March 2025 Newsletter

1 November 2024 – 31 January 2025

This reporting period provided positive returns for all major equity markets with North America providing the most significant growth as US business confidence was generally buoyed by Donald Trump’s convincing election win.

During the reporting period, North American markets outperformed with the Investment Association (IA) North American sector returning 9.66%. IA Japan, IA Europe (Ex UK), and IA UK All Companies returned 6.42%, 6.27%, and 5.04% respectively. The IA Global Emerging Markets sector and IA Asia Pacific (Ex Japan) provided more muted returns of 1.91% and 1.67% following strong returns in the previous quarter whilst IA UK Gilts fell by 0.13% as borrowing costs remained high.

The US election took place on 5th November 2024, being a symbolic date in the UK celebrating the unsuccessful attempt of Guy Fawkes to blow up the House of Lords in 1605 with gunpowder. Donald Trump swept to a convincing victory winning all swing states to provide a clear democratic mandate for his policies, being inaugurated as the 47th US President on 15th January 2025. His inauguration speech will likely be viewed by history as one of the most important speeches in a generation, and pointed to a new era of profound change, maybe even on the scale imagined by Guy Fawkes himself.

The key economic policies put forward by Donald Trump are the elimination of illegal migration and mass deportation of illegal immigrants, reduction in taxation for workers, significant expansion of manufacturing, significant expansion of energy production, and reduction to the cost of everyday goods. The first few weeks have seen the execution of 50 executive orders relating to wide-ranging matters such as the elimination of paper straws, a ruthless crackdown on waste via the Department for Government Efficiency (DOGE) headed by Elon Musk, and the implementation of tariffs.

The ‘honeymoon’ period is in full swing at the time of writing, with much optimism that ‘the Donald’ can deliver the paradisiacal vision he shares with his many supporters. Brexit voters may remember the festival mood that followed the referendum outcome on 23rd June 2016 however the £300m per week boost to the NHS remains elusive, as do many of the other expected Brexit benefits, reaffirming the reality that all change, even for the better, is often painful and slow.

Given the full democratic mandate, securing the borders and effecting mass forced deportation of illegal immigrants can be implemented in short order. Although this may reduce criminal activity, it will impact businesses that have used the cheap enthusiastic labour offered by hard-working immigrants. The long-term success of the US has been founded on immigration and the significance of this policy appears ignorant of the associated inflationary risks. Similarly, the imposition of tariffs is also inflationary and represents a tax on spending akin to VAT applied to imported goods.

Elon Musk and DOGE have implemented sweeping changes already, initially focused on the immediate disassembly of USAID, responsible for providing foreign aid, removal of diversity, equity, and inclusion (DEI) programmes together with many other initiatives targeting education, the IRS, and other government agencies altogether expected to create government spending savings of $1 trillion. At this early stage, the implementation of these new policies feels frenzied, immature, and ugly with mass redundancies announced gleefully and swaths of government workers characterised as incompetent, unproductive, and/or corrupt.

The breadth and speed of policy implementation is so significant, with few checks and balances in place, that unanticipated outcomes are certainly creating risks of unintended negative consequences. The multiple experiments being trialed simultaneously will be observed by other economies who will be drawn to strategies where the outcomes are positive. For example, the initiatives around government waste will be of particular interest as many economies, the UK included, have high levels of government spending and could be drawn to take a similar approach if the benefits appear to outweigh the disadvantages. No doubt, some of these experiments will be successful and adopted by others whereas the costs of painful lessons will accrue to the US.

The US has a population of around 4% of the global population and accounts for approximately 8.5% of global trade by exports and 13.2% of imports leading to a trade deficit of around $1.4trn. This is a key focus of the new administration wishing to level up trade through tariffs and close this deficit. However, little is said about the US stock market capitalization being nearly 74% of all global stock markets which is a distortion of a much greater magnitude and partly due to US stocks being significantly more expensive than their global counterparts listed in other markets.

The term ‘credit’ is derived from the Greek word ‘credo’ which translates as ‘I trust’. The value of money and other assets is a function of trust within a financial system. The US has benefited from high levels of trust within global markets, being considered a haven and further supported by the dollar as the global reserve currency. As the US turns to America First policies and launches trade wars against its closest allies there is a danger of trust being eroded damaging global support for US assets and threatening the key imbalance that favours the US. The phrase ‘be careful what you wish for’ feels relevant as the advantage of leveling trade could lead to the loss of a more valuable advantage elsewhere.

In the post-global financial crisis era the yield on Government bonds fell significantly with some countries, notably Germany, able to issue bonds with negative yields creating the remarkable situation that lenders paid interest rather than borrowers. The irrationality of bond markets was demonstrated in 2017 when Argentina, a country with a poor track record for debt repayment, issued a 100-year bond that was oversubscribed and offered a coupon of only 5%. A default occurred after only 3 years and the bond was restructured in 2020 with investors losing around 50% of their initial capital. The failure of the Argentina bond not only demonstrated irrational investor behaviour with this asset but also a wider problem in fixed interest markets which would later experience significant capital losses as interest rates normalized post-Covid.

