MARKET OVERVIEW
Q1 2025 began like a roller coaster, with numerous developments unfolding. These included a reversal of the prolonged US growth and tech trade, and a value recovery led by Europe and emerging markets. Additionally, interest rates displayed divergent trends, with rates declining in the US and rising in the eurozone. Even the typically sluggish European region has provided reasons to invest in its future. These changes have led to rapidly evolving shifts in trends, favouring value-oriented trades. The level of uncertainty was most acute in March, due to US-led trade tensions.
Key events during the quarter occurred in Europe and the US. Germany made a historic move by shifting away from its conservative and debt-averse fiscal policy to support increased defence spending and a special fund for infrastructure. In parallel, the EU announced the ReArm Europe plan, which could mobilise close to EUR 800 bn for defence spending. In the US, the Trump administration remained fully committed to its aggressive trade proposals, with potential widespread reciprocal tariffs to be announced in early April.
The equity market was therefore caught in significant cross-currents. In the US, investors worried about the negative implications of higher tariffs for the domestic consumer, growth, inflation, and the reaction function of monetary policy. On the European side, however, the mood was somewhat more constructive as cyclical equities benefited from the positive perspective of fiscal loosening.
INVESTMENT THESIS
The world is, to put it mildly, in flux. Politicians in many countries are thinking about how to respond to the actions of the new administration in Washington, D.C. The tariffs announced on 2 April went far beyond our expectations of their scope and severity – indeed beyond the expectations of almost everyone in the market. The 9 April announcement of a 90-day pause on some tariffs may provide only temporary relief.
The investment team’s immediate task is to consider how the companies in the portfolio will deal with this unprecedented shock to the global trading system.
The changes are much more radical than those under the first Trump administration. Back then tariffs were focused largely on China. In response, many companies relocated production or rerouted goods through other Asian countries (especially Vietnam, but also Thailand and India), allowing them to skirt the tariffs. This time there are few, if any, escape valves. Vietnam, for instance, now faces a ‘reciprocal tariff’ on its exports to the US of 46%, one of the highest rates of any country. As a back-of-the-envelope calculation, Asia faces an average reciprocal tariff of 30%, compared with Europe’s 20%. The effective rate the US must pay on imports could shoot up, as the chart below demonstrates.
At this stage, the investment team cannot predict the full effects of the tariffs. It is quite possible the administration will implement further carve-outs that soften the effects. Generation can say with more certainty, though, that they believe the portfolio is well prepared for what is to come. Since at least 2018, at the start of the Trump administration’s first trade war, the investment team have analysed the exposed to traded goods – particularly industrials, consumer discretionary and manufacturing-focused healthcare. Generation have assessed the implications for cost of goods sold (COGS), then moved to examine how companies might respond. Specifically, they have looked at their ability to pass on cost increases versus squeezing their margins – and how quickly they can do this. In short: pricing power.
From there, the investment team have tackled the more complex issue of the extent to which consumer demand may be destroyed or deferred – both of which are likely outcomes when prices rise. This part of the analysis depends heavily on where we are in different economic cycles. These cycles are not synchronised. For instance, the European residential cycle is not in the same place as the US one. The investment team have therefore been working to track the cycles individually.
Ultimately, our goal is to identify companies with two key traits. First, they must have a strong value proposition from the outset. Second, they must have some form of market power. If a company ticks both boxes, they should be able to pass on higher costs while minimising demand destruction.
It is also important to be clear about what Generation do not do. When a crisis strikes, it is tempting to retreat to defensive assets. During a trade war these include many companies involved in the provision of non-tradable services, such as utilities and certain consumer staples. Yet firms in non-tradable sectors tend to be mature and highly capital-intensive. They tend not to compound earnings over many years. The investment team generally have a bias against them, and seek to find capital-light companies with a great value proposition targeting large markets.
We are currently in a great environment for investing. At present the markets are driven by fear, responding quickly to the latest news development. People’s time horizons have compressed. Asset prices are highly correlated. At the time of writing, the investment team are active in the market, buying some excellent companies with strong long-term prospects that have derated.
PERFORMANCE REVIEW
Generation's process is underpinned by a bottom-up approach to stock selection, the manager refers to the stock attribution attached for the drivers of performance during the month of March.
As long-term investors that integrate a sustainability lens into their analysis, Generation is focused on their long-term outlook for the companies in the portfolio and whether their thesis remains intact, despite any near-term headwinds and share price movements.
The top performers during the month included Becton Dickinson, Steris and Nestle. The bottom performers included Adyen, Gartner and Workday. Whilst these companies are experiencing short-term headwinds, the Generation team retains his conviction in the long-term thesis on these names and others in the portfolio.
Generation is focused on strong execution of its process and has made adjustments on areas the manager identified for improvement.
