Keep calm and carry on
Monday, 17 March 2025 17:13
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The late Benjamin Graham used to say that “the market is a pendulum that forever swings between unsustainable optimism and unjustified pessimism”. Although the price tag for the renewed trade uncertainty is not so elevated (S&P 500 -8%, Nasdaq -11% from the peak mid-February), we believe assertions about the end of American exceptionalism in financial markets are based on unjustified pessimism.
We acknowledge that there are good reasons to fear that possibility. The new US administration’s approach appears so chaotic and generates such uncertainty that it could indeed cause a recession and lead to deep distrust of American assets. Credibility is the main intangible asset of a debtor and distrust has been on the rise in the past few weeks. But a boycott of American assets looks impossible. The power and hegemony of the United States for many decades imply that the dollar became the global reserve currency almost a century ago. Meanwhile, US Treasury bonds are the benchmark risk-free asset and US stocks have been the best performing and most coveted risk asset. The unravelling of this status would mark the end of American leadership in financial markets. But in practice this is quite unlikely and would take decades to play out, far beyond the term of the Trump mandate. At the end of 2024, the share of the US dollar in international SWIFT payments was nearly 50%, while it was 82% in trade finance, and almost 90% of global FX transactions involved the US dollar.
A buying opportunity in the US? From a short-term investment perspective, history suggests that a 10-12% equity drawdown is something to consider, provided there is no recession ahead. However, critical milestones in trade wars in early April may prevent a quick rebound until markets have more visibility. We show in the report that the valuation of US equities has become more attractive, and that the outperformance of Europe is becoming stretched. But in the mid- to longer term, the cycle of European underperformance had been so extended until recently that there is room for further normalisation.
What can push European equities higher? The two drivers for maintaining the momentum in European equities are currently the German stimulus package that we discussed last week and a potential conflict resolution in Ukraine/Russia. With regard to the latter, the road to a peace agreement is fraught with pitfalls but the probability continues to increase. Our Ukraine basket of European equities fully captures this possibility. Its bias towards materials and industrials means that our Ukraine basket is also capturing the newsflow on Germany’s stimulus package, which is highly likely to move forward now that a deal has been reached with the Green party.
- ETF flows into European equities reached record highs in early March according to Kepler’s ETF advisory team (USD6.3bn on week 10, among which USD4bn from European-listed ETFs and USD2.4bn from US-listed ETFs) thanks to purchases of pan-European indices (USD5.1bn), German shares (USD1.4bn, among which USD900m into German mid-caps) and Swedish stocks (USD140m).
Which sectors/asset classes might benefit the most? Materials, energy-intensive industrials (chemicals), and consumer-oriented sectors have underperformed in recent years on the back of the rise in energy prices and the loss of household purchasing power. These sectors would benefit the most from Germany’s stimulus package and a Ukraine/Russia conflict resolution, assuming the latter translates into a pullback in energy prices in Europe. This would also contribute to lifting sentiment towards European SMIDs, which are trading at a historical discount to large caps. In parallel, the rise in bond yields has proved supportive for financials, but we believe there is limited additional upside for euro area bond yields. The German stimulus package is now likely to be extended from 10 to 12 years in order to limit the debt burden.
Week ahead: US retail sales (February), FOMC, BoE and BoJ monetary policy meetings. In China, retail sales will be released. The Bundestag will hold an emergency session to approve the stimulus package.
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