The Tesla share price seems to present an ‘Argentina’ moment at present being over 100 times both the historic and prospective expected earnings. Tesla sells electric cars to many customers concerned about the environment and risks associated with global warming yet Elon Musk, as CEO, is working closely with Donald Trump who has withdrawn the US from the Paris Climate Agreement and has announced a policy to increase oil production under the mantra ‘Drill, baby drill’. Recent data suggests his association with Trump is damaging sales which have been further undermined by intense competition from low-cost Chinese electric vehicle manufacturers and high-quality German car brands. The high valuation suggests irrational investor activity and is unlikely to be confined to just one stock therefore other capital risks could also be lurking within popular US assets.

US gains in recent years have focused on artificial intelligence (AI) with many of the US’ largest companies investing significant sums in this new technology. The launch of DeepSeek by a Chinese company caused pause for thought as their AI models were produced on a tiny budget yet performed similarly to their expensive US counterparts. There is a question about how AI can be monetised to provide a return on a significant investment, especially if low-cost models can easily compete. Many technologies, such as broadband, have required costly investment to enhance the service only to retain customers rather than grow revenue. Current valuations are based on an expectation of future AI monetisation and would be vulnerable to any disappointment.

Given the risks of US policy deployment, where can investors seek potential upside and diversification outside of US assets? The most significant short-term risk is the application of tariffs with the effect on US indices unclear as the level of reciprocation by US trading partners in response is unknown. The two markets which appear attractive are the UK and China which are both at attractive valuations on a historical basis and relative to the US. The UK does not have a trade imbalance with the US and should be spared any punitive tariffs thus avoiding much of the current uncertainty. China, by contrast, has a large trade surplus with the US but was ruthlessly targeted by Trump during his first term and has become resilient to tariffs.

Although Donald Trump expects to bring prices down, economists generally view his policies as inflationary. JP Morgan has adjusted their forecasts and now expects no further interest rate cuts by the Federal Reserve in 2025. Conversely, Europe, the UK, and China are expected to reduce interest rates further or increase stimulus in the case of China, which generally supports asset values.

In summary, the new US President has created feverish excitement but is unlikely to be able to deliver on all promises. Given the US market is priced for perfection and demonstrating some ‘bubble’ type behaviors the current rapid policy implementation agenda ratchets up the risk of unexpected outcomes and potential losses. Meanwhile, other markets, particularly the UK, China, and Emerging Markets are offering attractive valuations with reasonable levels of earnings growth and so better placed to meet investors’ expectations.

Strategy

The election of Donald Trump has elevated inflation expectations, and we expect both inflation and interest rates to be higher for longer in the US while other economies, such as the UK, Europe, and China will reduce interest rates modestly this year.

The strategy of fast policy implementation in the US creates a risk of unexpected outcomes, particularly for US stocks which are priced for perfection and exhibiting some signs of being in a market ‘bubble’. The enthusiasm around AI is a particular concern as the route to monetisation of this considerable investment is not clear.

Diversification away from US assets is appropriate in favour of the UK, Asia, and Emerging Markets which are more attractively valued. Fixed interest holdings are positioned with shorter durations as the additional yield available for longer maturities is not adequate to compensate for additional duration risk.

Toby Ricketts CEO, Margetts Fund Management Ltd.

On 6 April 2024, the UK’s Lifetime Allowance (LTA) was abolished and replaced with a new lump sum framework. The LTA is the amount of savings you could take from all your UK pension savings (excluding the UK State Pension) without facing a UK tax charge. Since 5 April 2020, the standard Lifetime Allowance had been £1,073,100, unless you had some form of protection (for example Fixed Protection 2016).

Under the new legislation, three new categories of UK pension allowance have been introduced. The two of relevance to our clients are the Lump Sum Allowance (LSA) and the Lump Sum and Death Benefit Allowance (LSDBA). These allowances only apply when lump sums are being drawn from your UK pension(s).

• The LSA restricts the maximum cumulative UK tax-free pension commencement lump sum (PCLS) you can draw from your UK pension to £268,275 (25% of the former LTA) unless you have a higher protected amount.
• The LSDBA is the fixed cumulative amount of lump sum payments that can be paid to or in respect of an individual UK tax-free in life and death. The fixed limit is £1,073,100 (or any higher protected amount as above). Lump sum payments like PCLS use up this allowance. The LSDBA only applies if you have died before age 75.

Under the LSDBA when a death benefit is paid as a lump sum to a beneficiary, it will only be UK income tax-free if it falls below the deceased member’s remaining LSDBA. Any excess will be taxable at the beneficiary’s marginal rate of UK income tax.

However, any death benefits paid via Flexi-Access Drawdown are not tested against the LSDBA. So, on death before age 75, beneficiaries who choose beneficiary’s drawdown can draw as and when desired income UK tax-free.

If you die over age 75, all death benefits would be subject to income tax at your beneficiary’s marginal rate of UK income tax.