Exceptional start to the year

There were no shortage of market moving events to start the year. The inauguration of President Trump and a flurry of executive orders, a bond market sell-off saw yields spike to 2023 highs, and challenges to the dominance of U.S. AI all tested expectations about the duration of the equity market rally at elevated valuations. Despite a choppy start equities rose in January and bonds had positive returns. The MSCI World index rose 3.5%, and emerging market equities by 1.6%, while the Bloomberg Global Agg returned 0.6% (total returns in local currency).

Despite the numerous executive orders signed by President Trump on his first day, there was some relief that tariff policy was not as aggressive as feared. However, tariffs return to the agenda at month’s end after President Trump used emergency measures to enact 25% tariffs on Canada and Mexico and a 10% tariff on China, causing heavy selling. Several unknowns remain, including potential retaliatory tariffs, expansion of tariffs to other markets like Europe, or the duration of these tariffs given their link to non-economic parameters. However, what is certain is that “American First” policies, which boost U.S. exceptionalism, only increases global growth uncertainty.

This policy outlook is contributing to central bank policy divergence. The U.S. Federal Reserve (Fed) held rates at the January meeting, adopting a hawkish tone. The Fed is willing to be patient as it balances potential impacts on growth and inflation from policy changes. Meanwhile, other major central banks continue to cut to either build a buffer for future challenges (Bank of Canada) or to stimulate a flagging economy (ECB).

Progress on lowering inflation should allow the Reserve Bank of Australia (RBA) to ease rates for the first time in this cycle, delivering on the pre-Christmas dovishness. While there are reasons the RBA to hold rates – low unemployment rate, potential for fiscal stimulus post the Federal election, and import inflation – the breadth of inflationary pressures has narrowed significantly in recent months. Over half the inflation basket is increasing by less than 3% y/y and under 20% by more than 5% y/y, the lowest since the end of 2021. However, a first cut is may be viewed as more a policy step towards a less restrictive stance given the softer economic activity. The RBA is unlikely to rush neutral stance, preferring to verify the path of inflation in the quarterly reports and align further cuts with their quarterly forecast schedule.

The competitive moats of U.S. tech firms were called into question. While the AI investment thesis has not fundamentally changed, the pace of innovation in this space creates uncertainty on the long-term competitive nature of U.S. tech and whether the sizable capex investment is justified if technology can advance at much lower cost. The concentration risk is equities is not new and the broadening out of earnings growth in the U.S. creates opportunities for investors across market cap size and styles.  

Australian economy

The unemployment rate rose 10bps to 4.0% in December. Employment increased by 56,000 but was offset by a rise in the participation rate. Soft economic growth and steady fall in job ads could lead to a small increase in the unemployment rate in the months a head (GTM AUS page 9).

Business conditions improved in December, retracing some of the prior month’s weakness. However, business confidence remains subdued and well below the long-run average. The improvement may have been driven by seasonal demand and expectations for the start of the RBA easing cycle (GTM AUS page 6).

Equities

The U.S. earnings season was largely overshadowed by other events. But, by month-end just under half of companies (by market cap) had reported earnings, with year-over-year earnings growth tracking a respectable 12.7%. Looking at the breakdown between the mega caps and the rest of the market, of the “magnificent 7” which have reported earnings growth is 26% y/y and 8.7% for the rest of the market. Valuations on equities rose in January. The P/E ratio on the S&P 500 rose to 21.9x, the ASX 200 to 18.4x and European equities to 14.0x (GTM AUS page 35).

Fixed income

The monthly moves masked the large swing intra-month. Bonds sold off heavily in January and the U.S. 10-year yield spiked to 4.79% on stronger economic data – strongest non-farm payroll report in nine months – before falling back. This was the highest yield since October 2023. Japanese yields reached a decade high of 1.25% as the Bank of Japan raised the cash rate to the highest level in 17 years. Riskier parts of the bond market performed well, with global high yield and EM debt both returning 1.2%. While the risks to growth outlook increased, the probability for recession remain lows supporting credit market (GTM AUS page 54).

Other assets