Global markets began 2025 strongly, reaching record highs. However, three factors have introduced uncertainty and signal a new investment phase, coinciding with Trump’s return to the White House. These are robust US economic data with potential inflationary pressures, the emergence of a Chinese AI competitor, DeepSeek, and escalating trade tensions involving tariffs.
The US economy shows continued strength, with manufacturing joining the already robust service sector. Survey data shows accelerating economic activity, boosting corporate profit outlooks. The latest earnings season reveals double-digit growth across various sectors, not just technology, suggesting broader market support beyond the “Magnificent Seven” tech companies. This diversification is timely, as the market questions the massive infrastructure investments by these tech giants. DeepSeek’s claims of matching US AI model performance at lower cost and using older semiconductors, due to US technology restrictions, add another layer of complexity.
Two primary drivers underpin the increased infrastructure investment: powering more intensive AI models and supporting a larger volume of less intensive ones. The arrival of a less intensive model, regardless of origin, isn’t necessarily negative. A trend towards smaller, specialised, and less computationally expensive AI models was already appearing. The outlook remains cautiously optimistic.
In contrast, European and UK economic growth is sluggish. While there are tentative signs of manufacturing improvement, considerable progress is needed, and service sector strength lags the US. Asia faces growing risks surrounding China’s economic growth. Continuing property price declines since 2022, coupled with renewed weakness in the sector, create negative wealth effects, making a consumption-led rebound unlikely. Furthermore, US tariffs pose more challenges for Chinese manufacturing.
A stronger US economy, including signs of inflationary pressure in wages and in some business surveys, means the prospect of US interest rates coming down is diminished and this means bond prices could fall as market interest rate expectations readjust. European and UK interest rates are more likely to come down, which would normally be a good reason to invest more heavily in bonds from these markets. Our refrain is based on fiscal concerns, especially in the UK. While we expect the UK government to adjust its spending plans in the coming months, we think they will still be left with little room for manoeuvre, weakening the growth agenda and keeping UK government bonds in the market’s crosshairs.
Overall, we are optimistic, but we also recognise there are significant macro-economic and geopolitical forces with the potential to materially alter the investment outlook. As such we have adjusted the composition of our exposure to the market (see our accompanying report on a change to our strategic asset allocation) but we are still close to neutral in our relative exposures to minimise risk.
Any questions?
If you would like more information about EQ’s investment views and services, please get in touch.
Please remember, this content is provided for information purposes only. Investment involves risk. Past performance is not a guarantee or indication of future results. Investment return and the principal value of an investment may go up or down and may result in the loss of the amount originally invested. All investors should seek professional advice prior to any investment decision, to determine the risks associated with the investment and its suitability.
