Welcome to your March monthly market outlook from atomos
Defence and security have risen to the top of European leaders’ agenda as geopolitical instability persists across the continent.
President Trump paused military aid to Ukraine following an ugly public spat with President Zelensky, while European allies rallied to support Ukraine’s embattled leader.
Under the new US administration, there has been a renewed push for a peace agreement in the Russia/Ukraine conflict. Early discussions show some momentum from both a US and European perspective. European equity markets have rallied year-to-date, partly due to the possibility of lower gas prices, investment opportunities from rebuilding Ukraine (the World Bank estimates it would cost $500bn), and increased European defence spending.
We think challenges remain for all these themes. In the case of European energy markets, a peace deal is unlikely to restore Russian gas supplies to Europe to pre-conflict levels. However, we do expect to see a material impact from a huge spending package on defence and infrastructure just announced by the German government. More on this below.
Rush to fund defence
The foreign policy of the Trump administration has also brought the issue of European rearmament to the forefront. We can see this trend in recent announcements such as the UK's plan to increase defence spending to 2.5% of GDP by 2027, and the EU exploring new financing instruments to fund weapons programmes.
Europe is likely to look to Germany for leadership on this front, which underscores the increased focus on the German election results and the importance of a stable German coalition government. Expectations of increased government debt issuance to fund defence spending have been one factor creating moderate volatility in European government bond yields. However, the region will have to contend with competing priorities. Germany has a relatively low level of government debt to GDP and the scope to increase government borrowing and spending. However, other European countries including France, have less fiscal wiggle room. Consequently, higher defence spending could lead to welfare spending cuts or higher taxes, which could weigh on the broader economic growth environment.
Germany announces spending spree
Germany held elections on 23 February, with markets closely monitoring the results given their implications for fiscal policy, defence policy, and NATO relations. This is especially important at a time when the region is facing barriers to macroeconomic growth and fragilities in the NATO alliance. Results show the conservative CDU/CSU block, led by Friedrich Merz, securing the most seats, followed by the far-right AfD, with the parliamentary maths suggests a likely CDU/SPD coalition.
While the new parliament isn’t convened until 23 March, on 4 March the heads of the CDU and SPD already announced they want to implement a huge spending plan. If this is passed in the next two weeks, it would be a big boost to German real GDP growth: it could add 0.2%-0.5% to growth this year and more in 2026. This could be an important positive growth factor to help offset the risks to growth from likely US tariffs on European goods.
Strong start to the year for European equities
European equities performed well in the first quarter, significantly outperforming US and global stocks. The rally has been broad, with all major European sectors and country indices including the German DAX and French CAC delivering positive returns. Some possible drivers of this could be:
- hopes of a Russia-Ukraine peace deal
- a rise in industrial and defence stocks on higher spending expectations
- a rebound in global luxury goods demand from the US and China which has supported consumer discretionary stocks in Europe
- IT stocks benefiting from the AI theme
- loose monetary policy from the European Central Bank making it cheaper for banks to borrow than lend, boosting the financials sector.
However, the recent rally has only helped partially catch up the underperformance in 2024 and previous years (see chart), and we do not think it is the start of a sustained period of outperformance.
Our outlook for Europe
Overall, we believe the ‘easy gains’ for investors in Europe are behind us and the recent strong performance from European stocks is unlikely to continue. We don’t expect higher energy costs to come down quickly, even with a Ukraine-Russia peace deal. US trade tariffs on the EU are likely, which could have a notable economic impact depending on their scale. Europe has also lost market share of exports and faces increasing competition from Chinese goods.
Europe has experienced a decade of weak economic growth and low productivity, which will be challenging to reverse. However, the German government spending package is a clear plus for economic growth.
Markets fall on tit-for-tat tariffs
Meanwhile, Trump confirmed additional tariffs on goods imported from China, Canada and Mexico will come into effect following a month’s suspension from February. This news caused global equity markets to fall as China and Canada announced retaliatory tariffs. (Carmakers were given a one-month reprieve, which was enough to lift some stocks). We have not revised our outlook or investment views based on this as the impact we have seen so far is still well within the range of likely scenarios we had expected coming into this year. We are keeping an eye on the potential for a US government shutdown if lawmakers can’t close a deal around the federal budget or temporary funding measures for the upcoming fiscal year by the 14 March deadline. The issues of tariffs are fast changing so this information is correct as of date of publishing (6 March).
America’s biggest companies post impressive earnings season
The fourth quarter of 2024 was a standout earnings season for America’s largest listed companies, which recorded earnings growth at a three-year high, beating expectations. However, the percentage of companies posting positive earnings surprises was below the five-year average.
Earnings growth broadened out, with all sectors (except energy) recording growth. The financials, consumer discretionary, and communications services sectors led the way with double-digit earnings growth and significant earnings surprises.
Morgan Stanley data revealed mentions of ‘AI adoption’ in earnings transcripts hit a record high, pointing to the increasing use of artificial intelligence in big business. A key trend to watch is whether lower training costs accelerate AI adoption and shift focus from AI infrastructure to applications.
US shoppers hunt for deals
Credit card companies reported increased consumer spending, driven by holiday purchases, but it seems shoppers are looking for bargains. Major US retailers noted retail strength but observed selective consumer behaviour influenced by promotions. With a short-term drop in consumer confidence in February, consumer spending remains a critical US macroeconomic indicator to monitor.
Sector in focus: Energy
While energy stocks are up in absolute terms, the energy sector has been one of the worst performers since January 2024. The broader MSCI World has increased 25%, while the MSCI World Energy sector has risen 6% in total return terms. Price changes have primarily been driven by shifts in valuation, reflecting expectations of higher profits due to rising energy spot prices. Sector performance is influenced by three main factors: supply, demand, and geopolitics. Overall, we see these forces as being largely balanced. US supply has been plentiful and is expected to continue. President Trump has declared a "national energy emergency", embracing fossil fuels and degrading or rescinding clean energy policies. However, OPEC+ is likely to continue to mitigate this effect by restricting supply to defend prices.
The demand picture has been mixed across core economies, which is likely to remain the case. We expect US growth to remain robust, while we are less optimistic about European prospects. Also, while we expect reasonable growth in China in 2025, downside risks to this and China’s energy demand remain. Finally, geopolitical risks remain two-sided, in our view, relative to market pricing. We continue to monitor developments in the Middle East and Ukraine closely.
If you would like to discuss any of the topics covered in this month’s outlook, our door is always open. Contact us
Content correct as of publication on 7th March 2025
All investment views are presented for information only and are not a personal recommendation to buy or sell. Past performance is not a reliable indicator of future returns, investing involves risk and the value of investments, and the income from them, may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested. Any views expressed are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by atomos. Any expressions of opinion are subject to change without notice.