This month, written by Tom Day.

Summary

Markets all over the globe have been experiencing a mix of volatility and recovery in recent months, influenced by various economic and geopolitical factors. In the United States, the S&P 500 and Nasdaq indices have been particularly volatile, influenced by President Trump’s new tariffs, as well as ongoing concerns about other trade policies and the potential of rising inflation.

In Europe, major indices have seen growth, partly due to the EU’s commitment to increase spending on defence. The DAX in Germany has seen the most notable rise, signalling a recovery from earlier losses and years of less than optimum returns. The UK’s FTSE 100 also returned to growth, gaining ground as inflation data provided some relief to investors. However, the broader European and global markets remain sensitive to shifts in US trade policies and their potential impact on global growth.

The pound has also shown strength against both the US dollar and the euro, reflecting a degree of confidence in the UK’s economic outlook.

Overall, the global stock market remains in a state of uncertainty, with investors closely monitoring inflation trends, trade policies, and geopolitical developments. While there are pockets of recovery and optimism, uncertainties persist, particularly over President Trump’s tariffs, making it a critical time for investors to stay informed about potential risks and developments. In this environment, holding diversified investments is proving crucial once again.

Germany sends global bonds spinning.

European equities were boosted midweek by Germany’s larger-than-expected defence spending package. This was led mainly by defence stocks – particularly German arms manufacturer Rheinmetall, which has nearly doubled in price since the start of the year. At first glance, it might seem strange that military spending should improve the overall economic outlook – given that defence is the stereotypical ‘unproductive’ investment. But after years of a manufacturing slump, Europe has a great deal of spare production capacity. Getting that going will provide a short-term boost, even if none of the goods produced are used for productive purposes.

The real hope, though, is not just about higher production, but Britain and Europe developing a joint military tech sector that leads to economically productive tech for the long-term. The spending packages already announced might not achieve that on their own but, if they lead to greater European cooperation, the impacts would be immeasurable.

Along with the defence boost came a spike in European bond yields – thanks to Germany’s announcement of plans to remove its constitutional debt brake. This reverberated across global markets, even pushing up yields in the US, despite fears about growth in the world’s largest economy. Higher yields mean lower bond prices, which can be difficult for fixed-income investors to stomach. But we should bear in mind that the German yield spike was not really about public debt fears, but rather improved growth prospects.

 Trump’s Tariffs

Trump’s 25% tariffs on Canada and Mexico briefly took effect this month – only to be negated by the president’s delays and exemptions. An additional 10% tariff on Chinese goods went ahead as planned. Now that tariffs are here, it is worth looking at the White House’s economic rationale – offered last year by Trump adviser Steven Miran. Miran has argued that tariffs push up the value of the dollar by reducing US demand for imports and drawing investment-led capital flows to the US. This currency appreciation should, in theory, neutralise the tariff costs to consumers, while raising Federal tax revenues and making American industry more competitive.

The reason the US can do this – so the argument goes – is because of the dollar’s supremacy in global trade. But in reality, the dollar has weakened substantially this year. This is because trade is relatively small component of what makes currencies move; a much bigger impact comes from capital flows.

Trump and his advisers want to reduce the US trade deficit (exports minus imports). That can be done by increasing the volume of domestic production through increased productivity, but that is usually a slow process. The administration hopes to achieve some of this more quickly by firing what they see as unproductive government employees – who then switch into the productive private sector -, but this is also unlikely to move the needle in the near-term.

The other way is to reduce US domestic demand relative to others. But strong US demand is what makes the US economy strong – and a strong US economy is why US assets have beaten all others in recent years.

This points to a general problem of unintended consequences. Maybe Miran’s tariff plan could work in controlled isolation, but the other parts of Trump’s agenda are working against it. Spending cuts are making US demand weaker, and the isolationist ‘America First Investment Plan’ is disincentivising the free flow of capital. On top of all this, political volatility is making it hard for businesses or investors to feel confident enough to go ahead with capital investment. Just look at the speed of Trump’s back and forth on Canadian and Mexican tariffs earlier in the month. The trading environment is changing so rapidly that businesses are struggling to get to grips with the current rules – let alone the future ones. Would-be tariff planners need certainty, but Trump loves to keep people guessing.

Central Bank Updates

The Federal Reserve held rates steady but predicted worse growth and higher inflation for 2025 – explicitly tied to Trump’s tariffs. However, this didn’t materially shift the Fed’s “dots plot” (a graph of members’ rate expectations), since chairman Powell expects tariff inflation to be “transitory”. That’s because sales tax hikes usually act like one-off cost hits, which don’t impact inflation figures beyond a year.

But it’s a big assumption to think that Trump’s tariffs will be one-offs; he’s already engaged in tit-for-tat with trading partners. Chairman Powell’s comments also avoided any mention of recently weaker employment numbers – which could become a problem if growth slows further.

