In our end of year wrap up for clients, our Investment Committee discussed everything from the year that was, geopolitics, elections, volatility in markets and what’s driving valuations to what we can expect from investment markets in 2025 and how to ensure our portfolios are positioned for growth in what will likely be a lower growth global landscape.
Global equities have risen significantly since October 2023.
Is 2025 a year where we need to balance optimism with caution?
A lot has happened during that period, particularly, with interest rates, predictability of earnings and the clarity going into 2025 versus 2024, which was a unique period with a record number of global elections that created uncertainty. The question remains how sustainable are the outstanding returns from US equities, particularly large-cap stocks? Returns over this period have actually reflected the earnings and earnings upside, as we are trying to track earnings in a nominal sense of circa 6.5% on average, and it’s been well above that. Given the lower interest rate environment, even though we’re in a shallow interest rate cutting cycle, rates won’t go as low as they have been in the last 10-15 years. Nevertheless, the framework is that those returns have reflected earnings growth. Expectation for 2025 is that US earnings growth is 10-14%, reverting to core 6.5% growth the following year. At a high level, the rally since October 2023 is justified given the circumstances, however we’re now targeting long-run averages of earnings, which whilst lower, still look quite healthy one-year forward, particularly US and not Europe.
What’s your on the ground perspective from London and thoughts on Europe?
We tend to focus on the US, as it is an increasingly significant part of global markets. The reality in the UK and Europe is that growth is anemic and the political uncertainty in Europe is increasing pressure on business earnings and hence equity markets, which we don’t expect to change over the next 12-18 months. Political turmoil remains, as elections haven’t reached any natural conclusions. There’s pressure from the right to effectively ‘Trump-ise’ the European hemisphere, which is still playing out yet perversely, the UK has gone slightly the other direction, with a Labour government that has done its best within 6 months of being elected to likely make themselves unelectable in 5 years’ time. The key reasons being poor budgetary policies with regards to business and policies introduced largely to appease unions and workforces. So, there’s little positivity in terms of earnings within the macro framework of the European Union and for that matter within the UK.
Moving to the US, what’s the mood of the nation, especially with Trump coming into office in January 2025?
While the election result may have been a surprise to parts of the US, markets had largely anticipated the result, despite strong early polling from Harris. What was interesting was people’s frustration at difficult economic conditions and inflation, which has certainly hit hard in the US as it has around the world. Yet the economy is in pretty good shape, performing strongly, earnings have been growing and employment is solid. So, there’s a paradox of the president being elected off the back of voter dissatisfaction with the economy, where the economy is doing well. There’s an expectation that with a republican controlled Senate and House, and Trump’s ability to bring Republicans into line, that he will be able to achieve a lot of his agenda, including tariffs. That’s important for people outside the US to understand, as whilst tariffs may be negative from an overall economic perspective, they are supported by a significant number of his base, as perceived low-paying jobs have gone elsewhere, there are jobs available, but not every metal-worker or car manufacturer wants to retrain as a computer programmer, and they certainly don’t want to move from Iowa or rural Indiana, to places like Denver, San Francisco, or New York where the jobs are. There is reasonable support for the tariff agenda in the US and he is likely to get that or parts of it, through creating winners and losers within the domestic US market. The market may not be ready for that kind of disruption, so until we see more details, we won’t know which industries are going to be affected.
On interest rates, is it fair to say that 2024 answered the question, “when will policy rates start to fall?” and 2025 will answer the question, “how low will rates go?” What are your thoughts, considering the shallower rate cutting cycle?
We’ve just experienced the most aggressive rate hiking cycle in 40 years, up until about seven or eight months ago. It’s also surprisingly the only interest rate hiking period that didn’t lead to a recession, which is quite unique. When there’s resilience in aggregate, you’ve got predictability in earnings and future credit conditions, and with core inflation in the US behaving, you don’t have to cut interest rates to emergency low levels. Another way to think about it is during the pandemic, there was $15-18 trillion put into the system with quantitative easing. With quantitative tightening there’s still about $7 trillion in the system, so on the back of that, there’s no need for the US to cut aggressively. Higher tariffs are inflationary, deregulation of the US economy and a stronger USD are disinflationary, so it’s a watching brief on inflation.
What’s the outlook for fixed interest and bond returns?
Each market is moving in a different way. Where the US goes will be different to Europe, UK, Japan or China. The EU is in recession if not close to it and lacking leadership. The UK, post-budget is likely to follow suit, so from a European perspective, interest rates are likely to be significantly lower than in the US. That has knock on implications for the Euro (possibly parity with the USD) and a weaker GBP against the USD. The policies enacted in Europe have been to slow down economies, rather than stimulate growth. By contrast, in Japan, inflation is emerging for the first time in some people’s lifetimes. In summary, there are opportunities in fixed interest, but you’d be brave to take on too much duration at this point in the cycle.
What’s the outlook for equity markets?
