The good, the bad and the volatile
The year 2025 saw global equities begin on a positive note, though leadership shifted, with Europe outperforming the US. Volatility was a recurring theme, driven by inflation concerns, disruptive developments in AI, and renewed trade tensions.
Early in the month, stronger-than-expected economic data and persistent inflation raised doubts about the pace of Federal Reserve rate cuts. Markets had anticipated multiple reductions, but the Fed signaled a more measured approach. In the middle of the month, China’s DeepSeek introduced a competitive AI model, leading to a temporary sell-off in tech names. Towards the end of January, the Trump administration’s announcement of new tariffs on imports from Canada, Mexico, and China had a negative effect on sentiment.
In Japan, equities were initially weak following a 25-basis-point rate hike by the Bank of Japan but recovered later, with the TOPIX ending slightly positive. European markets outperformed, supported by a rotation out of US tech and strong performance in financials and healthcare.
The Federal Reserve maintained its policy rate at 4.25-4.5%, while the European Central Bank delivered a widely expected 25-basis-point cut to 2.75%.
The Tareno Global Water Solutions Fund recorded a performance of 1.47% for the month (W-EUR Tranche).
Five key themes to watch in 2025
Inflation vs. Deflation: A Confusing Battle for Investors
Investors are caught between concerns about rising inflation and fears of deflation in certain sectors. While overall inflation remains stubbornly high, some manufacturers and distributors of commodity-based products have seen their stock prices drop due to deflationary pressures. Companies like Core&Main and Advanced Drainage Systems have struggled as they face declining prices in their markets. However, given the current monetary and fiscal policies, inflation is likely to stay above 2%, and pricing power should strengthen in 2025, benefiting companies currently seen as vulnerable to deflation.
Federal Spending: How Long Will the Government Keep Supporting Markets?
Since 2021, federal spending on water infrastructure has more than doubled, driving strong revenue growth for companies like Badger Meter and Xylem. While this spending has fuelled industry expansion, the key question for 2025 is whether leadership changes in Washington will shift toward a more balanced funding model.
Environmental Regulation: Will Policy Changes Impact Water Regulations?
There is ongoing debate about the future of environmental regulations, particularly with the shift in U.S. leadership. While some expect significant rollbacks, environmental protections like the Clean Water Act have bipartisan support. Recent incidents of water pollution, such as a chemical spill in New Jersey, underscore the necessity for effective regulation at both the federal and state levels.
Agriculture & Irrigation: Searching for Stability
The agriculture sector has been experiencing a protracted downturn since its peak in 2012, and forecasts for 2025 indicate ongoing challenges. Major equipment manufacturers such as Deere and AGCO anticipate significant declines in unit sales. However, companies like Lindsay have shown resilience, and if 2025 brings any positive surprises, investor sentiment may improve.
Valuation Disparities: A Challenge for Investors
The water industry has always had a range of stock valuations, but the gap has widened dramatically. Some stocks trade at exceptionally high multiples due to their perceived scarcity value, despite lacking strong financial performance. Price-to-earnings ratios have widened considerably from 14 to 45 times (compared to 16 to 26 times 10 years ago), highlighting a growing divergence between fundamentals and relative valuation.
Our month in water
Earnings season kicked off in January with reports from A.O. Smith, Badger Meter and Tetra Tech. While the reports did not bear major surprises, the visibility into 2025 seems limited.
The A.O. Smith business in China is still facing challenges, and there are signs of increased competition in the US market. The stock has already discounted many of these issues, and there may be an inflection point soon, especially if the Chinese government introduces stimulus measures.
Badger Meter released a report showing a solid operating performance, and we took the opportunity to reduce our position in response to the positive market reaction. Metering Infrastructure has been a beneficiary of federal spending in recent years, which might change under the new administration. With the earnings release, Badger announced the acquisition of SmartCover. The company provides assessment solutions for underground infrastructure such as stormwater networks. This is a timely move to diversify the portfolio away from metering.
Rolling with the punches
There is one situation that has recently stood out. Tetra Tech faces significant uncertainty under the new administration. Trump 2.0 appears more aggressive and unpredictable with threats to agencies like FEMA (Federal Emergency Management Administration), the EPA (Environmental Protection Agency) and USAID (U.S. Agency for International Development). While this poses a risk to Tetra Tech’s federal business which accounts for about a third of revenues, the stock has fallen about 35% from its pre-election highs, a sell-off, that seems overdone. At the end of the day, Tetra Tech remains a compelling growth story, led by a seasoned team of executives with a stellar reputation and a talented engineering team that will be in high demand.
Outlook and Positioning
Earnings reports will be a focus over the next few weeks, and it will be interesting to see how European companies perform in this challenging environment, and whether there will be a rotation out of large cap tech into small and midcap names. January pointed in this direction, but we have been there before. There is cause for optimism that Europe’s outperformance can continue. Just have a look at Ursula von der Leyen’s competitiveness compass.
Minimal adjustments were made to the portfolio, with only a slight reduction in US exposure and an increase in cash to capitalise on opportunities in the event of unjustified volatility following news flow.
