Weekly Comment: Markets sell off, but fundamentals remain solid

Market overview – Caroline Simmons, Chief Investment Officer

Rising concerns that the US economy could potentially be heading for a recession sent stock markets lower at the start of the week, as the recent equity decline accelerated. Tech stocks were among the worst hit, with US tech indices posting a 4% decline on 10 March for their worst daily return since 2022.

The catalyst appeared to be Donald Trump’s remarks over the weekend in which he refused to rule out the US entering a recession this year. “There will be a period of transition, because what we’re doing is very big,” said Trump. The comments added to growing worries that the US President is following a different approach than during his first term, when it was widely believed that signs of economic or financial weakness would cause policy U-turns.

US stocks negative year to date

Recent declines have erased the post-election gains, with US stocks falling below the level they traded at on polling day. After Monday’s sell-off the MSCI North America index is 6% lower for 2025 (all returns in sterling, unless otherwise stated), with US dollar weakness adding to the drop. This can also be seen in global indices now being lower for the year, with the MSCI AC World benchmark returning -4%, despite the MSCI UK (+6% YTD) and MSCI Europe ex UK (+10%) enjoying strong starts to 2025.

In recent years there has been a clear focus among US policymakers on bringing down inflation without triggering a recession, targeting a so-called soft landing. However, recent changes to fiscal policy suggest a diminishing willingness to support the economy, pursuing policies such as trade tariffs and governmental spending cuts. If the US does enter a recession, then we would expect further downside in equities, but if it doesn’t then the recent correction may simply represent a paring of strong gains and more upside ahead based on higher earnings.

Valuations have dipped during this decline, with the sell-off driven by a change in sentiment rather than negative earnings developments. The latest earnings updates were pretty solid and overall saw more upwards than downwards revisions. Fundamentals remain strong on the whole, but there are three potential areas of concern to keep an eye on:

• The predicted slowing in the growth of AI capital expenditure, which is forecast to decline from a 54% rate in 2024 to 9% in 2026.
• The detrimental effect that higher levels of uncertainty can have on growth stocks. The more risks there are to the outlook, the more that could go wrong and detract from future growth.
• Higher interest rates due to trade tariffs. Although bond yields have fallen of late, tariffs are inflationary and could lead to higher rates, leading to a larger valuation discount being applied to future earnings.    

Still some way to recession

Although stocks are lower now for the year, they are coming off the back of a couple of very strong annual results. The MSCI North America index returned 26% in 2024 and 19% in 2023. Whilst the markets were driven higher by strong earnings growth, there was also some re-rating The MSCI N.America was trading at a 12 month forward P/E of 22.15 , come the start of this year.

The US index’s seven largest stocks are the Magnificent Seven — Apple, Nvidia, Microsoft, Amazon, Meta, Tesla and Alphabet — and after leading the way higher for much of the last two years, these have been among the worst performers in recent weeks.

Although recent comments have caused alarm, it’s worth noting that most economic indicators are not flashing warning signs. 25% tariffs on Mexico and Canada and 20% on China could potentially shave up to 50 basis points off US real GDP this year (all else being equal), but with forecasts in the region of 2.2%, there is still a reasonable margin of safety above a recession. Should the tariffs, activity hiatus due to uncertainty and poor sentiment all occur simultaneously there could be a sizable hit in one quarter, but over the year the forecast is still generally robust and we expect a higher real GDP growth level in the US compared to Europe over the course of 2025

Fixed income investments have provided some diversification benefits in the US in the recent equity weakness, with the US 10-year Treasury yield falling 8 basis points during Monday’s decline. After briefly trading as high as 4.80% in early January, the 10-year Treasury yield has declined to around 4.20%.

In summary:

We anticipate risk assets to stabilise, however market participants and businesses don’t like uncertainty. At the moment it seems it’s more the uncertainty than the policy that is weighing on sentiment and the longer the uncertainty on the final tariff landscape persists, the more likely we are to get a pause in economic activity which could weigh on growth.

In our experience, during such market gyrations it is often best to move back to model positions unless the fundamentals have changed.  We see no evidence fundamentals have changed – we’ll get some downgrades to growth in the US and maybe some upgrades in Europe but the quantum of the changes is not sufficient for a recession, in our view. We are therefore comfortable with our positioning.