US markets are expensive, as opposed to European markets, which are not. If you buy 1-year forward cheaper valuations in core Europe, you may be disappointed in a year, given uncertainty of delivery. Valuations in the US are expensive, purely because there’s more predictability around earnings.
From a US perspective, the bulk of earnings upside has come from 7-8 stocks over the past 18-24 months, which has contributed circa 90% of aggregate EPS. The size of these companies means that an extraordinary amount of cash is spun out but on a 1-year forward basis. Deregulation of the world’s biggest economy will create other opportunities, hence the expectation of a more broad-based market.
Given an expensive US market, is now the right time to deploy capital, if we’ve been sitting in cash?
Pulling the trigger and buying US earnings 1-year forward is reasonable acknowledging they’re expensive on a multiples and earnings basis. It’s inherently difficult however to time entry into markets and consensus on EPS growth of 10-14% is positive, unlike other economies, including Europe. The US is introducing tax cuts in addition to deregulation, which should also contribute to EPS upside. That said, a well-diversified global portfolio is your best protection to preserve and grow your capital over time.
What’s going to drive the mid-cap part of the market, and what’s your view on that?
The AI technology dividend opportunity is mostly now reflected in the stocks that are directly manufacturing computer chips or control a lot of internet traffic. What we haven’t seen yet is increases in companies that could be significant beneficiaries from AI and able to automate their workforce or improve productivity, which exist in the small and mid-cap space. In the US, there appears to be more opportunity at that small and mid-cap end of the market than large cap at this point in the cycle.
To take a contrarian and long-term view, everything Trump is doing is isolationist—policies with America vs the rest of the world. History tells us that this ends badly for everybody. Over time retaliation to tariffs will likely significantly burden the US economy. The US has a population of 360 million people, as opposed to a global population of 9 billion. India and China and emerging Asia all matter ultimately more significantly over the long-term than the US so cutting themselves off from the rest of the world will at some point damage their economy and the great businesses they have and policies will change. The US will certainly not be without its challenges.
What are your thoughts on Emerging Markets at this point in the cycle?
Outside of China, there hasn’t been much to focus on. In comparison to the US, which appears to be relatively overvalued, Europe which looks historically undervalued, emerging markets are performing to expectations. Policies employed by the US are policies that will ultimately lead to its accelerating decline, if you cut yourself off and decide to trade with yourself, you inevitably end up with a smaller economy. How that plays out is impossible to tell, but you need to bear that in mind as you consider designing your portfolio over the medium-long-term.
China
The second largest economy in the world is still dealing with the largest property construction collapse the world has ever seen. When you have a balance sheet recession at the household level and negative wealth effects, municipals collapse as they have no earnings and to compound matters, there is weak domestic demand. On the other hand, China is the most successful efficient exporter on the planet, with exports the biggest contributor to national accounts and domestic demand, a detractor, yet they have no policies to address this. This needs to be solved by Beijing and the PBOC, as stimulus doesn’t work. In 100 years’ time, the Chinese population will be half of what it is today, a major issue that can’t be easily fixed, hence Southeast Asia is a beneficiary within emerging markets.
China looks somewhat like Japan when it collapsed in the late 1980s. Huge asset inflation ultimately takes years to work through, however breaking their trade relationship with the US, will likely force China to become creative and innovate their way out of this.
Everybody should be cautious about pointing fingers and worrying about property bubbles as, let’s face it in New Zealand, Australia and the UK we are not immune from this problem. There is huge asset price inflation in all these economies, which is unjustified. Property (houses) are not an investment and ultimately create a drain on economic resources. It’s money you can invest in businesses to grow, create jobs or use for innovation, rather than being tied up in an unproductive asset. There are a few economies that will bear this pain over the next few years and we will all suffer as a result.
Japan
Japan has retooled its economy over the last 20 years. It has the equivalent of an ASML there, robotics etc., the next generation of innovation. Japan is a buying opportunity largely because of the JPY weakness created by a strong USD and interesting opportunities, despite their long-term problems with demographics.
Australasia
The New Zealand economy is not without its challenges, rates are coming down, inflation is moderating and the RBNZ is trying to stimulate the economy. The fact that we haven’t ended up in a recession is positive and that will be reflected in the equity market, however, remember we’re coming off a low base. For example, over the last 5 years the MSCI world index delivered 76%, the ASX delivered 48%, and the NZX delivered 16%. That said, there are opportunities for well-capitalised businesses to acquire and there is optimism for a bounce in 2025, although growth will likely be muted. Australia’s central bank was hesitant to raise interest rates as aggressively as others, hence they are dealing with stubborn core inflation as both federal and state governments had overdone the stimulus. The RBA recently changed their narrative which creates a pathway for interest rates cuts in February 2025 but that’s predicated on weak economic data. There are inefficiencies with investing in your shelter, being your home, but societies are not rational investors. Expect interest rates to be higher for longer and when the RBA do cut, it will likely be shallow.