Wake-up call for Europe

• Volatility is rising, fuelled by US politics and fears of a deterioration in the economy.
  
• The “Trump Trades” are weakening due to uncertainty over tariffs and the economic slowdown.
  
  
• Europe is holding up well, supported by the ECB and the investment plans being discussed by the Member States.

After a euphoric start to the year, stock markets showed signs of tension in February, with marked performance divergences across regions. These tensions were fuelled by the narrative of American exceptionalism and the uncertainty created by the numerous announcements of new tariffs imposed by the United States. The market seems to be gradually absorbing these announcements, raising concerns about their effects on corporate earnings and consumer sentiment, thereby amplifying worries about economic growth.

The S&P 500 recorded a decline of 1.30% in February, with the technology sector (-1.75%), communication services (-6.6%), and discretionary consumption (-9.0%) particularly affected. The stocks of the "Magnificent 7" – the seven largest U.S. companies – were also under pressure. The sharp drop in the discretionary consumption sector was largely driven by the correction in Tesla (-27.5%) and the decline in Amazon (-10.7%). Among these giants, only Apple (+2.6%) and Nvidia (+4.0%) saw their valuations increase compared to the beginning of the month.

Source: Bloomberg/Banque Heritage

European and Swiss stocks continued their positive momentum, outperforming U.S. markets in February. The Stoxx 600 gained 3.43%, supported by strong performances in the financial (+8%) and communications (+5.6%) sectors. Value stocks significantly outperformed growth stocks, with the MSCI Europe Value index rising 5.6%, compared to 1.7% for the MSCI Europe Growth index. The European financial sector remained in demand, supported by attractive valuations and a favourable yield curve.

The Swiss stock market saw an increase of 3.2%, led by heavyweights Nestlé (+12.4%) and Roche (+4.6%), followed by Holcim (+7.2%) and Zurich AG (+6.6%) among the best performers.

Bond markets, both in the U.S. and Europe, also saw gains, benefiting from lower long-term yields. In the U.S., the 10-year Treasury yield fell by 23 basis points, closing at 4.21% due to increasing economic uncertainties. The Citi Economic Surprise index, reflecting the U.S. economic climate, plunged into negative territory in February. Business and consumer confidence indices also showed signs of weakness, with the services PMI dropping to 49.7 from 56.9 the previous month. Consumer confidence, measured by the University of Michigan index, fell to 64.7.

In Europe, the yields on 10-year German Bunds recorded a slight decline of 5 basis points, closing at 2.41%. Optimism surrounding a potential ceasefire between Russia and Ukraine supported growth expectations.

In emerging markets, Chinese tech stocks continued their ascent, driven by enthusiasm surrounding DeepSeek and, more generally, the advancement of artificial intelligence in China. This helped the Hang Seng index rise by 3.4% in February.

A weaker U.S. dollar (DXY -0.7%) also provided some relief in emerging markets. In contrast, the Japanese TOPIX dropped by 3.8%, pressured by the appreciation of the yen after the Bank of Japan raised its benchmark rate to 0.5% at the end of January 2025. This rate hike pushed the yen higher, creating pressure on Japanese exporting companies.

The "Trump Trades" have taken a hit in recent weeks, and the month of March is not starting off on a positive note. The unpredictability of Donald Trump’s trade policy, particularly regarding tariffs, is starting to weigh on the morale of businesses and consumers. At the same time, economic indicators in the United States are showing a sharper-than-expected slowdown at the beginning of the year. The GDPNow indicator from the Atlanta Fed, albeit to be taken with caution, predicts a contraction of -2.1% in GDP for the first quarter. Although this figure seems excessive compared to expectations and is skewed by the fact that businesses are likely restocking in anticipation of tariff hikes, it still gives a clear trend regarding the evolution of the U.S. economy in the coming months.

Source: Bloomberg/Banque Heritage

In the face of uncertainty generated by Washington’s policies, the Federal Reserve has kept its interest rates unchanged since the beginning of the year. Chairman Jerome Powell even stated last week that the Fed will probably maintain its key interest rate stable in the coming months, waiting for the "uncertainty" caused by Trump’s policies to dissipate. Restrictive financing conditions and an unclear and highly emotional U.S. policy are factors that markets do not appreciate, partially explaining the strong underperformance of the U.S. equity market since the start of the year.

However, one positive point in this cloudy outlook: inflation. In February, U.S. inflation dropped to 2.8%, compared to 3% the previous month. These figures are below economists’ forecasts, which had expected an average of 2.9%. This is also the first decrease in inflation since September 2024. Excluding energy and food products, inflation reached 3.1% in February, compared to 3.3% in January. A less sustained inflation rate is good news for the Fed which will meet in the coming days, although no rate cuts are expected during this meeting given that uncertainty remains.

European equity markets, for their part, have shown remarkable resilience in the face of political events in the United States. While the economic situation remains more complex in Europe than in the U.S., the European Central Bank’s decision to ease monetary policy on 6 March has sent a positive signal to investors. Recent political events in Germany have also boosted investor sentiment.

Two weeks after the federal elections, the parties forming the next coalition announced their intention to create a special fund of 500 billion euros over 10 years to modernize national infrastructure, including transportation, energy, digitalization, as well as the education and research sectors. This plan aims to make up for decades of underinvestment. At the same time, military spending could be significantly increased, highlighting the need to sustainably rearm in the face of a rapidly changing world. The adoption of these measures, which would mark the end of German budgetary orthodoxy, is far from guaranteed, as the political path ahead remains complex. However, this awareness, which is not limited to Germany but also seems to be spreading to France, the UK, and other key European players, finally constitutes a positive signal coming from the continent. A longtime spectator, tossed between American supremacy and the rise of China, Europe seemingly has received an electric shock from Trump’s arrival. Past certainties and old alliances no longer hold; it is time to wake up!

During our last investment committee, we decided to reduce our exposure to U.S. equities in favour of Europe. Although the performance gap between these two regions is already significant, we believe that the political situation in the United States will continue to generate volatility in the markets. U.S. growth could slow more sharply than expected in the first part of the year due to restrictive financial conditions, significant political uncertainties, and inflationary concerns related to immigration policy and tariffs. Even though the recession scenario is not what we anticipate, we prefer to take profits on certain riskier sectors (such as biotechnology, for example) and reallocate these flows into European equities. The defence sector, despite having risen sharply in recent weeks, represents a strategic long-term sector in Europe, particularly due to the rearmament plans currently under discussion. Infrastructure is also an area that should also benefit from these expenditures.

The volatility we anticipated is indeed present, which is why it is necessary to maintain a diversified approach, combining growth pockets, yield, and assets that offer a high degree of diversification.


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