February 2025 was a month of substantial change. U.S. President Trump introduced new tariff proposals, implemented policies aimed at improving government efficiency and adopted an unconventional diplomatic approach to the situations in the Middle East and Ukraine. Meanwhile, the Chinese market enjoyed a new wave of positive momentum with increased optimism about the country’s artificial intelligence development and future influence, as well as signs of government support for the technology sector to drive innovation. European equities also posted their best performance in a year.

Against the backdrop of these changes, U.S. equities underperformed compared to Europe, China and Asia ex-Japan in February, as well as year-to-date (YTD). U.S. Treasury yields have come down from their January peak, even as the Federal Reserve (Fed) prefers to maintain its policy rate in the coming months. This could reflect the soft performance in equities, or some investors may be starting to question the sustainability of U.S. economic growth momentum amid a series of executive orders that could raise uncertainty for businesses.

A busy start

According to the U.S. Federal Register, U.S. President Trump has signed over 70 executive orders since his inauguration. Meanwhile, the Department of Government Efficiency (DOGE) has proposed some significant changes to government departments to reduce costs. For investors, the tariff measures are arguably the most relevant and urgent. The U.S. has already imposed a 10% tariff on all Chinese exports to the U.S. and announced a 25% tariff on all steel and aluminum imports starting March 12. Meanwhile, the U.S. is still negotiating with Canada and Mexico to avoid a 25% tariff on all their exports to the U.S., which would take effect in early March if they fail to reach an agreement. U.S. President Trump has also proposed several additional tariffs on auto imports as well as on European Union (EU) exports.

All these measures are clearly challenging for global trade, affecting both U.S. importers and their trade partners around the world. Meanwhile, there is anecdotal evidence that U.S. consumers are looking to make purchases before tariffs take effect, and retailers are already raising prices in response to this preemptive demand. Hence, the Fed is taking a more cautious approach to cutting rates given sticky inflation and the risk of it rebounding. The futures market is now pricing in the first rate cut to come only in October.

Other actions by U.S. President Trump and DOGE may have less immediate impact on the U.S. economy and corporate earnings, but they could still influence the business environment and global dynamics in the long run. CEOs may look at this environment and be more cautious in making investment decisions until there is more clarity on the policy impact. Hence, one possible scenario would be for investors to worry about the short-term upside inflation risk from the Trump administration while switching focus to the downside risk to growth later in the year as policy uncertainties lead to lower capital expenditure and housing spending.

Not just counting on government stimulus

On the other side of the Pacific, the Chinese markets experienced a positive trend driven by renewed optimism about China's advancements in artificial intelligence (AI). The launch of the DeepSeek R1 model shows that China is not too far behind the U.S. in its AI progress, despite U.S. export restrictions on top-end graphics processing units (GPUs). Meanwhile, Chinese firms are moving toward the inference stage, where companies are looking for ways to use trained AI models to make decisions.

Even though it is still too early to deduce how companies will monetize AI, the potential for a new tech cycle combined with reasonable valuations has kicked off a fresh round of market rally. Moreover, President Xi Jinping met with leaders from the tech sector on February 17, which was seen as an endorsement from Beijing on the sector’s development. This is quite a turnaround following the regulatory reform on the tech sector in 2020, when the government launched several antitrust investigations on e-commerce giants.

This also means the February market rally is not driven by expectations of government policy to boost the economy, even though that could still come with the National People’s Congress meetings in early March. Investors may see this as a fresh investment cycle by the business sector. Not only could this contribute to earnings growth in the medium term, but also investment spending and increased hiring by companies could help to boost economic growth. While we are always cautious about the Chinese market reaching too much too quickly, we do think this development could potentially put China back on investors’ radar for 2025.

Europe and the U.S. dollar

European equities and the U.S. dollar (USD) also defied market consensus at the start of the year. MSCI Europe was up 2.7% in February and over 9% since the start of the year, hitting its record high alongside the Stoxx 600 and Germany’s DAX index. Financials and industrials led the way, given the consolidation of the tech sector in the U.S. We see the relatively attractive valuations in Europe and light positioning helping to explain the current rally, even though the overall economic momentum in Europe has been lagging. We still see active selection in sectors and stocks as crucial in delivering returns to investors from this asset class.

For the USD, the Dollar Index lost 3% since hitting its peak in mid-January. The Japanese yen (JPY) and the British pound were the outperformers. The steady rate rise path of the Bank of Japan (BoJ) helped to support the JPY. Meanwhile, the Canadian dollar did gain against the greenback but lagged behind other major currencies because of the tariff proposals from the U.S. Overall, the strong USD outlook remains largely unchanged, in our view, as the Fed is looking to go slow on rate cuts relative to other major central banks.

Dealing with a less impressive Sharpe ratio

Despite all the policy uncertainties from the U.S., we still see the current environment as constructive for equities and risk assets, but market volatility is likely to rise from policy headwinds. Hence, investors will need to prepare for some deterioration in risk-adjusted returns.

Instead of just focusing on the U.S., especially the tech sector, we see the benefit of diversification in equity portfolios. In Asia, the Greater China region and Japan should continue to benefit from global AI development, both in the U.S. and in China.

