• High level of geopolitical uncertainty
• US growth slows, European earnings expected to improve
• Equity overweight spread across industrial nations

February presented a challenging environment for global financial markets, as investors grappled with heightened geopolitical risks, escalating trade tensions, and concerns over slowing economic growth. While US equities struggled, European markets demonstrated resilience, continuing their recent trend of outperformance. The S&P 500 fell 1.3% in February, erasing much of its year-to-date gains, while the broader MSCI All Country Index declined by 0.8%. High-quality government bonds, however, benefited from the risk-off sentiment, with US Treasuries returning 2.2%, while commodities saw mixed results, with gold rallying on geopolitical uncertainty and oil prices softening due to supply dynamics.

In the US, economic data painted a mixed picture, with early signs of slowing growth. Consumer confidence fell sharply, and household spending contracted in January, raising concerns about the sustainability of economic momentum. Inflation remains a persistent issue, with price increases proving more resilient than expected, limiting the Federal Reserve’s flexibility to cut interest rates aggressively. Although the labor market remains stable, recent trends suggest a softening in job creation, contributing to a cautious outlook for US equities. At the same time, the Trump administration’s trade policies have added further uncertainty, with increased tariffs on imports from China, Canada, and Mexico. These measures risk dampening corporate profitability and can lead to higher inflation expectations, complicating the Fed’s policy decisions. While markets have reacted negatively to these developments, we do not foresee a full-blown recession but rather a moderation in growth.

The European economy, on the other hand, has shown relative resilience, despite lingering structural weaknesses. Economic data has been somewhat better than expected, with consumer sentiment improving and credit growth stabilizing. European earnings expectations, which had been declining in previous months, have now shown signs of recovery. The political environment is also shifting, with Germany on course for a more stable government coalition that just unveiled plans for economic reforms and infrastructure spending. However, geopolitical risks remain a key challenge. The Ukraine conflict has taken a new turn as the US withdrew military aid, forcing European leaders to reassess their defense strategies. Increased defense spending across the region may provide short-term economic support, but it is not an optimal long-term driver of growth. Trade tensions with the US also loom, with potential tariffs on European goods still a risk. Despite these concerns, European equities have continued to perform well in February (STOXX 600 + 3.3%), benefiting from stronger earnings sentiment and a weaker euro, which boosts export competitiveness. After years of underinvestment, we believe higher fiscal spending would be well rewarded by equity markets as well.

Monetary policy remains a key market driver. In the US, the Fed is still expected to lower rates by 50 bps later this year, given that they remain in restrictive territory. The European Central Bank is also preparing for additional rate cuts, though inflation remains above target. Amid falling interest rates in Europe and potential risk to US growth, we believe high-grade bonds offer a compelling risk-reward.

Although policy uncertainty may contribute to increased volatility, we believe that the solid underlying corporate fundamentals will continue to prevail throughout the year. We project that earnings will grow at a high single-digit rate this year and into the next. While US companies have generally delivered solid results for the fourth quarter, the outlook has weakened, with analysts lowering earnings forecasts at an accelerating pace. In contrast, European and Japanese earnings trends have stabilized, providing a more favorable environment for equity markets outside the US. As a result, we have adjusted our portfolio positioning, reducing our overweight in US equities and increasing allocations to European and Pacific markets. Emerging markets remain neutral, as risks tied to global trade and China’s economic slowdown persist.

Fixed income markets have benefited from declining interest rate expectations, but we remain selective in our allocations. We continue to prefer high-quality bonds, particularly in Europe, where spreads remain attractive. We consider the recent increase in 10-year Bund yields to represent an opportunity, given Germany’s robust fiscal position. It is our view that bond markets have overreacted to what is perceived as a increase in credit risk arising from Germany's additional spending measures. In the US, investment-grade corporate bonds offer less compelling value due to tight spreads, leading us to maintain an underweight position. In commodities, gold remains a key hedge against geopolitical and inflation risks, while oil prices have softened due to supply dynamics.

Looking ahead, markets will remain sensitive to macroeconomic developments, trade policy shifts, and central bank actions. Geopolitical risks - including the potential for further increases in US import tariffs - are significant; however, we believe they will not impair growth to the extent that corporate profits and equities experience sustained underperformance. We believe the Trump administration is likely to ultimately step back from measures that could trigger a resurgence in inflation, disrupt the Federal Reserve's easing cycle, and halt the equity rally. Our overall equity allocation remains unchanged, although we have slightly reduced our exposure to the U.S. stock market in favor of Europe and Japan, where profit dynamics have improved.

Please find attached our last Asset Allocation Update for March.