The Bank of England’s (BoE) 8-1 vote to hold rates was surprisingly emphatic. The UK economy doesn’t look as weak as it did – with the expected drop in employment (in reaction to the national insurance hike) not coming through. However, fiscal policy will remain tight, with the government favouring spending cuts to fund defence, rather than new borrowing. The BoE won’t react until after the spring budget.

Japan held rates steady last week – but bond yields counterintuitively rose. This bears closer inspection, as we know from last summer that Japan’s market dynamics can quickly become everyone’s problem.

The ECB is the only central bank not in “wait and see” mode, and it is expected to remain accommodative even after historic defence spending deals on the continent. This is mainly because none of the bonds for the fund raising have actually been issued or spent yet, leaving the economy in an awkward limbo. The financial market impacts of defence spending have already happened, but the economic benefit will take a while.

In an ever-changing world, diversification is key.

It might feel like Trump’s confrontational style is to blame for market jitters this month – but it is important to distinguish between politics and policy. Trump has always been volatile but, during his first term, his policies were reliably market friendly. That no longer seems to be the case, and it is the policy uncertainty that is hurting investor sentiment.

European stocks may be in the ascendency now, and US stocks lagging, but a few months ago the complete opposite was true. Last year, global investors were so convinced by America’s growth supremacy and Europe’s failings that the current situation would have seemed absurd.

The US economy seems to be slowing now, but this has already led the Trump administration to ease up on tariffs and federal spending cuts. Clearing the obstacles for growth is not the same as boosting it, but we have every reason to think that the popularity-craving Trump will want to unveil some economic stimulus in the weeks to come. If so, the narrative could easily flip back to US growth exceptionalism, or at least rejuvenate the attraction of the globally operating US mega caps.

The point here is not that you should or should not trust any particular investment position. It is rather that, in a deeply uncertain world, diversification is your friend. The outlooks for each region are uncertain, and increasingly desynchronised. In which case, it is best to own parts of each – to get the benefits where they come, and avoid excessive risks. Diversification has always been central to a long-term investment strategy, and it is important now more than ever.

Other Viewpoints

Cash

Although cash continues to offer decent rates, we expect interest rates to fall over the next few years. Instant access rates are available from 4.5% but fixed term savings are only slightly higher as banks don’t want to tie themselves into providing guaranteed higher rates in the future when they expect interest rates to be lower themselves.

Fixed Interests

The yield difference between corporate and government bonds is currently very tight, and the spread is vulnerable to widen in the event that economic growth comes in weaker than expected. Bonds are once again being used by portfolio managers as a hedge against equity risk, however finding good value in them at the moment still proves difficult. Very similar situation to last month.

Global Shares

We expect the global economy to continue to expand, which is consistent with corporate profits going up. We also believe there is the potential for AI advancement to drive both strong economy wide productivity and continued solid profit gains. However, there is limited room for cyclical economic growth. With most economies close to full employment and labour force participation high, there isn’t much scope for workers on the side lines to get a job, earn an income, and increase consumption.

Alternatives

Following the recent strong rally in gold, portfolio managers have taken some profits from this position. Central banks may continue to diversify their reserve holdings out of the dollar due to US uncertainty, so there may be some more potential upside to this.

UK Shares

Although the domestic economic outlook is less important for UK performance given its high international exposure, it still matters. We suspect Labour will have some success in boosting economic growth, notwithstanding rising doubts in the market. The UK equity market is also heavily undervalued.

US Shares

Things have changed drastically in the last month with regards to US Shares. The Trump administration shows signs of being ready to wage a trade war with many countries simultaneously, and they all seem ready to retaliate. If things progress this way, it would make the growth/inflation impact in the US more severe than if it were to just focus on a smaller group of countries. For this reason and others, including Trump’s immigration stance, stretched valuations, and a still richly valued USD, many portfolio managers have reduced their weighting in the USA. Nevertheless, we are still more optimistic on US equities than other regions. We expect the US to maintain its productivity advantage vs most of the rest of the developed world.

European Shares

The recent pickup in European shares has been driven by a combination of the weakness in US mega cap digital names, an improvement in the European economic data at a time when US indicators have softened, an uptick in optimism toward the cheaply valued European names following a period of deep pessimism toward the region, and the prospects of significantly higher European defence spending. While a trade war between the US and EU could be more damaging for the latter, investors are very aware of this risk. European currencies also remain cheap, even after the recent rally.

Asian Shares

Much the same as last month, Japan’s shareholder friendly reforms have already done well for their markets, but their shares aren’t cheap at the moment, and with a high labour participation and low unemployment there isn’t a huge amount of room for natural growth, so I am not particularly positive on Japan’s prospects for the short term.

China continues to battle a weak housing market, but productivity in China is a notable bright spot. Meanwhile, the policy focus is shifting from a stance to contain the private sector to one that supports it.

Emerging Markets

Emerging markets are very closely linked to commodity prices and we don’t expect to see much growth from that sector in the short term. There is unlikely to be much upside to commodity prices in an environment where global growth is slowing.  That said, emerging markets remain very cheaply valued.