CIM Market UpdateFebruary 2025 (covering the month of January)

Strong start to year for markets

·       DeepSeek’s rise triggers AI stock selloff.

·       President Trump warns of 25% tariffs on US imports from Mexico and Canada, effective 1 February.

·       Trump signs over 30 executive orders, including withdrawing from the Paris Climate Agreement and WHO.

·       UK inflation fell to 2.5% in December, driven by lower hotel and restaurant prices.

·       UK government bond yields drop after weak inflation data, having hit their highest level since 2008 the previous week.

·       The UK economy grew 0.1% in November, missing the 0.2% forecast.

·       Aldi, Lidl, and Sainsbury’s had record Christmas sales, while Asda suffered its worst since 2015.

·       Russian gas supply to Europe via Ukraine halted after the transit agreement expired.

·       BP announce 4,700 job cuts, over 5% of its workforce; Sainsbury’s plan 3,000 layoffs.

·       UK Chancellor Rachel Reeves backs FCA proposals to ease mortgage limits to boost homeownership.

·       Israel and Hamas agree to a ceasefire and hostage release, halting 15 months of conflict in Gaza.

January proved to be a strong start to the year, as both equities and bonds broadly delivered positive returns. President Trump’s return to the White House and his 'America First' agenda initially boosted US equities, but the emergence of Chinese Artificial Intelligence firm DeepSeek cast doubt on the US technology sector’s dominance, and resulted in a selloff of AI related technology stocks.

DeepSeek has claimed it took just two months and cost under $6 million to build an AI model using Nvidia's less-advanced H800 chips. An app powered by the model briefly became the top iPhone download in the U.S., leading a to a rapid sell off in technology stocks that until now had been priced highly due to the money they would make from their own high-cost chips everyone assumed were needed in the AI development race.

The Chinese company’s sudden release of a chatbot, that it says was radically cheaper to develop, was a wakeup call for an industry that for the past two years has operated under the assumption that the only way forward in AI was to have more computing firepower. Its arrival is a reminder that tech hype can make for a very volatile investment. When OpenAI introduced the world to generative AI with its ChatGPT chatbot, it kicked off a years-long rally in tech shares and turned Nvidia, a chipmaker known mostly among gamers, into a multitrillion dollar industry.

This time around, new innovation is threatening to puncture the bubble — if powerful AI models can be developed without Nvidia’s pricey hardware, the bullish case for AI spending suddenly looks a lot shakier. “If” being the operative word. DeepSeek puts its achievements down to innovation and clever use of less powerful chips. More sceptical observers say it may be piggybacking on western technologies or relying on more advanced US hardware than it claims. China’s DeepSeek has been threatened with ‘aggressive countermeasures’ by US rival OpenAI amid claims that the AI company ‘sucked knowledge’ from ChatGPT to develop its system.

The standout performer among major equity regions in January was Europe, which benefited from tentative improvements in eurozone economic data. UK equities also fared well, aided by the depreciation of sterling, which benefited exporters. The FTSE All-Share gained 5.5%. The US economy remained resilient, with strong job creation in December and annualised GDP growth of 2.3% in the fourth quarter. Optimism was further supported by Trump’s pro-business policies. However, DeepSeek’s innovative AI model pressured Nvidia, leading to a $600 billion market value drop on 27 January, which represents the largest ever one-day loss for a US stock in history. The S&P 500 Index returned 3.6%.

Elsewhere, Chinese equities edged higher, buoyed by improving domestic economic data and less aggressive tariff threats from President Trump than the 60% figure suggested during his campaign. However, a subdued performance from Indian equities weighed on broader Asian and Emerging Market indices.

Bond markets saw heightened volatility in January, as expectations of higher US inflation, driven by Trump’s tax cuts, immigration restrictions, and tariffs, pushed yields higher early in the month, leading to lower bond prices. UK bonds, in particular, came under pressure amid concerns over stagflation, a combination of high inflation and sluggish economic growth. This briefly pushed 10-year gilt yields to their highest level since 2008. However, bonds later rallied after weaker December inflation prints in the US and UK, and following the AI sell-off. Most global bonds ended positive, supported by tighter credit spreads.

Commodities also had a strong month, with gold and other metals rising amid Trump’s tariff rhetoric. Meanwhile, oil prices were lifted by cold winter conditions and US sanctions on Russia.

The British pound fell to its lowest level in over a year in January, as concerns grew over the UK’s rising debt burden and persistently high inflation. Market anxiety over government borrowing saw UK gilt yields climb, with the 10-year yield hitting 4.93%, its highest since 2008. This increase in borrowing costs could add pressure on households, with around 700,000 mortgage holders due to see their fixed-rate deals expire in 2025.

In response to market jitters, the government reaffirmed its commitment to fiscal rules. Darren Jones, Chief Secretary to the Treasury, told MPs that gilt markets remained “orderly” and insisted that “meeting the fiscal rules is non-negotiable.” His remarks followed a parliamentary debate on the growing burden of borrowing costs.

Despite assurances, investors remain wary. Gilt auctions continue to attract demand, but concerns persist over weak economic growth and inflationary pressures. The Office for Budget Responsibility (OBR) will provide fresh fiscal forecasts on March 26, potentially influencing government spending plans.

The strain in bond markets has revived discussions on tax rises or spending cuts. The Treasury has indicated a preference for expenditure reductions over tax increases if fiscal headroom tightens further. Chancellor Rachel Reeves, who left herself just £9.9bn of headroom in the autumn Budget after announcing £40bn in tax increases, now faces a challenge as rising gilt yields threaten her fiscal targets. With the government’s annual interest bill exceeding £100bn, maintaining credibility on public finances remains a key concern.

January highlighted the risks associated with high US equity concentration and lofty earnings expectations, reinforcing the importance of regional diversification. While the global economic outlook remains positive, we see government bonds as essential should political tensions weaken business confidence and growth. We also maintain an overweight position to alternatives within client portfolios, viewing them as valuable portfolio diversifiers amid ongoing inflation concerns and tariff uncertainty.