Investment Update May 2025

Investment Update May 25.pdf

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Happy New Month! After falling more than 10% at one stage during the month, the S&P 500 index came to rest at the end of April down just -0.76% (and -5.3% YTD). We did forecast the return of market volatility, but April has truly been a month when years happen.  We aim to summarise and cast an eye to the future in the update that follows.

The Swiss invented the term “nostalgia,” originally meaning a desire to go back to one’s past home. It was considered a mental illness (in the US civil war, soldiers suffering from nostalgia were hospitalised). Today “restorative nostalgia”—a desire to recreate a supposedly positive past—is a force in politics.

Politicians’ focus on manufacturing jobs is one example of restorative nostalgia. However, as economies become more developed, the share of jobs in the manufacturing sector should decline. The share of jobs in agriculture also declines as economies develop. Manufacturing employment share declines as an economy develops because labour-intensive tasks are sent to less developed economies, or domestic technology replaces labour in making things. Jobs shift to less repetitive and more creative roles.

US President Trump appears "very happy" with the economic consequences of trade taxes to date and is therefore proposing to add to US consumers' tax burden with levies on computer chips, pharmaceuticals and movies.

The imposition of tariffs in America is as old as the nation itself.  George Washington bubble wrapped budding American industry from the “old world” whilst Abraham Lincoln isolated the Southern States in 1861. In more recent years Ronald Reagan, George W. Bush, Barack Obama and Joe Biden all used trade tariffs to protect US industry.  Under President Trump, it is the seemingly randomness and chaotic setting of policy which disturbs markets and portfolio valuations.  Markets can cope with good and bad news, but uncertainty is tough to deal with.

Source: Hendry Hugh, 21 April 2025

President Trump’s policies are impacting GDP. The GDPNow projected lower economic growth and was the one key indicator which unsettled markets.  Lower growth was confirmed later in April by official sources, pointing to modest economic contraction of -0.3%.  In some ways this is not surprising, steep declines in US equity prices inevitably triggers a wealth effect whereby consumers turn to saving rather than continue spending.  Consumer confidence has indeed turned lower printing at 86 versus 93.9 last month according to the US Conference Board. Importantly, the impact of cutting back on Government spending is purposefully driving headline GDP lower. Under President Biden, Government spending alone made up 33% of GDP – this figure has already halved.

It is perhaps a little early to see signs of inflation resulting from price hiking tariffs although the costs of doing business in America will inevitably rise.  The Federal Reserve’s preferred PCE inflationary measure printed in subdued fashion at 2.6% just above the 2% target, causing no concerns so far.  We do anticipate Federal Reserve rate cuts later in 2025 although the pace is likely to be subdued as we all wait for signs of inflation to appear.  The Treasury yield curve has expanded at the longer end and the spread between 2-year and 10-year bonds is now at 0.5%. Whilst we pay particularly close attention to US economic trends, our own forecasts do not yet point to a strong recession probability although a slowdown from recent years heightened 5% per annum nominal GDP growth in the world’s largest economy is likely. We note Bloomberg’s recession probabilities have moved up to 40%.

The quarter one earnings season is so delivering broadly positive results with around 74% of those firms reporting so far ahead of forecasts.  In the “Big Tech” grouping, Microsoft has resumed its status as the leading company and is seen by investors as well positioned to weather the tariff storm, so far.

Source: Bloomberg, 2 May 2025

Under the credible stewardship of Mr Scott Bessent, the US Treasury continues with its policy of issuing Bills which adds liquidity to markets and in turn will in part assist with the refinancing of the $10 trillion debt later this year.  A lower yield on the 10-year US Treasury is also required and is a key success indicator for Trump policies and we expect all necessary levers will be actioned to meet this goal.  A weaker US dollar has resulted so far and is notable. This will add a little more lustre to the Treasury market for foreign buyers, many of whom have preferred other safe havens such as gold in recent times.

Historically a weaker US dollar has provoked international equities to perform well relatively.  To this end, international markets come with the bonus of favourable valuations to boot. Europe has fared well, and the European Commission have relaxed debt ceiling restrictions on EU member states allowing for accelerated investment in defence and infrastructure. Equities have responded well so far although excessive debt from historically controlled levels must be avoided, and we keep a close watch on indicators for stress in European markets – we expect domestic European government bond yields to be at least 0.5% higher from here.

The European Union decided to suspend retaliatory tariffs on steel and aluminium to create the conditions for negotiations with the US administration. This decision, coupled with political agreement in Germany to form a new government, provided partial relief, but the European equity market still fell by 0.4% over the month.  Ongoing stalemate in the Russo-Ukraine war weighs on stock prices in Europe – a settlement being long overdue.

In the UK, April’s flash PMIs (Purchasing Managers Index) showed a deterioration in economic momentum. The composite index moved into contractionary territory (48.2), with both global and domestic headwinds arising from a combination of trade uncertainty and higher domestic taxes. The UK equity market fell by 0.2% over the month.  The UK market houses some defensive stocks which tend to hold up well when global markets are turbulent and hold the additional attributes of offering attractive regular income streams through dividends.  We continue to find these attributes attractive despite the broader market holding lower appeal.

In Japan, the all-industry flash PMI rose to 51.1, thanks to a partial rebound in the services sector. However, the manufacturing index remained in contractionary territory, confirming risks related to the expected negative impact of US tariffs on export-oriented Japanese companies. Having fallen sharply earlier in the year, Japanese stocks were a relative outperformer in April, delivering a positive return of 0.3%.  The ongoing policy of yield curve control in support of servicing a colossal debt mountain of 235% of GDP, coupled with an ageing population, present strong headwinds and strong performance in 2024 has been locked into portfolios.

In the first part of the month, US tariffs on Chinese goods soared to an eye watering 145%, with tit-for-tat retaliation from China. Later in April, the US administration’s willingness to negotiate helped to ease tensions, which, combined with a solid first quarter GDP print of 5.4% year over year, helped to drive a rebound in Chinese stocks.  We are relieved China, and the US are prepared to engage in discussions around trade – inevitably a resolution of some sort will follow, we believe.  In the meantime, China’s export drive continues with notable success across the Global South.

Despite the rapid escalation in US / China tensions, emerging markets were resilient compared to developed markets. Countries such as Mexico and Brazil were relative outperformers, helped by the relatively less punitive tariff approach announced by the US administration.

At portfolio level we made no further changes during April.  Our previous rebalance certainly served to reduce portfolio volatility and a subtly lighter and refocused US allocation is well positioned to benefit from the rally back in stock witnessed during the final days of April.  A strong and reliable stream of dividends from the UK coupled with more attractively priced European equities, which are being positively stimulated by spending and investment, holds appeal.  Short duration fixed income will benefit from lower volatility and capital upside when rate cuts come.  We remain positive for a stronger second half of 2025, but a steady focus on risk and volatility are our watch words.

Written by the Alpha Beta Investment Team.

All sources Bloomberg unless otherwise stated.