Market Review – Q1 2025

We came into 2025 cautiously optimistic. With high income yields, inflation sticky, though generally trending downwards, and economic growth in most parts of the world holding up. The investment backdrop was favourable. That was the optimism part. The caution? Well, markets had started to count on Trump 2.0 as a sure win, with lower taxes and expectations leading to stretched equity markets in the US in particular.

Our view has always been that there was (and remains) a lot of uncertainty in Trumps policy playbook. Economists like to use the word ‘known unknowns’, which basically means a lot of stuff we know we don’t know. How would his tariff policy be implemented this time? Would he be pro or against government spending? Will he be as sensitive to equity markets this time around? Lots of questions, which at the time we didn’t have the answers to. We do now…. well at least for the time being.

To say the policy shift has been significant would be putting it lightly. On the government spending point, the introduction of the Department of Government Efficiency (DOGE), headed up by Elon Musk with a target to slash government spending by $1 trillion, is a meaningful shift. If achieved, that would be equivalent to a reduction in spending of 3.6% of GDP in 2025, great for the long-term debt position, but challenging for short-term economic growth.

On top of that you have the tariff and immigration policies, which have at times been interlinked. Some measures are already in force, others threatened, and a few announced and rolled back. The overriding impact has been business uncertainty, with implications across a broad range of sectors from steel to wine & spirits.

Now it is worth saying that these are all subjective factors at the time being, with no hard economic data yet available to show the effects. That said, investors have become nervous, starting to price in a higher risk of a US recession over the coming months, potentially spreading to other economies.

Over this side of the pond there are a different set of challenges. As well as being ‘tariff targets’ the UK and Europe are having to balance their own spending budgets. A clear implication of the US starting to signal a withdrawal of support for Ukraine, and NATO in general, is that European economies need to up their own defence bill. That’s easier said than done though, with the UK for example having to slash welfare costs in order to raise defence without spooking the bond market, which is effectively a gauge for the UK’s longer term financial stability.

For those interested, it is worth explaining that the bond market dictates the cost of borrowing, by requesting a desired level of return to purchase government debt. The higher the risk, the higher the return demanded, which increases the cost for the government to borrow. We saw in the aftermath of the budget that too much (economically non-productive) spending will quickly get punished, so Rachel Reeves and co have had to be extra careful with their recent pledges.

Overall Q1 has been all about government policy, with investors scrambling to understand the shifts and having to adjust their forward outlook. To highlight some key trends, we have seen a period of significant underperformance from the US equity market, with the S&P 500 down 7.2% the first three months of 2025 (in sterling terms), compared to positive returns of 9.1% and 6.1% for the European and UK equity markets respectively. Interestingly given the weighting the US now holds in the global equity market, the overall global equity benchmark is down 4.7% for the year (represented by MSCI World), despite certain areas performing well.

At the same time, it has been a better period for government bond markets, in particular in the US where a potential recession has started to be priced in. Corporate bonds, which also hold some sensitivity to recession risk, have underperformed for the first time in two years, highlighting a widespread move away from riskier assets over there. Fortunes in the UK have not been as strong, with investors still cautious over UK government spending and returns reasonably flat on the quarter. In part investors have had the benefit of comparatively good equity returns, so given this, UK bond markets have operated as we expected from a functional perspective.

Given all the above, it probably won’t surprise you that we finish the quarter with a lot more caution, and an equally lower dose of optimism. Now it isn’t all bad, and as we will show in the following section, the portfolios have held up well despite the challenges. That in itself will give us opportunity at some stage.

Portfolio Review

In our last quarterly update we talked a lot about the importance of diversification. We don’t take one way bets within our portfolio’s, as this increases risks and volatility. 2024 was a great example of one sector driving total returns, where the US equity market stood well above the rest. This reduced the benefits of the diversification we work so hard to implement. Despite holding a lot less exposure than most, all portfolios still finished at the top of the list of peers that we follow, which was specifically pleasing as the environment didn’t really suit our philosophy.

This year so far has been the opposite of last, where diversification has mattered again. Despite global equity markets overall being down close to 5%, and bond markets flat since the start of the year, our portfolio range has returned between -2.07% (High Risk) and 1.58% (Very Low Risk).

Three of our six multi-asset portfolios have produced positive returns across the first quarter, naturally positioned at the lower end of the risk range. These portfolios have some core assets that we expect will continue to support them. Firstly, the underlying income stream, which remains between 5-6% per annum, and therefore between 1.25% and 1.5% per quarter. Irrespective of what happens in equity markets this will keep coming in, providing protection against capital value reductions.

