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Marketing Communication | Quarterly Commentary
Market Update
The first quarter of 2025 experienced significant market volatility. January 2025 began positively with the MSCI All Country World Index rising 3.4% due to optimism around Trump's proposed policies and strong corporate earnings. However, bond and currency markets faced turbulence, notably in Japan due to its contrasting monetary policy.
In February 2025, global stock prices corrected, driven by concerns about Trump's policies potentially impacting US economic growth. Despite this downturn, the bond market rallied, and gold reached a new all-time high. Positive developments included a potential Ukraine ceasefire, German election results, and increased support for the Chinese stock market.
March 2025 brought a reversal in market sentiment, with the MSCI All Country World Index falling 3.9%. US markets saw steeper losses, while European indices curbed theirs. Market concerns were fuelled by potential impacts of US-imposed tariffs, fears of a global trade war, and signs of a slowing US economy. Meanwhile, European bond yields rose, and the euro strengthened due to the prospect of a more expansionary fiscal policy in Europe.
Sentiment towards European equities improved markedly through the first quarter of 2025, driving a sharp rebound from oversold levels. The performance differential in the first quarter versus US equities has been particularly stark, with over 14% outperformance from Europe (in EUR terms). Flows into European equities have picked up in recent weeks, coincident with the strong absolute and relative performance. At the end of 2024, the Euro Stoxx 600 index traded at a record 40% discount to the S&P 500 index based on 2025 forecast earnings. Global fund managers were underweight European equities and very few expected them to outperform other markets in 2025 (according to the January 2025 Bank of America fund manager survey). So much pessimism created a low bar for upside surprises from European equities in 2025. These upside surprises have come from various areas:
i) European listed corporates have enjoyed positive earnings revisions in Q1, with a notable divergence versus their US counterparts.
ii) Relaxation of Germany’s debt brake, with a much larger than expected fiscal stimulus package. The German parliament (Bundestag) as well as the lower house (Bundesrat) agreed to change the Constitution. €500bn has now been set aside to improve Germany's infrastructure, and defence-related spending above 1% of GDP will be exempted from the debt brake.
iii) Broad political support across Europe for fiscal stimulus via increasing defence budgets. Following what appear to be dramatic shifts in US defence policy, European governments are now firming up plans to increase defence budgets from close to 2% (as a % of GDP) today, to possibly over 3% in the coming years. This would equate to incremental EU defence spending of c.€175bn per annum.
iv) Renewed efforts to unlock the €11.6 trillion sitting idle in EU bank accounts and cash reserves - about a third of total private wealth in the EU. The EU has revived its capital markets union plan to seek to unlock these savings, proposing a raft of measures including tax incentives for savers to invest in European assets, a review of capital requirements for lenders and insurers, and more centralised market supervision.
v) Hope that we may be nearing a ceasefire in Ukraine. The Trump administration has led talks with both Russia and Ukraine on ending the war, but a full ceasefire has not yet been possible. While Kyiv agreed to an immediate cessation of hostilities in the Black Sea and a US-backed 30-day ceasefire, Moscow has so far only pledged to pause attacks on energy infrastructure, saying it would comply with the Black Sea deal only after the West lifted economic sanctions.
vi) Linked to all the above points, we have seen improvements in European macroeconomic data releases in recent months and upgrades to GDP growth expectations for the euro area in 2025 and 2026. The euro area composite Purchasing Managers' Index appears to have bottomed in November 2024 and is slowly moving higher, up to 50.4 in March. The uptick in the manufacturing sector has been the main driver behind this improvement.