Weekly economic announcements

Strong US employment:

Last week’s busy calendar kicked off with the Institute for Supply Management’s (ISM) US manufacturing Purchasing Managers’ Index (PMI). According to the report, manufacturing activity expanded slightly in February with an index reading of 50.3, down -0.6 from January.

Meanwhile, the ISM’s services PMI increased by 0.7 to 53.5, marking the eighth consecutive month of expansion. The services employment index also rose by 1.6 to 53.9, the highest reading since December 2021.

On Wednesday, the Federal Reserve released its Beige Book—a summary of economic conditions in each region—which noted that overall economic activity rose slightly since mid-January. However, consumer spending was lower, price sensitivity increased, and prices rose moderately in most districts. Tariffs were mentioned 49 times in the report, with most districts reporting continued uncertainty regarding the potential impacts of new policies.

The week wrapped up with the Labor Department’s closely watched nonfarm payroll employment results. According to the report, the US economy added 151,000 jobs in February, slightly below expectations but ahead of January’s reading of 125,000. Health care, financial activities, transportation, and warehousing saw the largest increases in employment, while federal government employment dropped the most. The unemployment rate ticked up to 4.1% from 4.0% in January.

In the markets, US large caps decreased -3.1% (-1.7% YTD), marking their third consecutive week of decline and the worst week for some major indexes since early September. Growth stocks returned -3.9% (-5.6% YTD), while value stocks lost -2.4% (2.5% YTD). Tech-heavy stocks fell -3.4% (-5.7% YTD).

Europe (excluding the UK):

As expected, the European Central Bank (ECB) cut its key deposit rate by 25 basis points (bps) to 2.5%. ECB President Christine Lagarde stated that rates were now meaningfully less restrictive. Touching on potential economic trade issues with the US, the ECB also lowered its forecast for eurozone economic growth to 0.9% for 2025 and revised its projection for inflation to 2.3% for 2025, up from the 2.1% expected three months ago.

In Germany, Friedrich Merz’s conservative alliance and the Social Democratic Party, which are in talks to form the next government, agreed to create an off-balance sheet €500bn infrastructure fund, exempt defence spending above 1% of gross domestic product (GDP) from the constitutional borrowing limit, and loosen debt rules for states. After the accord was announced, Germany’s 10-year Bund yield posted its biggest daily increase since just after the Berlin Wall fell in 1990. EU leaders said they backed plans to jointly borrow €150bn to spend on their militaries amid fears that Europe could no longer depend on US military aid.

In Europe, the MSCI Europe ex UK Index ended the week -0.2% lower (10.6% YTD) as investor sentiment was weighed down by uncertainty about US trade policy. Major stock indexes were mixed, with German large caps rallying 2.0% (15.6% YTD), France’s advancing 0.1% (10.2% YTD), and Italy’s losing -0.2% (13.3% YTD). The euro appreciated versus the US dollar, ending the week at US$1.08.

The United Kingdom:

The Bank of England (BoE) reported that net mortgage lending rose to £4.21bn in January from £3.34bn in December, the highest since September 2022. First-time home buyers have been rushing to take advantage of a temporary reduction in stamp duty that expires at the end of March.

UK large caps slid -1.2% (7.0% YTD), and mid-caps were down -0.9% (-2.0% YTD). The British pound strengthened versus the US dollar, ending the week at US$1.29.

Trump's Trade War Wages On:

Ongoing uncertainty around trade policy remained a focal point throughout last week as Tuesday marked the deadline for President Donald Trump’s previously announced tariffs of 25% on Canadian and Mexican imports and an additional 10% on Chinese imports. The Trump administration announced a slew of exemptions and delays for the tariffs later in the week—including an announcement that goods covered by the US-Mexico-Canada Agreement would be exempt for one month—however, the continued uncertainty and changing policies appeared to take a toll on investor sentiment during the week.

Adding to the geopolitical landscape, Mark Carney has been named as Canada's prime minister-elect, succeeding Justin Trudeau. In his acceptance speech, Carney vowed to stand firm against U.S. President Donald Trump’s trade threats, stating that "Americans should make no mistake" about Canada's resolve.  

To listen to all the past Weekly Comment podcasts click here or subscribe via the apps below: