Asset Allocation and Sector Focus in Spring 2025

Communications

Expectations around artificial intelligence have been a tailwind for the sector recently, leading the performance of key sector players to be strong. Whilst AI is likely to benefit the sector, premium valuations now more than reflect this. The telecoms element of this segment looks less stretched in terms of valuation; however, these companies make up a smaller part of the sector. Whilst we continue to like the sector from a structural point of view, we retain an underweight due to valuations.

Consumer Discretionary

The sector is exposed to macroeconomic data in Europe and China. As the name discretionary suggests, demand for these products is non-essential and is therefore sensitive to consumer budgets. We see valuations in the sector as increasingly attractive and we expect further policy support in China and Europe to support consumption. This sector is also our preferred way to play our short-term positive view on China given the exposure of the sector to this region. We therefore upgrade our view to overweight.

Consumer Staples

Input cost inflation continues to be a headwind for the sector, with pricing remaining high and volume still weak and we expect the legacy of high inflation to weigh on margins. We also are seeing divergence between brands. This divergence is and will be largely driven by their ability to drive volume growth, as consumers remain budget conscious, limiting the sector’s ability to implement further price increases. 

Energy

Brent crude started the year at $75 and ran up in January but has since fallen. We see the outlook as evenly balanced, with the marginal cost of production and OPEC providing a limit to the downside, but Trump’s pro-drilling policies providing a cap to the upside. With this lack of directional conviction, we retain a neutral weighting to oil.

Financials - Banks

Financials performed well in 2024, and valuations have increased. Whilst we do think rates will come down more slowly than previously thought, banks make money from the difference between long and short rates, which remains in positive territory. We do not expect a significant steepening of the yield curve from here and, therefore, with valuations where they are, we retain our neutral rating.

Health care stocks suffered at the end of 2024 as the appointment of Health Secretary Kennedy in the US increased uncertainty around pharmaceutical regulation. Since the appointment of Kennedy, the sector has continued to struggle but we believe valuations have reflected the risk and we now expect health care to perform better and so move to an overweight to reflect this. 

Industrial equities performed well in the second half of 2024 on the back of loosening monetary policy and supportive fiscal stimulus in China which was to the benefit of our prior overweight position. Looking ahead in 2025 the valuations of many industrial companies appear quite rich against a backdrop of low global growth and the potential threat of tariff exposure. Given these considerations we see an opportunity to take profit and in doing so move to a neutral position. 

Performance following Trump’s election has been strong, and valuations provide limited margin for error should earnings disappoint. AI will provide a tailwind to the sector, but it also requires significant capital investments before the demand can be serviced. We also note that with fewer US rate cuts now expected this year, interest rate sensitive sectors such as this could struggle. We continue to see the structural drivers of this sector over the longer term but remain underweight on valuation grounds. 

China remains the largest medium-term influence in the materials sector. Whilst we saw fiscal stimulus in China in 2024, large volumes of unsold inventory remain within the Chinese property sector and targeted stimulus in the form of a property stabilisation fund is needed. Longer term, we continue to see the attractiveness of the copper market and a possible bull move in the commodity super cycle would boost the outlook. For the shorter term, the sector is unlikely to outperform without further Chinese stimulus.

2024 was a challenging year, due to persistent inflation and a 15-year high in interest rates. Valuations fell with heightened borrowing costs. The recent rate reduction is helping stimulate activity, whilst modest inflation is providing rental growth and helping investors reduce their ‘risk off’ position. Even though the market remains fragile, we believe an uptick in the real estate sector is due on the back of easy comparatives and suppressed valuations.

Utilities in the US saw strong performance in late 2024 post Donald Trump’s election victory. In the same period UK power names published their draft business plans for the next power transmission regulatory cycle RIIO-T3, with the proposals appearing both reasonable and fundable. Conditions in the UK water sector remain challenging, however. All things considered, we remain neutral on utilities and continue our preference for power over water.

UK

The UK economy slowed in 2024, as the Autumn Budget landed badly. Wages have recently been reaccelerating, whilst activity data has been weak. The Bank of England must choose between the upside risk to inflation versus the downside risk to growth in the next few years. With valuations remaining attractive relative to both Europe and the US, and evidence of broadening corporate earnings delivery, a more activist Bank of England and less robust sterling are likely to support investor appetite to the UK stock market. 

North America

The US economy continues to grow solidly, supported by robust consumption growth.  Wages have been growing more rapidly than inflation, the pace of hiring has picked up and household balance sheets are still resilient. Against this background, Trump’s trade, immigration and tax agenda may have the effect of pushing up long-term US inflation expectations which could cause an undesirable increase in long-dated treasury yields. Given the high rating of many US equities, this environment could cause a reversal of last year’s outperformance.

Europe

The European Central Bank (ECB) has continued monetary policy easing as incoming activity data remains disappointing. The significant downshift in Chinese demand has been a particular challenge for the export sector and domestic vehicle production has faced considerable headwinds from Chinese competition. Whilst the prospect of across-the-board US tariffs on all imports is a material concern for investors, at current valuations there is value in the price and we expect the ECB to deliver further aggressive monetary policy stimulus, so we move to neutral in Europe.

Japan

We expect Japan to sustain a strong cyclical upswing during 2025. This will be driven by a combination of positive real wage growth, the conclusive end to corrosive disinflation, and ongoing reform of the corporate sector. These are clear tailwinds to the growth outlook. We expect the Bank of Japan to increase interest rates moderately over the year, in contrast to the other major central banks. 

Asia Pacific

Recent monetary policy easing by the People’s Bank of China in addition to liquidity support for highly indebted local authorities has generated a strong upswing in economic activity into 2025. However, the ongoing threat of tariffs presents a significant potential headwind to the export and industrial sectors in China.  Elsewhere in Asia Pacific however, with regional growth still solid and scope for central banks to ease policy from currently restrictive levels, we are more optimistic on the growth and earnings outlook ex-China. 

Emerging Markets

Last year’s rally in the US was a headwind for emerging markets. Looking ahead, much of the rally in the dollar which one would expect because of Trump’s proposed tariffs has already occurred and any disappointment on the sequencing or delivery of his policy agenda is likely to see a reversal of dollar strength, which will ease financial conditions in emerging markets, providing a boost to the corporate sector.