Macro
The narrative shifted sharply in Q1, with ‘US exceptionalism’ being called into question. Tariff uncertainty contributed to a deterioration in economic data. Gross Domestic Product (GDP) growth data for the final quarter of last year eased from 3.1% to 2.4% and the Atlanta GDPNow tracker is currently expecting a material drop off in economic growth to -2.8% for Q1. As US firms front-loaded orders to get ahead of tariffs, this figure cites a substantial drop off in orders as these tariffs start to take effect. Meanwhile, the unease is plain to see amongst consumers, with the US Michigan Consumer Sentiment Index suggesting consumer sentiment hit a 12-year low in March. The tariffs are also likely to cause the Federal Reserve (Fed) a headache, with inflation data already coming in hotter than anticipated. The increase of Core Personal Consumption Expenditures (PCE) from 2.7% to 2.8% alongside slowing economic growth hints at the potential for stagflation to rear its ugly head. This is an economic phenomenon in which inflation and stagnating growth combine. As growth slows, the Federal Reserve would ordinarily ease monetary policy to prop up the economy. Meanwhile, a spike in inflation would lead them towards tightening monetary policy to control prices. Hence, stagflation would put the central bank between a rock and a hard place.
Across the pond, the disinflation trend has been very clear cut and the European Central Bank were able to proceed with another two 0.25% interest rate cuts during Q1. Core inflation at 2.4% is now close to the 2% central bank target, and therefore further interest rate cuts are likely still to come. Whilst US consumer confidence dropped, the inflation data and German stimulus announcement helped economic sentiment to jump to an eighth-month high in March. In contrast to the US, both Europe and UK consumers still have healthy balance sheets, which provides the capacity for strong consumer spending going forward.
UK core inflation also moved in the right direction, easing from 3.7% to 3.5% in March. However, growth still remains lacklustre, unexpectedly contracting in January, but the Office for Budget Responsibility (OBR) did raise growth forecasts to 1.9% for next year as Rachel Reeves restored the £10bn fiscal headroom at the Spring Statement.
In Asia, Japan’s data weakened with flash Purchasing Managers Index (PMI) data suggesting private sector activity hit its lowest since November 2022, and a drop off in inflation questioned the Bank of Japan’s hopes of an end to the era of deflation. In China, there were signs of improvement, with Caixin PMI data hitting its highest level since November. Consumer confidence and credit growth also picked up slightly but still remain in the doldrums.
Corporate earnings are largely reflecting the momentum in economic data, with US earnings rolling over, whilst they pick up in the UK and Europe. Earnings revisions in the US have moved deeply negative and are showing no signs of turning up.
Markets
Tariffs dominated the headlines over the quarter, and Trump’s back-and-forth rhetoric ahead of what he is calling ‘Liberation Day’ (2 April 2025) caused dollar assets to sell off, and European fiscal stimulus measures enabled Euro assets to absorb some of the capital leaving Uncle Sam’s wallet.
Not only was it the worst quarter of performance in three years for the S&P 500, but it was also the worst since 2009, relative to other major markets outside the US. The S&P 500 shed 4.27%, whilst the German DAX gained 11.32%. The elevated valuations of the ‘Magnificent 7’ tech stocks were somewhat undermined by Chinese start-up, Deep Seek, releasing an AI model with equivalent computing power to Chat GPT, but at a fraction of the cost. This news saw Nvidia record the largest single-day market cap loss in global market history.
In Europe, the German 10-year bund recorded the sharpest spike in yields since the fall of the Berlin Wall. The cause was a shift away from fiscal conservatism as German Chancellor, Friedrich Merz, announced a series of measures directed towards infrastructure and defence as the US suspended military aid in Ukraine. This stimulus package should help boost the European economy and remove Germany’s title as the ‘Sick man of Europe’.
Largely in line with the broader European index, the UK FTSE 100 churned out a respectable 6.11% as its relatively shielded position from tariffs and low market valuations worked to its benefit.
Gold continued its strong run, easily surpassing $3,000 an ounce after gaining 19% in the first quarter and the precious metal could have further to run amidst the geopolitical uncertainty and dollar weakness.
Positioning and outlook
As anticipated, the market is broadening out away from the ‘Magnificent 7’ tech stocks, which have driven market performance over the last two years. The term ‘Magnificent 7’ ironically points to the fragility of these market leaders, with a number of its members ceasing to exist in the film, and this will likely be echoed with these stocks. We are not suggesting that they will become bankrupt in the coming years, but the S&P 500 will unlikely be as reliant on all seven stocks in years to come. This broadening out of the US market alongside a large amount of divergence regionally makes for a great environment for active managers like us who have an underweight exposure to the few names that are driving index-level performance in the US.
As demonstrated below, we have already started to see a normalisation of the valuations in the ‘Magnificent 7’ and top 10 stocks.
We are also witnessing a narrowing of the discount that other major markets trade to the US.
We are likely still early in this broadening out trade and so we added to a US strategy that is exposed to the more attractively valued areas of the US market. We are therefore positioned for these trends to persist, but we are dynamic and will look to very selectively add to US tech if valuations continue to improve.
Our largest overweight remains the UK, which is starting to bear fruits, as it is relatively well shielded from geopolitical noise and tariff concerns. The cheap valuations, attractive distributions and improving fundamentals provide optimism that this year’s strong performance will continue going forward.
Within the sustainable portfolios, we increased our exposure to environmental equities, grid infrastructure, and water and waste, where we believe there are structural growth drivers that will enable strong performance regardless of sentiment towards sustainable investment.
Given the uncertainty in markets, this is an important time to remind readers that volatility and market corrections are a healthy part of price discovery in markets. Despite large corrections, markets more often than not generate positive annual performance, and the S&P 500 has averaged a gain of 10% per annum.
As ever, and as long-term investors, we welcome periods of volatility and will use them to add to areas where we have the most conviction.
Kind Regards,
Robert Matthews, Head of Research and Chartered Wealth Manager
Important Information:
For more industry terms and definitions, visit our glossary here.
All Index data figures are sourced by Morningstar and correct as at 31 March 2025, unless otherwise stated.
The value of investments or any income arising from them may fluctuate and are not guaranteed. Past performance is not necessarily a guide to future performance.