likely to be restrained and modest.
China's economy is facing a slowdown with expected GDP growth around 5%, primarily hampered by weak consumer demand, a struggling property sector, and potential impacts from trade tensions with the US. Analysts are predicting further policy stimulus to support growth, with a focus on addressing deflationary pressures, and boosting domestic consumption, while keeping a close eye on external uncertainties regarding tariffs, and global trade dynamics. A strong leading indicator is typically the stock market, which has shown renewed signs of recovery and optimism. Whilst tariffs may hurt export demand to America, Asia and much of the rest of the world continue consuming cheap goods manufactured in China.
At portfolio level, we have benefitted from higher cash positions during a volatile month, and have enjoyed the upside linked with European equities. Our US allocations, particularly those giant technology related holdings, have suffered during February. However, we remain confident in resumed growth as set out earlier in this update. Performance relative to peers is strong and importantly risk remains anchored firmly in line with relevant volatility corridors. We look forward to updating you next month.
Written by the Alpha Beta Investment Team.
All sources Bloomberg unless otherwise stated.