MARKET RECAP
Global equity markets closed out 2025 on a strong note, with international equities delivering their widest annual outperformance versus U.S. equities since the Great Financial Crisis (GFC). A weakening dollar, narrowing rate differentials, and attractive relative valuations all contributed to the reversal. A significant de-escalation in U.S.-China trade tensions provided additional relief and supported risk-on sentiment. Meanwhile, central bank policy paths diverged—the Federal Reserve (Fed) continued easing, the European Central Bank (ECB) held steady, and the Bank of Japan (BOJ) raised rates to their highest level in nearly three decades.
The fourth quarter proved challenging for our international portfolios as several themes that had contributed positively earlier in the year reversed sharply. Our Greater China holdings gave back a portion of their substantial gains amid profit-taking, though they remained additive to full-year performance. Value and cyclical leadership persisted, and we had no exposure to European or Japanese banks or to materials, where commodities rallied on AI-related infrastructure demand and precious metals prices. Within information technology, the market's enthusiasm for AI-related hardware contrasted sharply with weakness in application software and IT services, where concerns about potential disruption weighed on valuations. And in health care, company-specific concerns weighed on two of our holdings.
While this environment did not favor our quality growth approach, our investment philosophy remains unchanged. Our concentrated, conviction-weighted portfolios are designed to outperform market growth rates over an investment cycle. We prioritize businesses that align with secular trends and have strong competitive advantages and market positions. Our portfolio companies are chosen for their high profit margins, strong balance sheets, and consistent cash generation. We believe these qualities will endure even in challenging macroeconomic conditions, and we remain confident in the long-term potential of the businesses we own.
OUTLOOK
Looking ahead, we enter the new year with cautious optimism. Trade agreements have removed the most severe tail risks, but the underlying picture is mixed: inflation remains above target in the U.S., labor markets are softening, and central banks are no longer moving in unison. The key question for 2026 is whether the Fed can continue easing or whether persistent inflation forces a pause. Europe offers relative stability, though structural headwinds persist. And in China, policymakers have signaled a shift in priorities toward household incomes, but execution remains uncertain as export tailwinds may fade.
In the U.S., the Fed faces a delicate balancing act. Its most recent forecasts signal just one additional rate cut in 2026, reflecting the tension between a weakening labor market and inflation that remains above target. Recent minutes revealed deepening divisions, with some officials emphasizing the Fed can afford to be patient while others argued rates should be held steady for an extended period. Adding to the uncertainty, Chair Powell's term expires in May, and a successor more inclined to President Trump's preference for lower rates would introduce a new variable for markets. Indeed, the Fed may be facing a two-sided risk, with rate hikes possible if inflation re-accelerates, and pauses or cuts if the labor market softens further.
The most likely source of such a re-acceleration is tariff pass-through to consumer prices. Businesses have thus far absorbed cost increases, but those buffers are depleting. If inflation surprises to the upside while the labor market continues to soften, the Fed's balancing act becomes considerably more difficult. The health of the U.S. consumer adds another layer of uncertainty, with unemployment at its highest level in four years and sluggish job growth.
Europe presents a more stable, if subdued, outlook. The ECB is likely to hold rates steady through 2026, with inflation near target and growth projected at a modest 1.2%, though officials have emphasized that all options remain open on the monetary policy front. Fiscal stimulus should continue to support the economy, while the tariff framework with the U.S. provides a degree of certainty to export-oriented sectors. However, structural headwinds, including competition from China and Germany's slow recovery, underlie the modest growth projection.
China faces a challenging structural transition. The most recent Chinese customs data showed its trade surplus crossed $1 trillion for the first time, a milestone no country has previously reached. Despite reduced exports to the U.S., Chinese goods have found new markets in Europe and Southeast Asia, drawing scrutiny from the E.U. and emerging economies alike. While December's economic planning meeting signaled that boosting household incomes is now a priority, the coming five-year plan still lists strengthening manufacturing as its top objective. Consensus forecasts point to growth slowing to around 4.5%, slower than the country’s likely target, as export tailwinds fade. Stimulus measures have been targeted rather than transformative, and deflationary pressures continue to weigh on confidence.
In the International Fund, roughly 15% of assets are invested in Greater China* holdings, which is overweight relative to the benchmark. In the Global Fund, roughly 11% of assets are invested in Greater China* holdings, which is overweight relative to the benchmark. We believe our Chinese holdings are at valuation levels, in the context of their long-term growth outlooks and competitive positioning, that more than compensate us for the risks. Our Chinese holdings are focused on secular growth areas of the domestic economy (private consumption and health care) that align with government priorities. They have strong balance sheets, resilient cash flows, and are not reliant on restricted Western technology inputs for future growth.
Our investment strategy focuses on companies with strong competitive advantages, healthy profit margins, robust balance sheets, and consistent cash flow generation. In an environment of elevated tariffs and policy uncertainty, these characteristics matter more than usual. We believe our investment process is not affected by tariffs, and the quality profile of our portfolio companies means they are well-positioned to withstand external economic shocks.
Some of the most promising growth opportunities over long investment horizons may not be heavily influenced by current global events or specific regional circumstances. These opportunities include our investments in and around cloud computing, software-as-a-service, digital transformation, artificial intelligence, semiconductor technology, e-commerce, payment systems, industrial automation, electric vehicles, and innovative biologic and biosimilar therapies. Additionally, there are compelling growth prospects related to the rapid expansion of consumer markets, particularly in emerging economies and notably in Asia, which are driving the demand for various consumer products and financial services. In our view, slowing global economic growth should not undermine the enduring strength of these investment themes, or the business models and market positions of the companies in our portfolios.
U.S. market valuations remain significantly elevated, with the cyclically adjusted price-to-earnings (CAPE) ratio near historical peaks. In contrast, international markets trade at considerably lower valuations, offering a better starting point for future returns. A continued softening of the dollar may provide an additional tailwind. Thus, we remain strategically positioned with a preference for international equities, confident that our selective approach and emphasis on quality will effectively mitigate tariff-related risks while capitalizing on secular growth and valuation-driven opportunities.
*Includes China and Prosus.
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