On the negative side, despite the European Central Bank (ECB) cutting rates six times over the past year, policy rates remain high and real government bond yields are elevated. Yields moved materially higher in March following the German fiscal developments. Tight financial conditions are still expected to drag on growth over the coming quarters and the ECB does not appear to be in a rush to move the deposit rate materially lower, from the current rate of 2.5%. In a change of tone that signalled a more hawkish stance, the ECB said in March that “monetary policy is becoming meaningfully less restrictive”. This is despite inflation continuing to head in the right direction, moving closer to the ECB’s 2% target. Headline inflation has fallen from a peak of 10.6% in October 2022 to 2.2% in March 2025. ECB projections for core inflation in 2025 were revised down in March to 2.2% (from 2.3% previously), whilst expectations for 2026 were moved up, but only marginally to 2% (from 1.9% previously). It is also important to highlight that both the US and German 2Y10Y yield curves un-inverted in September 2024, having been inverted for close to two years. Historically such developments have not been positive signals for economic health. The threat of tariffs on EU exports to the US (and any retaliation) presents an ever-present risk to the European growth outlook for 2025.
Noting the aforementioned developments, European value stocks materially outperformed growth stocks in Q1 2025, whilst cyclicals outperformed defensives. Large caps outperformed smid cap stocks. The best performing European sectors in Q1 2025 were financials, energy, communication services. utilities and industrials, whilst consumer discretionary and real estate were the major laggards.
Fund Performance & Positioning
The New Capital Dynamic European Equity Fund underperformed its benchmark over the first quarter of 2025 (MSCI Europe increased +5.9% in euro terms). The Fund aims to provide exposure to a core, balanced portfolio of quality European stocks across all sectors in the market, which is managed closely against the MSCI Europe equity benchmark.
Stocks that contributed to relative performance in Q1 2025 were:
Lottomatica (+26%) - consumer discretionary - gambling
Intesa Sanpaolo (+23%) - financials - banks
Prudential (+30%) - financials - insurance
Stocks that detracted from relative performance in Q1 2025 were:
BE Semi (-28%) – information technology - semiconductors
Novo Nordisk (-24%) - healthcare - pharmaceuticals
Schneider Electric (-13%) - industrials - capital goods
Outlook
We maintain a constructive outlook on European equities for 2025 but believe the probability of a period of consolidation in the market has now increased. The European market will need further positive macro/earnings developments in the coming months to move higher, noting overbought conditions in cyclicals and value stocks and oversold conditions in government bonds. Tactically we see significant value in European growth stocks at the present time.
With this in mind, we remain constructively positioned in our portfolios, currently running portfolio betas in excess of 1. Given where we are in the cycle and the uncertainty regarding the timing and pace of interest rate cuts, both from the ECB and the Federal Reserve, our preference remains very much on quality orientated stocks. In recent months we have been adding capital to ‘quality’ stocks such as Novo Nordisk, Unilever, Wise, AstraZeneca, Atlas Copco, Air Liquide and DSM-Firmenich.
We have also been adding to our industrials holdings, via new investments such as Ashtead and Siemens, whilst continuing to add to our small/mid-cap holdings via a new position in Lottomatica. European small and mid-cap stocks are currently very cheap relative to history and typically perform well as interest rate cuts come through, assuming of course that economic growth holds up.
The biggest risk that can derail our market outlook remains the threat of tariffs on EU exports to the US (and any retaliations). Whilst it appears widely accepted that tariffs will create short-term inflationary pressures in the US, it is not entirely clear if this will be the case in Europe. As UBS economists recently highlighted, the inflationary impact on Europe (of global tariffs implemented by the US) could be limited if the Chinese renminbi depreciates more versus the US dollar than the euro, given that China remains a key trading partner for Europe. The trade uncertainty caused by tariffs also poses risks to the supply/demand balance in the European economy, with any deterioration in fragile consumer and business confidence likely to create a further slackening in the labour market, weaken the outlook for economic growth and lessen domestic inflationary pressures.
We ask our investors to judge our performance over the full economic cycle. The past three years have been characterised by extreme volatility in European equities, with no fewer than 13 major factor swings over this period between growth and value factors. We believe that in such a volatile environment, it is important to remain disciplined and focus on our quality-growth biased investment style. This way the risk of being whipsawed in the market as these violent factor rotations unfold is reduced.