The shock waves were still reverberating around the markets from DeepSeek’s cheap artificial intelligence app when Trump dropped his tariffs bombshells.
DeepSeek challenges the dominance of the Silicon Valley giants. Tariffs are a geopolitical tool removed from economic orthodoxy. They erode the free trade infrastructure that underpinned globalisation and that acted as a deflationary force for many years.
All this means markets are facing a series of powerful and rapidly moving crosscurrents. (I am writing this while the US sleeps because that is my only way of being confident of reaching the end before things change, so feverish is the mood prompted by Trump’s return to the White House.)
The Nasdaq bounced quickly back to where it was before the DeepSeek strike, but Nvidia and other chip companies have not. Software has done better than hardware after a recent period of underperformance. Either way, a whole new debate has emerged more or less out of the blue sparked by low-cost Chinese piggybacking (something we have seen in so many sectors in recent decades).
We do not need to dissect whether DeepSeek is a genuine deflationary exogenous shock. And I have to be careful not to sound like I am seeing bubbles and calling an end to the market dominance of the Magnificent Seven and technology stocks in general. There is a saying that a bubble is something you don’t own that keeps going up in price. I don’t own any of the Magnificent Seven, which could make me sound very petulant!
I do not own them because I am an income investor with a strong focus on valuation. They are great companies but they do not pay high dividends and I think the stocks are expensive.
The importance of valuation
What I have found as a fund manager over the years is that the prism of income and value investing can open a world of opportunities for investors interested in building a broader base to their portfolio.
And the important word there is “world”. In the past two years, the North America exposure in our fund has fallen from half to a third. That compares to 66% of the MSCI All Countries World Index. Our fund trades on half the multiple of the market – and that is after topping its sector over one year and being top decile over three. It has an 8% free cash flow yield, which gives you a valuation cushion, one would hope.
Experience suggests that if there is a sell-off in markets, valuation usually helps. So where do I see the best opportunities for investors looking to mitigate the confusing array of risks we now face?
Where can you find value?
A quest for income stocks in under-appreciated areas has led us to be overweight Europe (29% of the portfolio) and Japan (10%). That’s where the dividend yields are high, often accompanied by share buybacks at decent valuations.
Europe is widely regarded as a basket case. We all know why. But European defence stocks have done well and still hold attractions in a more dangerous world. Consolidation is propping up valuations of European banks. Share buybacks and strong dividends mean banks are often returning a combined 30% or more of their market value to shareholders in just the next two years. In our top 10, we hold Germany’s Commerzbank, as well as the Italian bank BAMI; both have sought to rebuff bid interest from UniCredit of Italy. All you need in Europe is for the economy not to be quite as bad as people think for a bounce – as we saw in January.
Financials generally still look promising. We have an overweight to broad financials of 25% more than the MSCI index would guide a passive investor to own. After a good run, such a big sector exposure does present risks – especially if there is a recession or increased market volatility. Trump tariffs could be a catalyst for an unintended slowdown of the economy. That said, across the cycle, we believe interest rates will be higher for longer and inflation stickier than central banks would like to admit. Hence it is fundamentally a better environment for financials. That boosts lending margins at institutions which long ago repaired their balance sheets in response to the 2008 global financial crisis.
Having managed to make money when interest rates in their country were zero or negative, Japanese banks have rallied with the cost of borrowing this month hitting a 17-year high of just 0.5%, and the Bank of Japan signalling more hikes to come. Even so their shares are inexpensive, trading around 1x book value. Beyond the banks, Japan benefits generally from corporate reforms – and big Japanese companies are now buying back shares.
The world has just got more uncertain. I do not know if recent events will trigger a change in market leadership (but I do hope they will). Nor do I know what impact they will have on the global economy, but they should sound a warning note to investors to review their portfolios and put more value on value.
Jacob de Tusch-Lec is co-manager of Artemis Global Income and Artemis Monthly Distribution. The views expressed above should not be taken as investment advice.