Secondly, as we have spoken about for some time, our largest active overweight is in bonds, where we continue to value the great income provided as well as the protection. On the last point, it is worth remembering that bonds tend to perform well in a recession, as interest rates get cut to support the economy. They therefore act as great insurance if you are worried about a slowdown, paying you whilst you wait. This combination puts them in a strong position to weather storms.  Q1 so far has been a good example of delivering a positive return in a difficult environment. The opportunity doesn’t stop there of course, as the key is that if equity markets fall by 10%, and we can keep portfolio’s stable, then we are able to pick up opportunities in markets that are trading at a substantial discount. The so called Magnificent seven stocks in the US are now down over 25% as a collective since their December peak.

Finally, at the end of 2024, we repositioned our portfolio range to reduce our US exposure further, and to take an overweight position to the UK and Europe. This has been a contrarian position for some time, though we felt the relative value opportunity was significant, and again wanted to diversify across a broad spectrum of markets.

To touch on our activity, we have reduced our equity weightings quite significantly across the quarter. To use Low Risk as an example, we came into the year with a 26% allocation and finish the quarter with 19%.  Medium Risk has moved from 56% to 48% and even High Risk has moved from 89% to 82%. Within our equity bucket we have also reduced allocations to areas that are more sensitive to the economic cycle, focusing even more so on ‘quality’ businesses which tend to be resilient in periods of weakness.

The opposite side of the equity reduction is an increase to cash, alternatives and government bonds. These further increase diversification, as well as the income that is generated. In addition, we have placed and benefited from a few specialist trades such as hedging 30% of our US dollar exposure in January, which has improved our protection versus the US equity sell off.

Overall, it has been a busy period to say the least, but to summarise we have shifted to a more defensive position. That doesn’t mean we are negative on the outlook, more just aware of the short term risks, and conscious of protecting client capital as well as we can. In turn we hope this will provide some very strong opportunities to rotate again over the months ahead. As with any market correction, our objective is to correlate more on the way out than on the way in, using it to our advantage.

Market Outlook

Irrespective of what happens over the coming months, it is worth remembering with interest rates still high, the other side of the policy table, Central Banks, have lots of room to support should they wish.

Why haven’t they reduced them already given everything that is going on? Really that comes down to fears of a 2022 inflation repeat. Given base effects, we are likely to see inflation tick up over the next 6 months towards 3% and beyond, and therefore if they cut interest rates too early and stimulate growth, they risk the economic boost forcing inflation up further. The tariff uncertainty doesn’t help here, as even if not announced, they must build in a margin of safety, as again significant tariffs are likely to be inflationary.

To be clear though, all our research currently suggests the upcoming inflation movements will be temporary. As an example, all else equal we expect UK inflation will peak at around 3.5% in September, before quickly falling back well into the 2’s by the start of 2026.

Given that economic growth has not yet rolled over in the US or elsewhere, Central Banks have therefore remained cautious on interest rates. If the Trump Tarriff plan spooks markets, then we expect that to change quickly, markets will price that in before the cuts happen, and we should get some excellent support from our fixed income holdings.

Our view was always that the first half of 2025 would be tough to negotiate as we digested Trumps foreign and economic policies, and inflation stayed sticky. The second half of the year was where we saw the opportunity. We think our view now looks likely to be right, though with exaggerated volatility, given the aggressive starting part from Trump’s Tariffs.

So moving into Q2 global economic growth slowdown or a recession has become our most likely scenario. Again, this is not a one way bet, though we believe we need to be positioned to protect in the short term and take advantage of the opportunities this provides over the medium term.

Of course, there are a lot of factors that could change things, most obviously Trump’s policy stance on tariffs and US government spending. Our sense is that at the moment he is keen to get spending under control in order to bring the US deficit into better balance, but he will also have a pain threshold where economic weakness starts to affect the positivity of his support base, which could also change things quickly. He tends to start with an exaggerated stance, and then taper, so in terms of Tariffs, we don’t think the story is over just yet.

As of today, we are positioned cautiously, underweight equities, focused on quality businesses, and overweight bonds and cash. But that positioning really reflects our tactical short term view, and we can adapt our view very quickly should markets change. Indeed, we expect further shifts over the coming months and believe that once again our ability to be nimble and change things quickly will then have a big impact on the returns that can be generated over the years ahead.

Please Note: Due to the heightened nature of market volatility at present, we will be issuing a further investment update this coming Friday (11th April)