Headwinds are blowing but conditions are supportive, so we see both risks and opportunities in 2025.
In addition, earnings growth forecasts for 2025 in the US remain optimistic, at around 15%. This continued resilience is to some extent a little surprising, because the global economy is not without risks as we move into 2025 …
Headwinds are blowing
The geopolitical dangers we have experienced in 2024 have so far not led to a slowdown. But further escalation of multiple tensions remains a distinct possibility. The war continues in Ukraine, with both sides taking ground and no end in sight. In the Middle East the situation seems to be escalating, despite multiple pleas for a ceasefire. Both of these are human tragedies first and foremost, but it is our job to look beyond this at the economic consequence. Short-term volatility is a real concern, and in the long term the possible re-emergence of inflationary pressures, both of which will impact companies directly.
In the US, we have recently seen a victory for Donald Trump in the race to become President of the United States. We also saw the Republicans gain control of the Senate and the House of Representatives, which will make it easier for them to make their desired changes. This could mean lower taxes (not withstanding tariffs, which could go up) and reduced regulation, and have implications for international trade as we head through 2025.
Economic nationalism is increasingly baked in. Tariffs and sanctions tend to elicit reprisals and have the potential to spiral. This will likely be an important theme in coming years.
Divergence on a downward path
Many global economies suffered the same inflationary shock from 2023 onwards, but we are now seeing diverging approaches to subsequent recovery and economic growth.
The Bank of Japan is an outlier, having raised rates by 25bps in July. Elsewhere, the European Central Bank was the first to move with two 0.5% interest rate cuts. The Bank of England has been more cautious, with a cut-pause-cut approach, as high wage growth remains a concern. And in the US the Federal Reserve started late but did so with an aggressive 50bps cut and followed it up with a further 25bps in November (Figure 1). At the moment it appears it has been able to engineer a “soft landing”, but it’s all eyes on the labour market for signs of persistent weakness.
Figure 1: Rates tracking down … at differing paces
Source: Bloomberg, as at November 2024
However, with underlying inflation around 2.5% and core inflation closer to 3% in the US (and not far off elsewhere), we don’t expect rates to fall as far as people think – certainly they will be higher than the 2010s (Figure 2). This will have implications for investors and how they position portfolios.
Figure 2: The inflationary shock has subsided … for now
Source: Bloomberg, as at November 2024
Risks and opportunities in 2025
A new terminal interest rate means a new environment for companies to navigate. The rate-cutting cycle should create a favourable backdrop for high-quality bonds, but we think credit dispersion will increase in 2025. Balance sheet health across industries is not uniform, with highly leveraged companies particularly within high yield potentially vulnerable.
Equities enjoy a falling rate environment. But the likelihood of rates not returning to previous lows means companies’ capital allocation decisions will be key to successfully navigating this new environment. The US continues to be the most expensive market, trading in excess of 25x forward earnings; by contrast, the MSCI All-country world index ex-US is at 16.30x. That gap is near its widest in more than two decades. But the US also remains the most dynamic market in terms of diversity of companies, with some of the most advanced semiconductor equipment firms and artificial intelligence and generative AI businesses.
At some stage the US will be too expensive, but underperformance is most likely to happen when other areas grow faster. If, for example, Europe grows faster it will look attractive because it is that much cheaper. Do we expect it to do so? No. Elsewhere, China disappointed in 2024 and although we are now seeing that stimulus come through, will it be sufficient to drive sustainable higher economic growth? Coupled with challenges around its demographics and uncertainties over tariffs and global trade, there is some risk there.
Five years out from 2030
The energy transition will continue with further investment in alternative energy likely. But we would also expect that as we get closer to the 2030 deadlines, we will see a further dilution of energy transition targets. There is also the potential for these negotiations to become more political as well as pragmatic, with trade tariffs playing an increasing role.
Deficits: a new year concern
Budget deficits are not a worry until they become a worry – and they ought to become a worry. Major global economies – from the US, the UK and Japan to much of Europe – are running deficits of 5%-6% (despite Europe’s supposed 3% limit). That may be manageable if interest rates are low, but if deficits continue to rise and rates don’t come down as much as expected, financing the deficit becomes increasingly problematic. When this eventually becomes a focus, it will become a market-moving factor.
Bottom line
For equities to continue their exceptional performance we would need geopolitical risks to stabilise; growth, but not too much; steady but low inflation so rates can come down … a lot has to go right. So although we expect gains, we wouldn’t expect a continuation of the 20%-25% growth in the US stock market. Fixed income should start 2025 from a good base: yields are attractive and central banks are engaged in supportive, rate-cutting cycles, but disparities will exist. Stock and credit selection will be paramount.
All market data is Bloomberg as at November 2024 unless otherwise stated
