Stock Market & Economic Commentary - March 2025

“I’ve learned that people will forget what you said, people will forget what you did, but people will never forget how you made them feel.” Maya Angelou, American memoirist, poet and civil rights activist. April 1928 – May 2014

Economic Update

Defending Europe

For the last 80 years, Europe’s security has been underpinned by the US. With America’s support now in doubt, Europe is scrambling to rearm. As Sir Keir Starmer put it earlier this month, “the great post-war order” is being redrawn.

American spending on defence far exceeds Europe’s. The US spent about 3.2% of GDP on defence in 2023 compared to an average of 1.8% in European NATO countries, below NATO’s 2.0% target. Almost all European NATO states have raised defence spending in the last decade in response to Russia’s invasion of Ukraine and rising levels of geopolitical risk. Countries closest to Russia – Poland, the Nordics and the Baltic states – have stepped up spending the most and have the highest military spending as a share of GDP.

Perceptions of the threat tend to diminish the further west and south one goes. 8 out of NATO’s 29 European members, including Italy, Spain, Belgium and Portugal, spend below the 2.0% NATO target. Germany, Europe’s largest economy, only reached the 2.0% threshold last year after years of low spending. The failure of many countries to live up to their NATO commitments has been a source of frustration for successive US presidents. Donald Trump is the first to suggest that America could walk away from a military commitment to Europe.

In terms of dollar spending, the US dwarfs its allies and its rivals. In 2023, the US spent more than $900 billion on defence, 65% of all NATO spending, and equivalent to the total of the next nine highest spending nations combined. In dollar terms, the US spends more than twice as much as China and Russia combined.

What is clear is that a US withdrawal would leave a large gap in Europe’s defences. Not just US leadership and 90,000 personnel stationed in Europe, but communications and electronic warfare support, tanker and heavy transport aircraft, and ammunition resupply.

So how does Europe, without America, measure up against Russia in terms of scale? Estimates vary, but most point to a significant mismatch. The Economist thinks that in the long-term European defence expenditure needs to more than double to deal with Russia. Figures cited recently by Fenella McGerty, senior fellow for defence economics at the International Institute for Strategic Studies, suggest that Europe would need to almost triple its spending to match Russia.

Yet Europe does not necessarily need to match Russian capacity 1:1 to deter aggression. A widely cited rule of thumb is that an attacking force needs three times the number of troops as the defending force to ensure success. This can be seen in Ukraine, a country with just 7% of Europe’s population and a fraction of its GDP, which has held back Russian forces for more than three years. The Economist’s defence editor, Shashank Joshi, cites the example of Israel which, although a small country with fewer than 10 million people, has sustained investment in defence and built up its resources and capabilities to world-class standards.

NATO’s European members make up one of the most economically developed and wealthiest areas of the world, with a population and combined GDP approximately five times that of Russia. In terms of economic heft and population, Europe far outstrips Russia.

Conflicts, however, are not always won by the richer or most populous power. Political will and public support matter enormously. The next test of Europe’s resolve will be whether it can raise the money to rearm.

Countries with low levels of public debt including Germany, the Netherlands and Sweden could finance increased defence spending through borrowing. Many European nations, including France, Italy, Spain and the UK, are more indebted and might need to raise taxes or cut other spending programmes. Without more borrowing, higher taxes or reducing spending elsewhere, Europe cannot increase defence spending. Germany has led the way with a plan to ease constitutional limits on public borrowing. Many others have yet to lay out a path to higher defence spending, let alone how it will be financed.

Was it ever different?

One of the world’s dominant powers is withdrawing from foreign affairs. Russian troops are in Ukraine. Britain, France and the other major European nations are considering their response.

It is 1856. And the Crimean War is about to begin. Other than the “ruling power” being the Ottoman Empire, instead of the US, there are some eerie similarities with the world today.

At a meeting of the great and the good in Paris (see how similar!), the French Emperor Napoleon III complained to a British inventor that it was impossible to get enough high-quality steel to produce reliable cannons. That was enough to prompt the inventor – Henry Bessemer – to come up with a process to produce steel at industrial scale quantities.

Rather than taking a day to turn five tonnes of iron into steel, it now took 20 minutes, and the cost fell from £40 a tonne to less than £6 a tonne. The Bessemer process took something which had been basically used to make cutlery and turned it into something industrial and commercial.

And although the initial development was fuelled by defence industry demand, you can’t put technological development back in a box.

