— Chinese proverb
“When the winds of change blow, some build walls – others build windmills.”
January has a bad reputation. The first month of the year is typically damp, dark, and, following all the drunken revelry and festive excesses of December, conspicuously dull; but, this year, while the weather has been predictably grey, events have been far from it.
For investors, the first two weeks of 2025 closely resembled the last two weeks of 2024. Sovereign bond yields continued to rise sharply in both the US and Europe, reflecting a hawkish shift in market expectations for rates on both sides of the Atlantic; and these soaring rates continued to drive a sell-off in equities, globally. In December, the Fed and the ECB had both pushed ahead with anticipated rate cuts (of 25bps and 50bps, respectively). But they also stressed that inflation pressures had yet to fully abate. Further monetary easing would therefore be conditional on evidence of further sustained disinflation; and, in the case of the US in particular, more evidence was needed. (This position was confirmed when the Fed decided to leave US rates on hold at the end of January while the ECB cut European rates by another 25bps). An immediate equity market sell-off ensued, given that investors were anticipating multiple rate cuts in the year ahead; and, by January, while a weaker euro had eased some of the bloodletting in Europe, the same could not be said for the US, where a string of robust economic data and uncertainty over the incoming President’s protectionist and likely inflationary trade policy led to a stronger dollar, which in turn reinforced the negative move.
Nevertheless, by mid-January the gloomy mood had started to improve. News that the President-elect might at least delay (or stagger) the implementation of proposed blanket tariffs encouraged investors to re-focus on more market-friendly elements of his America First agenda: namely, tax and spending cuts and de-regulation. This brought a rally in bond and equity markets, notably in Europe and China. Shortly thereafter, Hamas and Israel reached a ceasefire agreement after many months of negotiations. (Both sides appeared to fear what Trump might do if he felt they were dragging their feet, given his promise of ‘hell to pay’ if there was no deal before his inauguration.) This de-risked a geopolitical flashpoint and helped to consolidate the risk-on move. Finally, a string of expectations-beating earnings announcements from US financial and tech companies added momentum to the positive upswing. Equity markets were thus soon back at all time highs as Trump’s inauguration neared, with investors in good spirits once more!
“A string of expectations-beating earnings announcements from US financial and tech companies added momentum to the positive upswing.”
And what a blizzard of activity there has been since Inauguration Day. President Trump has issued a panoply of orders aligned with the priorities of the MAGA base. These include orders to purge the federal bureaucracy of DEI initiatives; pardon the Jan 6th convicts; expel millions of illegal immigrants; send troops to the Southern border; end birthright citizenship; freeze federal loans and grants; revoke electric vehicle targets; remove barriers to technological innovation; leave the WHO; withdraw from the Paris climate agreement; boost fossil fuel production; and pause the TikTok ban. He has also announced a major effort to downsize the federal workforce, freezing hiring, offering generous redundancy packages, and warning those who choose to stay of future cuts. And, finally, on the geopolitical side, Trump is demanding rearmament in Europe and flirting with territorial expansion in the Western Hemisphere, notably to Greenland.
This mix of policies shows what we can expect from America First: restrictions on immigration, both legal and illegal; de-regulation, particularly of favoured sectors like technology and energy; anti-progressivism at home; and anti-globalism and unilateralism abroad. So far, so predictable. However, the ambition and pace of change has been breathtaking and deliberately disorientating for his opponents.
Where Trump is yet to show his hand more fully is on trade. He has confirmed a 25% tariff on Mexican and Canadian goods as of 1st February. But he stepped back from the massive China tariffs he threatened on the campaign trail, for now. Still, there is no doubt major change is coming to trade policy. One reason for the delay appears to be that there is a debate underway between hawks and doves within the administration on how to employ the trade restrictions; specifically, whether such restrictions are only to be used temporarily to secure a specific change in others’ behaviour or policy (i.e., as leverage with which to secure resources, market access, or other such goals) or whether they might also be used more permanently to generate meaningful revenues or discourage extended supply chains.
“There is no doubt major change is coming to trade policy.”
This is an important distinction. But do not be fooled: the former approach to trade policy could be no less impactful for markets and global affairs. The recent episode with President Petro of Columbia is instructive – and looks like a template for the America First foreign policy: President Trump threatened a severe package of trade restrictions and sanctions on an ostensible US ally to engineer a change of immigration policy (which has nothing to do with trade). He succeeded, within a day. Denmark, Panama, and the rest of the world were watching as no one fell in behind Colombia. They all learnt a valuable lesson… as did President Trump.
Somewhat tangentially, it is perhaps no wonder therefore that Lithuania and Estonia have already agreed to boost defence spending to 5% of GDP, as Trump just recently demanded. We anticipate more NATO countries as well as the US’s East Asian allies will follow suit and for US defence stocks to be major beneficiaries of the Trump Presidency.
