The year started with a sudden sell-off of AI-related sectors late in January, after a Chinese start-up called DeepSeek released a supposedly impressive and cost-efficient large language model. This fuelled uncertainty about competition, investment and pricing, and raised questions about what was implied in many valuations. It led to a pull-back in the previously unstoppable share prices of US technology companies.
This was an important break as equity markets had reached the highest peak in concentration since the 1930s, both within the US and for the US versus the rest of the world. What normally follows is either a recession or an increase in market breadth. Current data are not suggestive of a recession on the horizon and therefore a natural broadening out of the market appears the more likely scenario, at least for 2025. Over the last three months the MSCI Europe has outperformed the MSCI US by almost 8% as European shares have returned to favour. This trend could continue to gain momentum.
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As money has flowed into a few select companies in recent years, both near-term cash returns and the equity risk premium over bonds are historically low. On the other hand, there are parts of the market where cash returns are unusually high, especially in the cyclical sectors. We again expect a reversion to mean and believe that this gap will close as valuation disparities are set to narrow.
The previous two points should favour more mid-sized and smaller companies as well as non-US investments. We like to invest in global leading businesses and increasingly see opportunities in so call global mid-caps (market capitalisation $2-10bn). In this space, we like the prospects for those that offer outstanding product innovation and customer support in niches that large corporates tend to overlook.
Likewise, European industrial activity has been depressed for two to three years thanks to high energy costs, political uncertainty and weak Chinese demand creating overcapacity. However, some of these headwinds are abating and I’d expect a modest pick-up in activity that will further boost investor confidence. Even a small improvement in volumes in the materials and industrial space could change both profits and sentiment very quickly. What could follow is investors taking money out of expensive growth companies and reinvesting in attractively valued industrial companies.
Which brings me to the next point: the conditions are there for capital expenditure spending to increase. After decades of underinvestment and outsourcing, developed nations are still playing catch up in improving infrastructure. Additionally, we see reshoring and pressure to improve productivity. In the US, but also increasingly in other regions, this will continue to be stimulated by governmental support. Although President Trump is likely to revoke some of the loans and tax grants for green energy, many infrastructure projects have secured funding, and other forms of spending may well replace anything that is lost.
Some of these phenomena may persist beyond 2025, some may not. We have clearly entered a new era where it may prove to be dangerous to feel too certain of anything. The good news is that all this change creates opportunities. Our job is to try and separate the temporary from the lasting, be open-minded to the wide ranges of outcomes, and stick to a consistent valuation discipline.
There are no shortcuts and now, as far as the number of opportunities go, there are no excuses. There’s no time to rest, just enough to take a deep breath. As active managers, we wouldn’t have it any other way.
Bettina Edmondston, Graham Campbell and Alasdair Birch are portfolio managers of the WS Saracen Global Income and Growth fund