In 1856, the US produced less than 20,000 tons of steel through the old, slow, expensive crucible method. Enter Bessemer and within 15 years, the US was making more than 1.5 million tons of steel, which was enough to start laying railway tracks and prompt an economic boom. And make Henry Bessemer into a “Sir” and a millionaire.

A more recent example: Rolls Royce – shares up nearly 40% this year – was formed through exactly that process. A carmaker asked by the British government to try its hand at aircraft engines, during the First World War.

Government demand for defence creates new technologies and new industries.

The recent rally in the share prices of defence companies can feel a little strange. Making money from conflict doesn’t sit too easily with many investors. But the above stories suggest that it’s not just about military supply contracts today – there’s always the possibility of one of them creating something which can change the world.

Stock Markets

As Vladimar Lenin (1870-1924, Revolutionary and former Chairman of the People’s Commissars of the Soviet Union) once said, “There are decades where nothing happens and there are weeks where decades happen.”

The momentous events of the last few weeks in the White House and beyond, have the potential to rewrite some of the fundamental underpinnings of investment markets.

Like most of us, I wake most mornings wondering what has changed overnight. What other inane comment has been shared over social media, and which other country/person/organisation has been maligned by a tweet or post? I’ve never been a big fan of social media and have always felt uneasy about Twitter/X but now I am beginning to dislike everything about it.

Anyway, back in the real world of markets and investors, it has been a thoroughly miserable few weeks – the Trump Bounce has lost momentum, and the Trump Trade is in full reverse mode.

While no one has privileged access to the future, here are a few thoughts on the potential implications of the fall out between the US and the rest of the world.

With the benefit of hindsight, it would be easy to conclude that investing has been a relatively simple game over the last decade: overweight the US and ignore everything else. This has manifested itself in huge flows of capital into global funds and the US stock market. In many ways this has been entirely rational. After all the US has been managed for the benefit of the stock market, whereas Europe and Asia have been managed for the benefit of debt markets. This is self-evident in the relative returns of these markets. Is this changing?

When Trump was elected, the belief of many investors was that the S&P 500, the US stock market, would be his key indicator of success. This may ultimately be the case, but he and his Treasury Secretary, Scott Bessent, have been much more focused on the debt market, and many of their actions have been suggestive of their priority to get the cost of debt down, rather than equity prices up.

This makes sense. Back in 2020, during the pandemic, interest rates were cut to levels which allowed governments and corporates to borrow at near zero cost. With the average length of debt being around five years, this will now need to be refinanced. Many entities, including the US government and Trump’s own businesses, which are heavily reliant on debt, may struggle to absorb higher interest rates which will be more like 5% than 0%.

The US needs to refinance nearly $10 trillion of debt this year. Billions of dollars in personal mortgage debt also need to be refinanced. Lowering interest rates will have a big impact. As will controlling inflation.

Most blue-collar Americans do not own a lot of stocks & shares but have mortgages to pay. They haven’t participated in the unprecedented bull market in growth assets. So, a temporary market correction and reduced mortgage payments is a positive for many. Getting the cost of debt down is, for now, more important for the US than getting equity markets up.

At the same time Europe is enacting a growth agenda. Admittedly, this is in relation to having to re-arm itself, but the Achillies heel of Europe, its reluctance to run deficits to fund growth, is being removed at speed. This is negative for European debt markets, but positive for European equities.

China too is re-embracing the corporate sector. Technological advances have rebuilt faith in its private sector. DeepSeek has surprised tech analysts with its advanced artificial intelligence model using less expensive chips. Bejing has announced a plan to “vigorously boost” weak consumption. China is, at the margin, becoming more equity friendly.

In totality, this is an inversion of the trends of the last decade. US equities are becoming less attractive at a time when European (including the UK) and Asia markets are becoming more so. Most investors are positioned the opposite way and were this to become a more permanent feature of markets, significant amounts of capital would need to move.

Thinking ahead

One of the most important rules of investing is that it doesn’t matter what you think, only what you think relative to everyone else. If it is in the newspaper, it is usually in the price. If it is a narrative, then it is possible it is already too late. The end of US exceptionalism, and the potential for a recession are the dominant narratives of the media and investors more generally, so there has already been a significant shift in views. This can be seen from the US equity market being down more than 10% year to date, and the German equity market being up more than 10%. A 20% plus difference in performance in 10 weeks is noteworthy and already reflects increased pessimism to the US and optimism to Europe.

