The portfolio performed well last week. It is up +11% for the year, outperforming the MSCI World index by 10 percentage points.

European markets have started the year strongly, but I think there may be more to come.

As Tej Parikh argues in the Financial Times, the US economy may face a recession in 2025, despite it not being the consensus view among analysts. There are two reasons for this:

1. Pre-existing economic weakness. Even before Donald Trump’s inauguration, the US economy was weaker than perceived. Consumer spending was driven by debt, with credit card delinquencies reaching a 13-year high in late 2024.

2. Impact of “Trumponomics”. Trump’s policies are introducing stagflationary pressures to the US economy. The proposed tariffs could raise prices while damaging consumer confidence. Inflation and unemployment expectations have spiked, and real consumption dropped in January 2025 for the first time in nearly two years.

Little help may be coming from the Federal Reserve. A cooling economy suggests rate cuts, but rising inflation expectations may force the central bank to keep rates high, further slowing growth.

At the same time, the situation in Europe has improved in a major way this year. A resolution to the war in Ukraine seems to be moving closer, while Germany is about to loosen the debt brake. The resulting fiscal expansion can be expected to boost the German and European economies over the coming years.

What are the investment implications?

While the European market has already rallied this year, only 4% of the money that left European stocks since the start of the Ukraine war has so far come back.

Conversely, only 6% of the money that went into Tech since November 2022 has been taken out.

This suggests there is much more potential in the Europe vs US trade.

European interest rates may go much higher. The size of the German fiscal expansion is about 2% GDP per year. At first I thought this would increase German long-term interest rates by +0.5%, based on empirical results from the IMF. www.imf.org/external/pubs/ft/wp/2010/wp10184.pdf

A recent Goldman Sachs analysis suggests the impact on German yields may be closer to +1%, however.

If Goldman is correct, the German 10-year interest rate could rally to 3.50%, up from 2.50% before the fiscal expansion news. We could end up in a situation – unthinkable just a few months ago – where German yields exceed US yields. www.investing.com/news/stock-market-news/its-lagnificent-7-now-not-magnificent-7-bofas-hartnett-3914325

If German yields do increase in the way predicted by Goldman, the euro will probably rally significantly, and European equities will almost certainly continue to outperform US equities.

This would be consistent with the Technology sector underperforming. The pace of innovation in AI this year is staggering and the societal benefits from the activity around AI will be immense, but a lot of the investments in AI will probably end up yielding low returns because in addition to the winners there will be many losers.

Just last week Chinese company Manus AI launched a new competitor to OpenAI’s DeepResearch. There are many strong large language models available. It also seems software companies will face more competition in future years as AI is making coding easier.

To position the portfolio for the new environment, I have reduced the share of real estate in the portfolio because this sector will be hurt by higher interest rates. Exposure has been increased to small and medium-sized European companies which have not yet rallied as much as the large caps and so could have more upside potential.

2025 is shaping up to be an interesting year.

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Tritax Big Box REIT was sold, Nexi bought.