A Healthy Return to Fundamentals in an Unpredictable Environment

It has been less than a month since the new US President took office, and not a day goes by without an announcement or new executive order, potentially postponed within hours, rocking the financial markets. As the announcements of tariffs continue to roll in, anxious investors may find plenty of reasons to doubt the short-term potential of equity markets.

Although the markets have posted positive returns since the start of the year, US equities have been blowing hot and cold in recent weeks, struggling to position themselves amid the constant flow of information from the new US administration. Against this backdrop, and for once, European equities have risen sharply on the back of attractive valuations, hopes of a renewed political impetus in Germany, uncertainties over US technology and an increasingly accommodating monetary policy from the European Central Bank.

It must be acknowledged that equity valuations will certainly be influenced by the Trump administration's decisions in the years to come, and uncertainty will be an inherent aspect of this period. Investors will have to contend with higher volatility and navigate between bluffs and measures that the administration truly implements.

On the other hand, if we focus on the fundamentals and disregard President Trump's unpredictability, the US is benefiting from one of the most pro-business and pro-innovation administrations the country has ever seen. The economy remains highly resilient, with an unemployment rate of 4%, an expanding outlook for services and even industry, with companies continuing to publish profits that are growing faster than in most other regions. Business confidence remains very strong in the United States, as evidenced by the latest Bank of America survey on the subject and references to ??weak demand?? in Q4 2024 earnings reports have fallen to a two-year low.

However, a harsh reality persists in US markets: the extreme concentration of key indices. The five largest companies (Alphabet, Apple, Nvidia, Microsoft and Meta) still have a combined valuation equivalent to the total of the 400 smallest capitalizations in the S&P500 index. These five companies alone represent the equivalent market capitalization of the Hong Kong and Chinese markets combined, or 24% of the entire US market. As for the 'Magnificent Seven', their valuations are 30 times higher than they were ten years ago.

Market momentum remains very solid in the technology sector. The Nasdaq has been trading above its 200-day moving average for more than 480 days, the second-longest rally of its kind in history after the period from July 2016 to October 2018, which saw the Nasdaq rise by 58%, compared with more than 80% in the current rally. It should be noted that in the nearly 400-day period before the dot-com bubble, the same index progressed by 180%.????

Even the recent announcements by Deep Seek, a Chinese company offering an AI model capable of competing with Chat GPT at a lower cost, have not been able to reverse the trend at this stage, and have not called into question the astronomical investments made by American Big Tech in the artificial intelligence sector. Indeed, Amazon Alphabet, Microsoft and Meta alone have announced spending three times higher than their levels of 5 years ago, at $315 billion, equivalent to the GDP of Finland! Europe is not standing idly by either, as demonstrated by Emmanuel Macron's announcement on the eve of the AI summit in Paris that more than €109 billion will be invested in artificial intelligence over the next few years. Ursula von der Leyen added € 200 billion for the European Union, which is also striving to reposition itself as a leading figure in the technology sector.

The United States, however seems firmly determined to win the AI race, which appears more than ever to be "opportunity of the century" to widen the productivity gap with other continents. From this point of view, the emergence of low-cost solutions is a very good sign, as it heralds the arrival of more affordable options, which in the medium term should enable many small and medium-sized businesses to embrace all the benefits of AI, currently reserved for the largest groups.

While it is true that the US market has been mostly stagnant in recent weeks, it is not experiencing a downturn. If US corporate profits continue to grow at a strong pace, while the market stagnates, this will be enough in a few months to bring equity valuations back more attractive levels, close to the historical average.

To date, nearly 80% of S&P500 companies have published their Q4 2024 results, with earnings per share on average 4% higher than expected, compared with a historical average of around 5%. Year-on-year earnings growth stands at 12%, very close to our expectations.

That said, we should not underestimate the potential rebound in European equities, which have been battered by sluggish growth, (too?) low inflation and, above all, a lack of interest in the region on the part of investors. Will the rebound at the start of the year signal a return of performance for European indices in the face of the high cost of US equities?

Nearly 40% of European companies have reported their results so far, with a surprise 11% increase in earnings, well above the consensus for the time being. It is true that European companies with a significant proportion of their sales in the United States have performed better, with earnings per share on average 68% above expectations compared with 51% for those with more domestic exposure, helped no doubt by the stronger dollar. An additional catalyst is needed for Europe. This could potentially be a change of government in Germany. The CDU candidate and likely future Chancellor wants to boost German growth and productivity, and is prepared to spend more and cut taxes to achieve this. However, he still needs to obtain a sufficient majority on 23rd February.

Undoubtedly, the constant stream of decisions from the new US administration, combined with the uncertainties surrounding 2025 (China's recovery? Peace in Ukraine? Europe's rebound?), make any forecast more challenging than usual. This environment forces us to remain focused on the market fundamentals and companies to which our portfolios are exposed, and ignore short-term noise in order to maintain a strong course over the medium term.

At this stage, we are maintaining our slight overweight on equity markets, particularly US equities, while avoiding an overly biased consensus on technology stocks. We are looking beyond this, in particular at the many sectors that will benefit from real efficiency gains thanks to artificial intelligence.

Nicolas Bickel | Group Head of Investment Private Banking