Another important rule of investing is not to invest in the present. The skill is to think ahead and try to understand what the world will look like in the future. The here and now is usually already reflected in prices, the future often is not.

The most valuable pieces of information an investor could have today would be if this time next year the US is not in recession; if Europe has mobilised promised fiscal spending; and if China has continued its economic recovery. No US recession, European fiscal stimulus, and Chinese economic growth recovering would make investors bullish about future growth and equity market returns, and in turn would make prices after the recent pull back look attractive. Of course, if the opposite plays out, some markets will continue to struggle. Either way, it is not the present which counts in decision making, it is a view on the future.

Alongside avoiding short-term, consensual thinking, what else can help investors at times like these? Understanding that in the short-term macroeconomic issues are important to markets, but in the long-term micro, company and industry trends are more important.

It is important to understand that very few CEOs adjust their strategies to adapt to short-term news and events – most concentrate on how they can improve their companies and grow. This is a good lesson for portfolio managers too. Areas such as the growth in the digital economy, investment in physical infrastructure, and increasing innovation in healthcare will happen regardless of the events in markets over the last few weeks. In the end they are likely to be more important than politics and economic data. Listening to and understanding the economic and geopolitical environment we live in is important, but rarely defining over the long term for investment outcomes compared to other more company and industry led factors.

Recession watch

To use the saying, if I had a pound for every time I was told there is a recession looming, I’d be a wealthy man. Despite the US economy being in recession only 15% of the time since 1935, investors consistently worry about the possibility of if happening. Recessions do not appear out of nowhere either. They are usually a result of oil price shocks, financial crises, policy errors, and other events which dislocate the natural rhythm of growth we see for 85% of the time.

Concerns about a US recession today are based on the uncertain political environment which the new government has created. Anyone employed by the government will be concerned about their future jobs. This will impact consumer spending. For any company looking to invest, they will be concerned about tariffs causing them to pause. The case for an air pocket in economic growth is a plausible one. That these wounds are somewhat self-inflicted makes them frustrating and solvable, but there is a direction to US economic nationalism, at the expense of globalisation, which looks entrenched.

There are counter arguments to a recession, however. The US banking system is in good health, consumers are still benefiting from wealth effects of equity and home prices over the last few years, while lower taxes and deregulation are part of the Trump economic plan and will benefit the corporate world.

Conclusion

Investors have been left wondering if the investment environment has structurally changed in the last few weeks. Will investment performance come from different regions and sectors than in the past? If the US is increasingly being run for debt investors at the same time as its economy is slowing, and Europe is being run for equity investors at the same time its economy is accelerating, that is a big change. Add in a more favourable market in China and it is possible to see a very different future than what we’ve experienced in the past.

The consensus view today is the US is waning; Europe is rising, and China is re-emerging. As an investor the questions are what are my views relative to this, and how does this look in the future? A reasonable view would be too much caution is now baked into the view on the US economy, but perhaps not enough optimism regarding a real positive change in Europe and China where investment allocations remain low. If true, this suggests that investors are too cautious about all the key regions of US, China and Europe over the long term, and that would be a positive thing for future equity returns

Investors, of course, do not need to be binary. It is possible to have exposure to all the areas noted above in a portfolio. That may be the lesson of the last few weeks. Sources of investment performance are becoming broader, by geography and sector, and that will require some degree of change from the narrow, US tech-led portfolios which have been successful in recent years.

But if I was to predict one thing with certainty for the remainder of 2025 it would be for continued bouts of volatility. The re-election of President Trump, the rise of protectionism, escalating global conflicts, and widespread uncertainty, coupled with higher valuations, all point to this outcome. Volatility in financial markets can of course be unsettling in the short term, but it creates opportunity for the longer-term investor. At this point it might be reassuring to remind ourselves of the Clarion approach to factor investing and the Clarion investment philosophy by clicking on this link.

As always, we thank you for your continued support and we look forward to updating you regularly throughout 2025. Please get in touch if you have any questions.

Keith W Thompson

Clarion Group Chairman

March 2025

Risk Warnings

Any investment performance figures referred to relate to past performance which is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments, and the income arising from them, can go down as well as up and is not guaranteed, which means that you may not get back what you invested. Unless indicated otherwise, performance figures are stated in British Pounds. Where performance figures are stated in other currencies, changes in exchange rates may also cause an investment to fluctuate in value.

The content of this article does not constitute financial advice, and you may wish to seek professional advice based on your individual circumstances before making any financial decisions.

Stock Market & Economic Commentary – March 2025