Global equities reached all-time highs by mid-February, fuelled by strong gains in US equities. With the US economy ending 2024 on a firm footing, the potential impact of President Trump’s tax cutting and deregulation agenda and the prospects of further developments in Artificial Intelligence (AI) to support strong earnings delivery for the US technology giants fuelled a considerable amount of investor optimism in the first few weeks of the year.
However, the emergence of China’s low cost DeepSeek AI model posed serious questions about US tech titans’ supremacy and whether they had been overspending on capex. Furthermore, the more growth negative elements of the Trump policy platform – trade and immigration – took centre stage, with the US administration announcing increases in tariffs on Chinese imports from 10% to 20% and aggressive curbs on illegal immigration.
In addition, and after much toing and froing from the US administration, there was confirmation that 25% tariffs would be imposed on Canada and Mexico. With investors concerned that these policies would create a supply side shock to the US economy, raising prices and lowering the supply of labour, incoming economic data highlighting weak consumer and business confidence prompted a sharp unwind of US equity outperformance, culminating in a 10% correction in the S&P 500 over a 20-day period.
Over the quarter, UK and European equities fared much better, with the latter rallying strongly on an unprecedented German commitment to boost defence and infrastructure spending by more than EUR1trn in the years ahead, as European leaders faced the prospects of a future with a reduced US military umbrella.
In addition, the EU Commission proposed that member states could significantly increase defence spending without breaching the EU’s deficit rules. Against this background, the performance gap between European and US equities was the widest in a decade, with the Stoxx 600 returning +7.2% and the S&P 500 -7.2% in Sterling terms.
Elsewhere, the “Magnificent 7” mega cap US tech index fared worst of all, returning -18.5% in Sterling terms as enthusiasm for the positive AI narrative began to wane. From a regional equity perspective one notable laggard, however, was the Japanese Nikkei, which despite strong corporate earnings delivery and and an improving domestic growth outlook returned -8.2%.
With last year’s trend of falling US inflation showing signs of waning and consumer expectations of future inflation on the rise, the US Central Bank (Federal Reserve) maintained its key policy rate steady at 4.5%, though did reduce the pace of its quantitative tightening. In contrast, the European Central Bank and Bank of England cut their key policy rates by 0.25% to 2.65% and 4.5%, respectively.
Weakness in the UK economic growth outlook boosted short-dated UK gilts, but longer maturities were slightly weaker, reflecting a poor 2025 inflation outlook and a deterioration in the UK’s public finances which required the Chancellor of The Exchequer to announce spending cuts and welfare reductions to restore the Autumn Budget’s wafer thin £9.9bn fiscal headroom.
Gold was a standout performer over the quarter, rallying 15.3% in Sterling terms, its seventh successive positive quarter. Elevated geopolitical and trade uncertainty, sticky inflation and the prospects of further cuts in interest rates are, we feel, likely to remain a tailwind for Gold in the months ahead.
Whilst US growth expectations have been revised somewhat lower for 2025, a recession is not anticipated by the market. However, Trump’s announcement on “Liberation Day” of an average tariff rate of circa 22% was significantly above the expected level of roughly 10%. To illustrate the proposed tariff calculation, the US Trade Representative takes a country’s trade surplus with the US, divides it by the amount of trade it conducts with the US and then halves it. For example, China has a trade surplus with the US of $295bn on total exports of $438bn, which is a ratio of 68%, yielding a tariff rate of 34% (in addition to the existing tariff rate of 20%). Elsewhere, even where a country runs a trade surplus with the US it will still be subject to a 10% tariff.
Against this background, the prospects of a damaging tit for tat trade conflict and more aggressive fiscal consolidation driven by Elon Musk’s Department of Government Efficiency suggest that the Trump administration is “throwing the kitchen sink” at the US economy by delivering radical supply side reform well ahead of the end 2026 midterm elections. In this scenario a period of weak growth would draw the US Federal Reserve into a rate cutting cycle and lower the cost of government borrowing, paving the way for tax cuts later in the year, both of which should ultimately provide a boost to markets and improve Trump’s chances of maintaining control of Congress.
Outside of the US, whilst the UK economy looks set to record a year of modest growth at best, we expect a relatively favourable growth dynamic in Asia and Eurozone. This should be helped by a weaker US Dollar (which lowers the cost of borrowing for non-US corporates) which has had less interest rate support following recent declines in US Treasury yields.
Notwithstanding the elevated market volatility which we expect because of the Trump administration’s disruptive trade policies, we maintain cautious optimism on equity markets. We expect returns to continue to broaden out by region and sector and this should provide a good environment for active management. This is in marked contrast to 2023 and 2024, which was dominated by the Magnificent 7, both in terms of earnings delivery and market returns and proved highly challenging for active managers, who typically maintain more diversified portfolios compared to the increasing concentration seen in market-cap-weighted index funds.
The value of securities and their income can fall as well as rise. Past performance should not be seen as an indication of future results. All views expressed are those of the author and should not be considered a recommendation or solicitation to buy or sell any products or securities.