For fixed income, short duration is still the preferred choice, given the near-term risks of inflation rebounding in the U.S. We have highlighted for some time that corporate bond credit spreads are tight, both in the investment-grade and high-yield space. Yet, the steady growth momentum of the U.S. economy should help to keep default rates low and hence suppress spreads at the current level. Hence, the income generation from corporate bonds can help.

To help stabilize their portfolio’s Sharpe ratio, investors may also consider alternative assets, some of which provide a steady income stream over a long period of time. Some private market assets, such as infrastructure, transportation and real estate, also offer a liquidity premium if investors are willing to commit their capital for a longer period of time. This steady income stream can help to reduce portfolio volatility.

Global economy:

• U.S. real gross domestic product (GDP) expanded by 2.3% in 4Q on an annualized basis, with job growth slowing in January (non-farm payrolls increased by 143K jobs, below expectations), but the unemployment rate remained steady at 4%. Manufacturing purchasing managers’ index (PMI) improved but services PMI fell into contraction territory for the first time since January 2023. Toward the end of the month, several indicators worried markets, including February consumer confidence missing expectations at 98.3, the largest drop since August 2021, while average 12-month inflation expectations rose from 5.2% to 6%. Tariff headlines continued to be volatile, with various tariffs announced on Mexico, Canada, China, steel & aluminum etc.
  (GTMA P. 28, 29, 30)
• Europe’s 4Q24 GDP growth was stagnant by 0.1%, but saw an early recovery in economic data, including recovering consumer sentiments, retail sales and the composite PMI rising to 50.2 in February, driven by growth in services activity. Japan’s GDP grew at an annualized rate of 2.8% in 4Q24 while inflation and household spending continued to be solid. The BoJ raised rates to 0.5%, the highest in 17 years.
  (GTMA P. 18, 19, 20, 21)
• China’s lunar new year holiday showed record highs in box office and domestic travel spending. PMIs remained soft, showing a modest expansion with composite PMI falling to 51.1. On the upside, aggregate social financing and new Yuan loans hit record highs in January. Market attention remains on the Two Sessions set to be held in March.
  (GTMA P. 5, 6, 7, 8)

Equities:

• The MSCI AC World fell 0.7% in February. Developed markets underperformed with a -0.8% return, dragged lower mainly by the S&P 500 (-1.9%). Europe’s STOXX 600 rallied further in February with a 4.8% return, bringing YTD returns to 9.8%. Europe’s strength came from recovering cyclical data such as consumer confidence, manufacturing PMI and financial conditions.
  (GTMA P. 33, 34)
• In the U.S., the S&P 500 hit record highs mid-month, but reversed earlier strength toward the end of the month. Underperformance came mainly from growth sectors, with the consumer discretionary sector down 9.2% and tech sector down 3.8%. The NASDAQ was down -4.5%. Defensive stocks outperformed. This risk-off rotation was driven by heightened scrutiny around the soft-landing narrative, as macroeconomic data turned softer. However, markets were relatively cushioned by a rates rally and a pickup in the Fed easing expectations.
• Emerging markets’ outperformance was driven by a strong China market, with the MSCI China and the Hang Seng delivering 11.7% and 13.4% returns, respectively, buoyed by continued tailwinds from the AI theme and President Xi’s meeting with technology leaders. Onshore CSI 300 rose modestly by 1.9% due to less sensitivity to internet stocks.  Elsewhere in Asia, Indonesia and Thailand underperformed with -7.8% and -9.1% returns, respectively.
  (GTMA P. 33, 41)

Fixed income:

• While U.S. 10-year Treasury yields fell 35 basis points (bps) to 4.19%, the yield curve flattened, as the refunding announcement and Bessent’s comments on yields have eased concerns over term premium while elevated inflation expectations continue to push back expectations on the next rate cut. Duration on Australian yields relative to the U.S. remains attractive. Japanese government bond 10-year yield marked another decade high of 1.37% on strong wage and inflation data.
• Spreads on U.S. investment grades were largely unmoved but slightly widened on high yield, returning 2.0% and 0.7%, respectively.
• For emerging markets, government 10-year yields were also generally lower, except for China seeing a 10 bps rise in 10-year yields. Emerging market bonds returned 1.82% in USD terms.

Other financial assets:

• Gold prices hit another record high to USD 2,835/oz at month-end as tariff risks fueled demand for safe-haven asset. Brent crude fell 4.0% to USD 74.05 per barrel as a potential Russia-Ukraine truce helps supply expectation.
  (GTMA P. 73, 74, 75)
• The USD weakened slightly by 0.2% in February, continuing its decline since the start of the year. The February movement was mainly driven by global growth concerns from rising tariff concerns as well as weaker-than-expected U.S. economic data. The JPY strengthened significantly by 3.3%, reaching multi-month highs against the USD. This was driven by strong Japanese economic data and expectations for further rate hikes by the BoJ. The Chinese yuan was mostly flat in February, although it depreciated during the U.S.-China tariff announcements earlier in the month but later recovered due to a weaker USD and domestic equity tailwinds.
  (GTMA P. 13, 15, 74, 75)

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