“Denmark, Panama, and the rest of the world were watching as no one fell in behind Colombia. They all learnt a valuable lesson… as did President Trump.”
Other investible sectors likely to benefit from Trump are artificial intelligence (‘AI’) and digital assets. With Elon Musk at his side, and the other Tech bros falling into line behind him, Trump has pledged to make America the undisputed global leader in these two frontier technologies. Shortly before his inauguration, Trump launched his own meme coin – called TRUMP, of course – and in the days after he took office he issued executive orders to reduce the compliance burden on AI and cryptocurrency developers. He subsequently touted the launch of the Stargate Project, a new company founded by a consortium of SoftBank, OpenAI, Oracle, and MGX, which intends to invest $500bn in new AI infrastructure in the US over the next four years (with $100bn invested immediately). Some, including Musk, have loudly doubted the massive numbers involved; but Stargate certainly shows serious intent.
Unfortunately no sooner had Stargate been announced than an obscure Chinese start-up called DeepSeek claimed to have developed a high performance large language model (‘LLM’) of its own at a fraction of the cost of ChatGPT. This was previously thought impossible, and the news stunned the industry. Many investors had anticipated an AI golden age for America characterised by surging demand for chips and power, and had ploughed money into the big US chipmakers and energy companies to benefit. Now they were heading for the exit: NVIDIA fell -17.0% on the day (the 27th of January), Broadcom sank -17.4%, Vistra collapsed -28.3%, and Constellation Energy fell -20.1%. If such high performance LLMs could be developed with so few chips – and behind tight US export restrictions – then the vision of US supremacy in AI had now been thrown into doubt. More concretely, the low cost of development seemed to rubbish aggressive forecasts of high performance chip demand premised on large initial outlays for training LLMs. It also calls into question the return on CAPEX already sunk into AI development by the Big Tech titans.
“The vision of US supremacy in AI had now been thrown into doubt.”
Of course, the true impacts of DeepSeek’s efficiency breakthroughs are unlikely to be reflected in the initial market moves, driven as they are by the panic of weaker hands. Training LLMs is an important source of demand for chips and energy, but querying LLMs also involves a lot of chips and energy and the volume of queries is growing rapidly. Lower LLM development costs will likely feed through to faster AI adoption and growth in query volumes. And this in turn should support chip and energy demand and the earnings and share prices of NVIDIA etc. The principal lesson from the DeepSeek sell-off is a more general one, we think: historically high valuation multiples for inherently uncertain future earnings, particularly in industries characterised by rapid growth and disruption, are by default dangerous. A stock priced for perfection carries negative convexity. In our portfolios, we have been both significant backers of AI through dedicated investments in a mix of associated software and hardware and underweight NVIDIA and the rest of the Magnificent Seven. Price does not matter until it does.
“The principal lesson from the DeepSeek sell-off is a more general one, we think: historically high valuation multiples for inherently uncertain future earnings, particularly in industries characterised by rapid growth and disruption, are by default dangerous.”
While the US and China battle for global technological and economic domination, one massive market is conspicuously absent from the tussle of the 21st Century: Europe. We have long argued that since the Global Financial Crisis, Europe has steadily transformed into a minnow: smaller than the sum of its parts, and mired in unsustainable debt, political instability, and productivity-crushing dirigisme (at least outside Eastern Europe). European leaders have been incurious about what works beyond the continent’s borders, and correspondingly unimaginative in solving Europe’s problems. The war in Ukraine; legislative gridlock in France; a multi-year recession and unstable coalition government in Germany; the incoherence of fiscal and economic policy under the UK’s Labour government… none of it looks promising.
And President Trump’s second coming only reinforces our negative outlook for European markets: he believes that the EU has treated America ‘very unfairly’ on trade and security – and you can bet that his revenge will be swift. Of course, a well-balanced portfolio includes exposures to next-best ideas to avoid the pitfalls of hubris and lashing one’s fate to the successful unfolding of just one narrative concerning an inherently uncertain future. But we continue to recommend under-allocating to European equities, selective (and sector-specific) exposure to European credit, and diversification beyond the euro for euro-based investors. The decision of the ECB to cut rates and the Fed to hold rates where they are at the end of January (even as inflation sticks in both regions) reflects America and Europe’s diverging economic fortunes – and adds to the negative outlook for EUR/USD. In the UK, meanwhile, we believe that the Bank of England will cut rates next week (as expected) but in the months ahead will then be forced to move further and faster than the market forecasts due to waning confidence in the government’s handling of the economy. Therefore we expect sterling to weaken as UK duration pays.
“We continue to recommend under-allocating to European equities, selective (and sector-specific) exposure to European credit, and diversification beyond the euro for euro-based investors.”
If you have any questions about the themes discussed in this article, please do not hesitate to get in contact with us: info@bedrockgroup.ch
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