Ongoing policy uncertainty increases volatility in February 2025
2025 is looking to be a year focused on policy, as Trump continues to implement hefty trade tariffs, and South Africa sees a postponement of the Budget for the first time in our Democracy.
Introduction
February saw an increase in volatility amidst ongoing policy uncertainty and investors appearing nervy about the AI theme. The US Market had a poor month and has ended up at a similar level to just prior to the election. The macro themes continue to dominate in between earnings season.
Inflation in the U.S. and the eurozone is diverging. Forecasts suggest U.S. inflation will hover around 2.8% over the next two years, while Europe’s is expected to stay at 1.9%. This divergence is due to differences in economic growth, U.S. trade tariffs, and a potential energy price drop in Europe if peace talks in Ukraine succeed. The knock-on effect to central banks is becoming clear with the likely path for the ECB involving further cuts while the Fed is expected to remain on hold.
China’s technology stocks had a good month following President Xi softening his stance on technology and strong AI stories coming out of various tech companies based in China. On the other hand, China’s manufacturing sector is struggling, contracting for the second straight month in February. The official Purchasing Managers' Index (PMI) is expected to be 49.9, which is contractionary as it falls below the 50-mark. This slowdown is driven by weak domestic demand and concerns over new U.S. tariffs, which includes a 10% hike on Chinese goods starting March 4. As a result, investors are looking ahead to China’s annual policy meeting on March 5, where the government is expected to announce fresh stimulus measures. The tariff theme continues to play out creating additional uncertainty in the wider global environment. Markets are unsure how to react as there are frequent threats from President Donald Trump but limited implementation to date. Regardless, the uncertainty is not good for markets, and if tariffs are implemented they are likely to be inflationary.
Finally the big news out of South Africa was the postponement of the Budget which has been pushed out to 12 March 2025. This is the first time the Budget has been postponed in our Democracy and signals the shift in power away from the ANC. This could be a positive step for the GNU and the country as a whole but we also need to see a negotiated consensus on the way forward. It appears one of the key issues sits around the VAT rate and the proposed 2% increase being blocked by the DA. There is no doubt we are in a difficult fiscal position with limited levers to pull but a continued maturing of the GNU will benefit the country in the long run. Overall February was a busy month for both local and offshore markets and we expect this trend to continue for the rest of the year as there are a number of shifting dynamics globally.
Macro Environment
The Trump administration intensified its trade policies by implementing significant tariffs affecting major trading partners. On February 1, President Trump announced a 25% tariff on all goods imported from Canada and Mexico, alongside a 10% tariff on Chinese imports, citing concerns over illegal immigration and drug trafficking, particularly fentanyl. These tariffs were initially set to take effect on February 4 but were paused for 30 days following commitments from Canada and Mexico to enhance border security measures. However, on February 27, President Trump confirmed that these tariffs would be enforced starting March 4, expressing dissatisfaction with the progress on curbing illicit drug flows. Additionally, the tariff on Chinese goods is expected to increase by an extra 10%, bringing the total to 20%. These actions have prompted strong reactions from the international community, with the European Union threatening retaliatory measures and China lodging formal protests, citing violations of international trade norms.
Central Banks remain in focus with the Federal Reserve's outlook uncertain as policymakers navigate mixed economic signals and face the threat of tariffs with an unknown impact. Inflation has moderated but remains above the Fed’s 2% target, while the labour market shows resilience despite some cooling. Recent comments from Fed officials suggest a cautious approach to rate cuts, with markets expecting potential reductions much later in 2025 if inflation trends downward. However, stronger-than-expected economic data or persistent price pressures could delay any easing. The Fed's next moves will depend on incoming data, with particular focus on inflation, wage growth, and global economic conditions. On Friday PCE, the Fed’s preferred measure of inflation, came out in line with expectations and was largely a non-event although per the chart below it has recently moved sideways.
Asset Allocation
Our local asset allocation remains unchanged at the start of 2025. We still prefer our bias to a Rand hedge portfolio based on the uncertainty in SA. Our offshore asset allocation also remains unchanged as volatility picks up we are actively managing the risk and reward in portfolios. We believe it is important to remain patient in the current market volatility. We have maintained the existing bond allocation. In addition, we have been adding to our Structured Notes position as an effective way to maintain equity exposure while providing some hedged protection with the US market looking a little stretched.
Market Performance
Markets saw a negative month in February with the US seeing a steep drop despite a rally on the last day of the month. The S&P500 was down 1.42% for the month, while the MSCI World was down 1.05% and the JSE just nudged into a negative 0.02%. As per the below chart the YTD performance for the S&P500 is up 1.24% (in USD) and the MSCI World is up 2.31% (in USD). Locally the JSE currently has a YTD performance of 2.20% (in ZAR).
Bonds
Treasury Secretary Scott Bessent has placed emphasis on the US 10 Year yield as the key focus for the administration in managing borrowing costs ahead of the Fed’s short-term interest rates. This is quite a shift for the administration and is easier said than done as the US 10-year yield is subject to a number of market forces and is not policy set by a central bank. As illustrated below the 10 Year yield spiked in early January close to 4.8% but has moved lower since then. However, this has been driven by various market forces as opposed to central bank policy alone.
Equities
We are largely through results season where we have seen pressure on Technology companies who despite producing good earnings have struggled to surpass the lofty expectations set by Wall Street. This is best demonstrated by Nvidia who beat expectations and raised guidance for the coming quarter but still experienced an 8% sell off. What has been interesting to see is that outside of technology where expectations have been lower the market has rewarded beats handsomely. Coca Cola is a good example who beat expectations and has seen a strong rally in February. Even a company like Domino’s Pizza who missed slightly saw some positive price action. This plays into the chart below which shows how the market has broadened out and the rest of the S&P500 outside of the Magnificent 7 had decent performance in Feb whereas the Magnificent 7 saw a steep drop. This plays well into our strategy of broadening out portfolios over the last couple quarters and highlights the importance of diversification. Naturally the significant weighting of the Magnificent 7 means the overall market has been negative and indicates the importance of stock selection in this environment. Overall the earnings season has been strong with Q4 S&P500 EPS sitting at 18.2% against an expected 11.9%. This has been a strong outperformance. However, the forward looking picture is a little uncertain with analysts making larger cuts to Q1 2025 EPS than historic average.
Conclusion
2025 is shaping up to be a year focused on policy. Be it Government, trade, or central banks there is a clear focus on policymakers and the market is not enjoying the uncertainty. With inflation gaps, trade tensions, and economic uncertainties, we expect markets to remain on edge. Investors will be closely watching policy decisions from China’s leadership in early March and how markets react to the new round of U.S. tariffs. We can assure clients we are monitoring all these developments closely and continue to position portfolios accordingly.