Monthly Market Commentary - February 2025

Macro outlook

What’s happened:

Stock markets made a bright start to 2025, with the MSCI All Country World index rising 3.9% in January (all returns in sterling, unless otherwise stated). European equities led the way higher with a substantial level of relative outperformance. Bond markets recovered from some softness in the first couple of weeks of January, with gilts providing a 0.8% monthly return.

What's ahead:

Deepseek disruption

The release of a generative Artificial Intelligence (AI) chatbot from Deepseek, a Chinese start-up, sent shockwaves through technology stocks towards the end of January. Deepseek’s R1 model, a rival of ChatGPT, surged to the top of Apple’s App Store as users rushed to use the new technology that is reportedly not only superior to competitors but, more importantly, produced at a fraction of the cost.

The clearest market reaction to the Deepseek news could be seen in US chipmakers, such as Nvidia, which experienced a swift market decline. These stocks have been some of the biggest beneficiaries of the burgeoning interest in AI stocks, as investors have piled in to companies making the “picks and shovels” for the technology — seen as a way to gain exposure to the broad theme without trying to select the big winners from productivity enhancements. Nvidia’s stock dropped 17%, wiping more then US$600bn off the valuation in the largest single-day drop on record. Utilities also declined on the belief that AI advancements may be less energy intensive than previously thought.

If Deepseek’s claims are to be believed the implications could extend further than just chipmakers. Big tech companies like Microsoft, Meta and Alphabet face the threat of new entrants into an area that was previously viewed as the preserve of very large companies that could afford massive levels of capital expenditure. The tech sector experienced its worst day in four years when the news broke, although there has been some stabilisation and recovery since. 

Sticking to their guns

Microsoft, Meta and Alphabet have all maintained or increased their commitment to largescale capital expenditures as they seek to protect their dominant market positions. Meta announced as part of its latest strong set of results that capital expenditure will rise to US$60bn-US$65bn, driven by AI data centre investments. Llama 4, Meta’s upcoming AI model, is expected to have much of the functionality that DeepSeek has recently broken through with.

Microsoft also acknowledged DeepSeek’s success but seems relatively unphased given its view that it continues to see advances in both hardware and software. Copilot was a positive within the company’s numbers as revenues were in line with consensus at 12% and bookings were strong, up 34%.

Apple’s broader ambitions now hinge on its new cycle of artificial intelligence, with a slight uptick in engagement following the recent release of Apple Intelligence. Apple is set to release additional language support for its AI in April, which could further boost adoption. The market has been getting excited about the implications of DeepSeek, believing that cheaper inference could significantly benefit edge AI. However, the company didn’t fully endorse the idea at its latest update, leaving some uncertainty around its long-term potential.

Fixed income:

UK government bonds delivered positive returns across the maturity spectrum in January after a shaky start. In mid-January gilts posted their best week in nearly six months as a string of weak data increased expectations of further Bank of England (BoE) rate cuts. The UK economy recorded 0.1% growth in November and although this marked a return to growth after two months of contraction it is still a meagre level and below consensus forecasts. An unexpected drop in retail sales in December also contributed to the notion that economic activity has effectively ground to a standstill.

There was more positive news with regards to inflation though, with an unexpected drop in the consumer price index to 2.5% in December. The reading is welcome given recent concerns that the UK is headed for a period of stagflation, where sluggish growth is accompanied by stubbornly high price pressures.

At its February meeting the BoE lowered its key interest rate by 25 basis points to 4.5%, the third reduction since August. Two of the nine rate setters voted for a larger reduction to 4.25%. The bank also announced its latest economic forecasts, cutting its 2025 GDP prediction to 0.75%, from 1.5% in November, while raising its inflation forecast to 3.7% in the third quarter. Derivatives markets are pricing a year end base rate of 3.75%.

Fed bides its time

The Federal Reserve’s decision to keep interest rates steady at its January policy meeting reflects a careful, data-driven approach in a time of increasing external pressures and market uncertainty. Despite calls from President Trump urging the Fed to cut rates more aggressively, the central bank opted to hold its ground. Inflation is still comfortably above the Fed’s 2% target and while inflation has slowed, several of Donald Trump’s policy proposals risk reigniting upward pressures.

The Fed has indicated that it’s ready to adjust its policy as new data comes in, but for now, it seems committed to a careful, well-reasoned strategy that resists both political pressure and short-term market fluctuations. In short, the Fed did a good job of convincing people that it wanted to cut rates but was in no hurry to do so.

The US economy slowed slightly in the final quarter of 2024, with the first annualised real GDP reading coming in at 2.3%, a little lower than expectations. While this is down compared to the 3.1% growth seen in the third quarter, this is only the first estimate, and we could well see revisions in the future. For the full year, real GDP increased 2.8%, which shows the US economy has remained remarkably robust during what has been a period of significant change, outpacing many of its peers.

A growing divergence between the US and European monetary policy is appearing, with the European Central Bank cutting its interest rate for the fifth time this cycle at its January meeting and derivatives markets pricing further rate cuts at its next three meeting. Derivatives markets are expecting no change in the fed funds rate until the summer.

Alts:

Gold made a strong move higher in January, rising 6.6%, as money flowed into the perceived safe haven asset amidst a backdrop of growing macroeconomic uncertainty. The biggest change driving prices higher appears to be the increased expectation of international trade wars. Oil prices edged higher in January, but to a lesser extent than the moves seen in gold, with Brent crude up 1.9%. The supply side of the market is caught between potential disruptions due to ongoing wars in the Middle East and Ukraine and Trump’s stated intent to increase US production.

The US dollar ended the month little changed after pulling back from a two-year high. Sterling declined by 1.0% against the US dollar in January, extending its decline in recent months to trade around US$1.24 — US$0.10 lower than where it was at the end of September.