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Markets and macro insights with Bernard Swords, Chief Investment Officer
What impact did political developments have on equity markets?
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Equity markets were up again last week to +1.7%. However, a strong euro currency, up almost 2% against the US dollar, meant world equities were flat in euro terms.
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There were few data releases last week, so political developments led the market. Week one of the Trump presidency has concluded, and there has been no rush to apply tariffs, which calmed market nerves. Instead, the administration has begun a process of investigation to see if tariffs are warranted. It would appear that tariffs are on the way, but there will be negotiation and consideration.
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Trump’s administration wants to reduce the cost of energy by promoting energy production. The net effect of possible tariffs and the focus on energy pushed equities up, weakened the US dollar, and caused oil prices to drop by 3.5%.
Did the US and euro economic background impact Goodbody asset allocation?
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The world economy is growing close to trend levels. The US economy is seeing higher growth rate forecasts. In contrast, the euro area is seeing downgrades. Higher-than-expected inflation in the US casts doubt on further interest rate cuts. In the euro area, interest rates could be cut by up to 1% over the next 12 months. The US government’s early policy statements were less extreme than expected. However, uncertainty about the direction to be taken by the new administration is dampening appetite for risk.
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We have made no change to overall asset allocation, with exposure to equities and fixed income kept close to benchmark levels. This was due to a benign economic backdrop already priced into equity markets and US policy uncertainty. The US interest rate outlook is unclear, and fixed income markets have already priced in good news on euro area interest rates.
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What we have changed this month is the regional mix of our equity exposure. We have reduced our investment in the US market and now have an overweight position in the euro area equity market. We believe that euro area equities are currently undervalued and that the record highs US markets have been experiencing will soon even out.
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During most of 2024, we held a high exposure of 75% – 80% equity holdings in the US market. The preference was due to the US market’s number of emerging industries, the superior profitability of US companies, and a stronger US economy. Part of this over-weighting was due to the likelihood of the US election producing a US-centric government policy.
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In the post-election period, US assets reached record highs, and the ‘America First’ policy was priced into the value of US equities. The outlook for the other regions, particularly the euro area, was not as poor as valuations had suggested. We believe global equity performance will even out as US companies face challenges. Tariffs will raise production costs while tighter immigration policies could lead to margin pressure, and a soaring US dollar will crimp earnings growth.
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In 2016, during the last Trump and Republican-dominated administration, US equities outperformed the rest of the world, and the value of the US dollar appreciated significantly. These trends peaked in January and February 2017. Following that period, other regions and currencies began to recover relative to US assets. We believe this will happen again. The euro area has a lower tariff risk than other regions, and expectations are low, currently making it a very attractive market.
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Therefore, we have changed the regional mix of our equity exposure and re-invested in euro area equity markets. A high exposure to the US equity market will be maintained (65% – 70%) given that the US economy and companies are performing well and have the highest number of growth industries.
The week ahead: what to watch out for
All eyes will be on the European Central Bank (ECB) policy meeting. Three of the mega caps: Meta, Microsoft, and Amazon—report results this week. From the US, the fourth-quarter Gross Domestic Product (GDP), and the Purchasing Managers’ Index (PMI) from China.
