Two months into 2025 and there are growing signs of change in markets. Global investment trends and market leadership have shifted in 2025 - not uncommon at the start of the year - but the supporting narrative appears to be structural, suggesting these changes might be lasting.
Europe isn’t as bad as feared
Europe’s macroeconomic and political issues with sluggish growth, high energy costs and intensifying competition for exports into China and the US are widely recognised - and because the market knows this, it’s arguably already ‘in the price’. From a relative valuation perspective, trading at a 35% discount to the US (close to a historical low) on a forward PE basis, Europe is attractively valued.
Source: IBES, Datastream as at February 2025
While value alone doesn't drive change, structural and long-term market shifts are emerging in 2025:
- Stabilising energy costs: manufacturing costs seem to be nearing a peak as the resumption of US Liquefied Natural Gas (LNG) exports recently approved by President Trump sees future energy costs rollover. US/European trade negotiations are likely to result in Europe agreeing to buy more energy from the US too, which will be incrementally helpful for Europe.
- Political reform in Germany: the prospect of greater political clarity, cohesion and appetite for change across the EU has been boosted by Friedrich Merz’s victory in the German election. His CDU/CSU party has a desire to loosen fiscal policy and drive domestic and regional reform. He doesn’t have a majority, so this will take compromise and time, but markets are increasingly excited about the change he brings. Plans to expand pan-European bond issuance for regional purposes such as defence expenditure would be another meaningful sign of increased unity and solidarity.
- Geopolitical risk - As the probability of a peace deal between Russia and Ukraine grows, full buy in by all parties will be key to its durability and success. But it is expected to ease risk and market uncertainty, boosting corporate and consumer sentiment and helping to support economic growth.
- ECB interest rate cuts: with continued disinflation in Europe, the ECB is expected to keep easing interest rates. This is in marked contrast to the cautious approaches of the Fed and Bank of England, where inflation is proving sticky. The ECB aims to underpin an improvement in economic activity and encourage less saving. This, in turn, could bring upside surprise in corporate earnings, something we are already seeing signs of in analyst earnings upgrades.
Source: HSBC Asset Management as at February 2025
Are US equities beginning to wobble?
The relative underperformance of the US year-to-date has begun to catch the attention of asset allocators. Consecutive years of strong absolute and relative outperformance mean for many of them, US weightings are at the upper end of their acceptable ranges. It’s no surprise that inflows have eased, with asset allocators neutralising underweights to Europe with profits from the US.
US investor inflows into Eurozone equity EFTs has picked up in February as inflows into US equities have slowed.
Source: J.P. Morgan Asset Management as at 18 February 2025
Questions about the sustainability of US corporate earnings growth, profitability and underlying valuations, especially amongst the Mag 7, are intensifying. Consensus expectations are for 15% earnings per share (EPS) growth for the S&P 500 in 2025 and a further 13% in 2026. These lofty expectations combined with full valuations at 22.3x forward Price-to-Earnings, versus a historical average of 17.5x, leaves little room for error. Look at the 8% fall in the share price of Nvidia following its latest Q4 numbers, despite revenues growing 12% over the quarter and 78% year-on-year. Coming in line with expectations is just not good enough, and when stocks are priced for perfection, care and discipline is essential.
Another important shift for investors is the Trump tick up in political and policy risk. Increased unpredictability and volatility typically comes with a greater discount. This is something we’ll be keeping an eye on. It’s clear from the latest macro data that heightened policy uncertainty is already influencing corporate and consumer behaviour. We’ve seen a paring back of discretionary expenditure, a pulling forward of imported items to avoid higher costs from potential tariffs, and a tick up in precautionary savings. If this persists, GDP growth is likely to disappoint, at which point aggressive trade negotiations are likely to moderate, otherwise the political fallout will grow.
China’s year of the snake is quietly on the rise
DeepSeek alerted investors to the fact that you don’t need access to the very latest chips to compete. In fact, if you have the technological expertise to improvise, which China does, limitations on things like access to chips drive innovation and creativity. With the world’s largest number of AI researchers and STEM graduates, China has secured a vast number of Generative AI patents over the last 10 years. This suggests DeepSeek shouldn’t be regarded as a ‘one-off’. What we’re seeing is a structural dynamic likely to be rewarded by investors over time with higher multiples – that’s why why the China Tech sector has been leading returns year-to-date.
Source: Macro Polo, CSET, UNESCO, WIPO Patent Landscape Report on Generative AI, Alpine Macro as at January 2025
Another notable shift, Xi Jinping signalled support for private sector growth in China by hosting a meeting with leading entrepreneurs emphasising collaboration with the Chinese Communist Party, rather than opposition. This is a clear turnaround from the restrictions imposed on private sector technology and education companies in 2020/21, and indicative of the determination of the Chinese authorities to revitalise growth in the economy, something which investors are gradually beginning to wake up to.
Time for a spring clean
2025 has already brought plenty of unexpected surprises for investors and there will be more to come. Signs of change are emerging, bringing risk and opportunity for investors. We’ll stay alert to these and lean into them wherever we believe the structural dynamic offers long term advantage.
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.
