Investment Update: January 2025

INVESTMENT UPDATE JANUARY

*all returns in local currency terms

Overview

The post-Trump election victory rally in US equities came to an abrupt end mid-way through December, following the US Federal Reserve’s (the Fed) latest interest rate cut of a quarter percent. Whilst the cut was widely expected by investors, the Fed’s Chairman, Jerome Powell, suggested that the uncertainty surrounding the outlook for inflation following the Trump victory meant that there were likely to be only two further cuts in 2025, versus the four that market pricing was indicating. This caused the about turn in the S&P 500, which despite being supported by a strong ‘Magnificent 7’ performance, ended the month down over 2%. However, this didn’t prevent the index delivering a return on over 20% for the second year in a row.

The Fed’s comments also had a marked impact on government bond yields, which had already been trending higher post the Trump win, rose again, causing prices to fall (prices move inversely to yields), as bond investors became equally as concerned as equity investors about the future direction of interest rates and inflation. A similar phenomenon was experienced in the UK, as government borrowing rates moved towards a multi-year high.

The net result was that all portfolios suffered marginal declines over the month, but here too results were strong for the year as a whole.

US

Whilst the extent to which President-elect Trump’s widely publicised views on tariffs and immigration eventually find their way into actual policy remains extremely unclear, what is evident that business leaders in the US are quickly moving to align themselves and their businesses to his way of thinking. The potential advantages of being able to influence Trump’s policies, particularly in the areas of deregulation, are clear to see. One only has to look at the performance of Tesla shares through December compared to the wider market, to see the benefits investors feel that Elon Musk’s alignment to Trump may bring:

Source: Morningstar

However, the wider market is clearly concerned that Trump’s policies may dampen the prospect for future rate cuts and cause government debt to rise. The S&P 500 was flattered by the performance of the likes of Tesla and the other Magnificent 7 stocks, which have an increasingly disproportionate impact on the index (representing over 30% of an index of 500 companies), delivering over 53% of the index’s return in 2024. So, we get a clearer picture as to the extent of investors’ concerns by looking at the performance of the more evenly distributed S&P 500 Equally Weighted index, which fell over 6% in December, as well as the Russell 2000 index, which represents small companies, which declined over 8%. Although the latter still managed a positive return of over 11% for the year.

Europe

In Europe, the euro / dollar exchange rate is heading closer to parity, marking out economic difficulties within the Eurozone. Energy security remains a critical concern, with German companies laying off staff and energy prices expected to rise further in 2025. Russian gas will be cut off to Europe by Ukraine during January. Germany has posted negative GDP growth in 4 of the last 8 readings and recession across manufacturing sectors throughout Europe is a real concern. The European Central Bank continues to cut rates ahead of the US Federal Reserve to support Eurozone economies, but Europe's energy costs and security hinge on geopolitical developments. The cost of energy led to a nudge higher in Eurozone inflation whilst wages fell.

The two countries at the heart of the EU: France and Germany, face disruption as both governments lost votes of confidence within the space of two weeks. In France, Prime Minister Michel Barnier’s proposed 2025 budget led to his government collapsing, and he was replaced swiftly after. Meanwhile in Germany, following the vote of no confidence, Chancellor Olaf Scholz now faces an election in February.

France’s CAC 40 index performed well despite the domestic political turbulence. It initially rose in the days following the French government collapse, benefiting from China’s most recent stimulus announcement—the CAC 40 is largely made up of luxury goods firms, which are poised to benefit from increased Chinese demand. It subsequently rose 2.1% in December, which contrasted with the decline in the Europe wide Stoxx 600 index.

UK

In the UK, the Bank of England (BoE) held rates at 4.75%. The decision to hold came after inflation rose to 2.6% in November, up from 2.3% the previous month. However, the 6-to-3 vote showed members were not in unison, with dissenters favouring a 0.25% cut. This so-called dovish hold indicates increasing concern about the state of the labour market and economic growth in the wake of Labour’s budget. Escalating debt woes are manifest in Gilt prices where yields have pushed to 4.6% for 10-year stock, now at levels last seen immediately following the infamous Liz Truss / Kwasi Kwarteng budget. The UK stock market offers undeniable value for determined and patient investors, although reliable dividend stocks remain appealing for income seekers and related portfolios.

Japan

The Bank of Japan faces a ‘trilemma’, with increasing imported inflation due to currency weakness. The Bank of Japan remains reluctant to raise rates to defend the currency, even with medium-term inflation expected around 2.6%, as higher interest rates could undermine affordability of further debt financing. With a debt/GDP ratio of 264% (in the UK we are concerned when it reaches 100%), rate hikes could exacerbate Japan's fiscal deficits, as interest payments increase with this. As China likely devalues, this will put pressure on Japanese manufacturers whose share prices have delivered strongly over the past year or two, partly as a result of the weaker Yen – a factor that helped drive the market to deliver an impressive return of over 20% in local currency terms over the year.

Asia and Emerging Markets

On the whole, Asian markets continued their recent decline, particularly in Korea which is suffering from political turmoil, as South Korean President Yoon Suk Yeol was impeached after declaring martial law on 3 December, leading to widespread protests. A notable exception was the technology stock rich Taiwan which delivered a 4%+ return, making it the top performing Asian market over the year.

China’s deflationary pressures continue to dominate, as bond yields there fell to 1.78%; now persistently below that of Japan’s. Investors are still trying to ascertain the impact of recent government led stimulus designed to address the huge debt levels at private and local government level, which have been exacerbated by the collapse of the property market there. With over 60% of private wealth stored in property, people are inclined to save to rebuild their personal savings rather than spend. Whilst the lowering of prices helps exporters in China, these are now in danger of increased levels of tariffs on their goods by the new Trump-led administration. The challenge of the authorities is how to increase consumption domestically. Despite this, the measures announced so far did help propel the market significantly higher over 2024, following over three years of decline.

Outlook

In the US, valuations, for certain stocks at least, remain at elevated levels. The question is, can lower interest rates, corporate taxes and a focus on domestic rebuilding and onshoring under President Trump maintain GDP growth, stimulate economic activity and employment at home? If so, the prospect for further US equity growth is possible from these levels. Government bond markets, particularly in the west, are likely to remain challenging, at least until a clearer picture on inflation and growth emerges and much of this will be determined by the extent of President Trump’s policies. Meanwhile, the non-fund blend portfolios will continue to benefit from the reduction in sensitivity to interest rates and increase in cash changes seen in November.

Rockhold Asset Management, with contribution from Alpha Beta Partners, Marlborough and LGT, January 2025