Commentary for January 2025
Market Overview
Global equity markets have had a strong start to the new year, rising 4.4% in January. Europe and the UK led the way, with gains of 7.7% and 6.1%, respectively. US shares gained 3.8% but lagged other regions as Chinese start-up DeepSeek challenged US leadership in artificial intelligence (AI). Emerging markets, Asia and Japan rose by a more modest 2% overall. Global bonds also rebounded after a weaker start to close the month 1% higher. The crude oil prices rose 3.2% to a five-month high, as fresh US sanctions on Iran and Russia threatened to crimp supplies and freezing temperatures swept across large parts of the Northern Hemisphere. Gold also leapt a further 7% to a new record high. The price has been rising relentlessly since November 2022; central banks continue to diversify their assets as the dollar’s role as a reserve currency is gradually reduced. Other commodities such as industrial metals and agriculture were also strong.
The AI disruptor is here. Chinese startup DeepSeek rocked the industry with a major innovation, raising questions about US dominance of AI and casting doubts on sky-high valuations for companies such as Nvidia. Deepseek’s answer to ChatGPT claims to produce comparable results at a fraction of the cost and is currently the top app on Apple’s iPhone download charts. It has been hailed as “one of the most amazing and impressive breakthroughs” by renowned tech investor Andreessen, as it can be run on much less powerful machines than the premium Nvidia hardware, thought to be essential until now. It is also open source, meaning that the code has been gifted to the world for anyone to use, edit and share. This lowers the drawbridge for smaller players, threatening the current big US tech company stranglehold. As a result, the shares of AI-related companies such as Nvidia fell sharply.
UK and European shares began the year on a strong footing. Both regions benefited from the rotation out of US tech stocks into other markets and sectors. Domestically orientated value sectors such as banks delivered robust returns, along with more defensive sectors such as staples, healthcare and utilities. UK recorded a new all-time high.
President Trump was inaugurated for a second term. US investor sentiment has been buoyed by his “America First” policy programme, although other regions are less enamoured with his agenda. So far, Trump has managed to upset the Colombians, the Mexicans, the Canadians and the Chinese, with rumours that the EU will be next. The imposition of tariffs of 25% on all imports from Mexico and Canada, along with 10% on all those from China, sparked a global sell-off at the end of the month. China hit back with 10-15% tariffs on a range of US goods and opened an anti-trust probe into Google. However, Mexico and Canada were issued a last-minute reprieve in return for agreements to increase border security to combat illegal immigration.
The UK market was buoyed by news that inflation had slowed unexpectedly in December, with a decline in the annual rate to 2.5% from 2.6% in the previous month. This allowed the Bank of England to cut rates by a further 0.25% to 4.5%. The move was welcomed by the bond market, where it will lessen the fiscal burden of financing the budget deficit. Bond investors were also reassured as Rachel Reeves reiterated her pledge to adhere to the Government’s fiscal rules, calling them “non-negotiable”.
The Federal Reserve held rates steady and signalled that there may be no further cuts forthcoming, having made 1.0% worth of cuts over the prior three meetings. The ECB cut rates as expected by a further 0.25% to 2.9%, with President Christine Lagarde warning that risks remain tilted to the downside given rising trade frictions and weak consumer confidence. Elsewhere, Japan raised its official interest rate by 0.25% to 0.5%, a widely expected move that supported financial stocks. The Japanese yen appreciated modestly as a result. Corporate earnings results for Q4 were also ahead of expectations. Ongoing improvements in corporate governance, such as share buybacks and dividend hikes, provided further support to the market.
Looking Forward
Bullish exuberance has returned to the markets in a big way following the presidential election. The improvement in optimism is unsurprising given the many anti-business policies and regulations implemented by the previous administration. With many of these hurdles now being repealed, businesses are feeling much more confident about the future. However, the Trump administration’s “ready, aim, fire” approach to foreign trade policy and tariffs looks like it’s going to make for added market volatility. During his first term, tariff threats came and went on a regular basis and investors are hoping this will be the case this time around.
The drama in artificial intelligence has largely fizzled out for now. However, a warning shot has been fired. The emergence of disruptors such as China’s DeepSeek could make valuations that have powered the bull market in US tech tough to justify. The rival technology questions the idea that companies wanting to make use of, or compete in AI, will have to make massive and very energy-intensive investments to do so. This could challenge Silicon Valley’s dominance in the race. However, any potential loss to US tech could be a significant gain for the world, accelerating the adoption of AI and boosting innovation and growth across the global economy. AI has the potential to deliver meaningful gains across a range of sectors and, in many ways, this is the more important take-out from the news. Although it could prove disruptive for the current incumbents, it could be very positive for productivity overall, supporting the idea that gains should broaden to other sectors going forwards. Diversification into cheaper markets and sectors is an effective way of managing portfolios from both a risk and return perspective.
Our Strategy
In equities, we are positive overall with a focus on markets outside of the expectation of a broadening rally.
UK equities represent a strong value-orientated opportunity, with many high-quality companies trading at valuations significantly below global peers. They also offer a compelling income stream. Sector exposures in the UK are very different to other global markets, bringing important additional benefits in terms of diversification. The UK has minimal exposure to technology, but greater exposure to cash generative financials, energy and basic materials, along with high quality consumer staples. This should prove beneficial if expectations for a sector rotation in 2025 prove correct.
The US monetary policy outlook is likely to be supportive for emerging markets, where equities look set to benefit from stronger domestic growth. Action by the US Fed also provides greater flexibility for this region to initiate its own policy easing cycle without the fear of negative repercussions for its currencies. We are cautiously optimistic on China, based on cheap valuations and expectations of further policy support. A stronger China would further increase the attraction of emerging markets in general and help unlock some of the value that’s been accumulating over the past decade or so.
While equities remain our preferred asset class, the prospect of lower rates means that bonds should outperform cash. From an income perspective, yields are now attractive in both absolute and real terms (relative to the level of inflation). Bonds also provide diversification in the case of slower growth but will not protect portfolios from the possibility that inflation remains higher for longer (with the exception of index-linked bonds), which remains our central view.
Alternative assets such as infrastructure, renewables, gold and commodity stocks offer a valuable additional source of diversification and allow us to hedge against inflation and other potential risks and capitalise on wider opportunities outside of traditional bonds and equities. Stimulus by China could exert further upward pressure on commodity prices. We continue to view gold as essential portfolio insurance. The combination of higher geopolitical risk, lower interest rates and strong central bank demand has created a highly favourable environment for the yellow metal. Our exposure to both physical bullion and gold mining shares across standard portfolios has been a major contributor to outperformance versus benchmarks.
Elsewhere, the infrastructure and renewables sectors look set to benefit from some weighty commitments outlined by the government in its new policy agenda. These include £35bn in roads and updating the digital grid, £20bn in green transport and a further £12bn in energy transition and renewables investment such as hydrogen, offshore wind and solar energy projects.
Overall, we continue to manage investments in a manner that allows us to capture the upside in financial markets while also effectively controlling risk to dampen volatility and smooth the path of returns.
