In our first market update for 2025, our Investment Committee discussed everything from trade tariffs and the impact this will have on local and international markets to politics, monetary policy settings both locally and offshore, and the recent earnings season.
What is driving the strong equity market performance in 2025 so far?
Growth predominantly out of the U.S. and an improving outlook in Europe (namely Germany) has been responsible for year to-date equity market performance. As we started this calendar year, it was all about marginal upgrades to global GDP (circa 3.3%), with the U.S. expecting to increase GDP at an increasing rate and earnings on aggregate having a double-digit forecast. The risks for the remainder of the year are that U.S. GDP growth will be downgraded, as the FED pulls back expectations of four rate cuts down to one to two. A key determinant of global GDP growth is whether Europe can grow, specifically Germany which has completed two negative calendar years of GDP growth. This is unprecedented and with a new government elected, it has contracted this quarter. Germany is negative with a marginal positive outlook and that’s the key for global growth. The risks are that core inflation in developed markets will be stubborn, so risk-return trade-off becomes more important.
What is your view on tariffs from the U.S. and how will they impact markets?
The economic issues are taking a backseat to the immigration issues currently. Tariffs so far have demonstrated Trump’s ploy of opening negotiations through posturing. His track record has been to make outlandish statements, establishing a baseline that is so horrific that their negotiating partners will agree to terms they would otherwise have backed away from. We believe this is not going to have a significant impact on companies, particularly in the U.S. and whilst this may be optimistic, it is likely tariffs are going to affect the bottom line of U.S. companies and be inflationary. Trump is likely to be okay with inflation so long as he appeals to his voter base. From a non-U.S. perspective, obviously a significant number of exports from New Zealand and Australia go to the U.S., with most not being subject to tariffs. What has been announced outside of the tariffs for China, Mexico, and Canada, is a somewhat reciprocal arrangement for tariffs, whereby if a country applies tariffs on the U.S., the U.S. will do the same. The reality is that New Zealand and Australia don’t impose a lot of tariffs on U.S. goods and services, so they’re unlikely to have huge impact. New Zealand is likely better placed than most Western economies to avoid tariffs.
Given the strong performance of last year and the recent earnings season in the U.S., how are companies positioned going forward in the current environment?
As an investor, it’s worth bearing in mind that asset allocation is your best protection from volatility. President Trump is operating the largest economy in the world like a business. Whilst quarterly earnings in aggregate are doing well, we are on track for the S&P 500 (the largest index globally) to have double digit EPS growth for the second year in a row. That is a lot of earnings to hit the U.S. economy which is going to improve credit conditions for companies. 2025 will likely have pockets of volatility as people react and overreact to changes of language from the large central banks.
What are your thoughts on AI and is it fair to say that the rally is broadening?
AI is a contribution of efficiencies to any economy and the U.S. economy will be a big beneficiary. When you consider the spend of the big technology companies, lower costs for AI from the DeepSeek narrative are a good thing for global economies and technology in the medium-long term. We are expecting volatility to remain however AI contributes to earnings through the cycle. We’re looking for evidence for the earnings from AI to broaden out into the mid-cap space and other asset classes. The momentum of the U.S. economy is very strong, with proposed deregulation positive for corporate America. Tax cuts over the last 40 years has been the largest contributor to earnings per share upgrades in the U.S. Today we have a multitude of factors at play with deregulation and proposed tax cuts, which are disinflationary, tariffs which are complicated and inflationary, so it will most likely be bumpy. AI will however, be a large contributor to earnings across sectors, but the volatility does not go away because of it. On the upside, most investors prefer to put their money in the U.S. because of the greater transparency as opposed to investment in China.
When do we start to look at Europe more seriously?
We’re observing the beginning of the expected growth that we thought that we would see. The prospect that Europe may be left to deal with the Russia-Ukraine war on its own without the support of the U.S., could be a significant distraction over the next five years if that situation plays out poorly. This is where we could see impacts on European markets from geopolitics. Absent that risk, we still think Europe is struggling relative to the U.S., however, investors are paying a lot less for European earnings. That said, while there may be some bargains to be had in Europe on a relative valuation basis, European companies are not likely to grow as much as their U.S. counterparts.
Valuations in Europe are still cheaper than the U.S., however, don’t underestimate the effect that government spending on defence budgets in the German economy will have on European earnings. There is so much money that needs to be spent on Germany’s defence that this could mean significant upside to European earnings going forward.
More locally, with the RBA beginning their rate cutting cycle last week, and the RBNZ continuing theirs, what are you seeing in Australia and what can we expect going forward in New Zealand?
In New Zealand, the RBNZ was very clear and concise on the 50bpt cut last week and has given guidance that there are likely to be 25bpt cuts going forward unless there are deviations. The New Zealand economy has a lot of relief on the short end cash rate relative to 7-8 months ago. Whilst there are still issues with immigration in New Zealand, the economy has relief coming, which has been clearly communicated and this should create a marginal improvement to sentiment if you’re seeking to borrow or access finite capital. In Australia, it is very mixed across the country – private sector activity across the state of Victoria is still quite depressed, but it has been redistributed to other parts of Australia. Federal government spending has had a consistently large and significant impact on GDP, now into the third year, as opposed to the depressed private sector activity which means that there is an uneven contribution to GDP in Australia. On government spending, there are large infrastructure projects underway in Sydney and Melbourne which are contributing to GDP. Retail sector spending has been depressed except for a small contingent who have been spending offshore. Overall, the RBA should not be cutting rates aggressively and the recent 25bpt cut is unusual given they increased their core CPI forecast 1-year forward.