Another Year of US Dominance
Reminiscent of the start of 2023, there was broad concern that the US economy, a key driver of global growth, was weakening as we moved into 2024. With inflation heading in the right direction, markets were expecting the US Federal Reserve to prioritise its mandate of promoting full employment in a weakening economy, to begin cutting interest rates in the first half of the year, and to continue cutting regularly to mitigate the risk of a “hard landing” in the US economy.
The year has played out very differently. As we move towards the end of 2024, growth in the US economy has remained resilient underpinned by fiscal policy, higher productivity growth, strong domestic consumption and net immigration. The first rate cut was not made until September and, paradoxically, led to an increase in the yield on longer dated US treasuries. This reflects bond investors’ concerns that policy focused on early signs of weakening in the US labour market may see inflation remain above target and “sticky”, given deficit spending concerns and economic growth remaining above trend.
The Magnificent Seven Ride Again
This relative strength in the US economy has again translated into outsized gains in US stock markets for the second year running. New all-time highs have been made as we move through the 4th quarter towards year end. Gains in the S&P 500 are well over 25% for the year to date, while those of the tech focused Nasdaq 100 are currently over 30%. Notwithstanding periodic signs of investors rotating into other sectors and smaller cap companies, this is again largely due to performance of the big tech giants (“MAG7”). Nvidia, despite recent weakness, is up some 170% year to date, with Meta and Amazon also now up over 50%. Tesla has benefited from Elon Musk’s association with Donald Trump’s election campaign, rising over 100% in the last 2 months. Alphabet (Google’s parent company) has also seen gains over 20% in recent weeks on reports of a breakthrough in quantum computing. While these companies are expensive on many traditional metrics, they have continued to deliver strong earnings growth.
MAGA 2 – The Return of Trump
Despite the US economy’s robustness, the lasting impact of inflation, growing wealth inequality, and concerns at the level of immigration, Donald Trump was elected president for a second term in November. The Republican Party also gained majorities in Congress and the Senate paving the way for Trump to push through his America First agenda.
This is expected to have ramifications both at home and abroad, although details remain unclear. Pro-business policies of tax cuts and de-regulation should support a broadening of corporate performance, while anti-immigration policies and any aggressive deficit reduction measures (under the new “DOGE” -Department of Government Efficiency now headed by Elon Musk) may detract from growth. The extent to which tariffs are implemented will also see winners and losers globally. It is likely that fiscal stimulus continues in some form which may increase inflationary pressures. This in turn may restrict the ability of the Federal Reserve to counteract cooling growth and rising unemployment with looser monetary policy.
First time round, Trump saw a rising stock market as an endorsement of his tenure in the White House. He will wish to see the same again, but starting levels of markets and valuations may make this a much taller order as we move through his second presidency.
Can America Continue to Outperform?
Reasons for concern include valuation levels relative to history and other markets (the cyclically adjusted price to earnings ratio “CAPE” is some 80% higher in US markets than in Europe), and dependency on performance of a few highly rated stocks (recent gains in “MAG7” stocks have seen their market capitalisation rise to over 30% of the S&P 500 again). Allocations to US equities are also close to record highs as capital continues to be drawn in from domestic and foreign investors shunning other markets and asset classes.
Similar concerns have existed for a long time now, but US exceptionalism persists. There are some unique factors that act as tailwinds to this outperformance. The US stock market contains genuine global behemoths such as Microsoft, Apple and Amazon that generate huge revenues and profits internationally. Strong companies continue to rise from a culture of innovation with strong capital support. This has led to the rare phenomenon of a sizeable cohort of US domiciled companies being both exceptionally profitable and growing strongly at the same time.
We do not expect to see 2025 returns repeat those of 2024, and would not be surprised to see volatility in the New Year, but with forecast earnings growth for 2025 in excess of 10%, and the potential for a positive Trump effect, we expect US markets to continue to lead and anticipate modest rate cuts in a non-recessionary environment will promote broader participation from sectors outside technology and the mega-caps. Greater adoption of AI (Artificial Intelligence) within businesses should also see the benefits of productivity gains broaden.
UK – A Shot in the Foot, rather than the Arm?
Hope that the election of a new government in the UK would act as a catalyst for improved performance of UK markets in the second half of 2024 has proved misplaced so far. The negative rhetoric of the incoming Labour government and the Autumn Budget in late October undermined both consumer and business confidence.
While the UK stock market has delivered a respectable return in the region of 10% this year, this was mostly achieved in the first half in response to a reduction in the cost of capital and improving earnings outlook. But the added burdens placed on business by the new government from increased national insurance contributions, a rise in the minimum wage, and increased employee protections, have seen UK markets weakening towards the end of the year as economic data underwhelms.
We do see some scope for improved performance in 2025 given political stability and an uprating of forecast growth to the third fastest in the G7. Value in UK markets is also supported by M & A activity, particularly in the mid-cap space, where several companies have been bought this year at large premiums to their prevailing share price. This underlines the potential for re-rating should positive sentiment finally return and ‘stagflation’ can be avoided (low economic growth with stubbornly high inflation). Further interest rate cuts by the Bank of England would be supportive to markets and the economy, but recent inflation data is restricting their scope for now. One bright spot from the Budget was the level of money being raised for infrastructure investment.
European Markets Remains Challenged
While relative stability has come to UK politics, we are seeing the opposite in Europe. Since the election of Trump in November, the Scholz government in Germany has collapsed, French Prime Minister Barnier has been ousted in a no-confidence vote, and the influence of far right and populist parties has increased across the continent. Stagnant growth and weak productivity have contributed to a persistent low growth backdrop that has seen the European Central Bank cutting interest rates in October and December.
This backdrop has seen European markets in aggregate significantly lag the US, declining in the 4th quarter and leaving year to date gains of the broader European indices struggling to reach 5%. Dispersion is however high with the French CAC40 a notable laggard while the German Dax has returned 20% year to date despite the downturn in its domestic economy. With challenges ahead from internal politics, potential Trump tariffs, high energy costs, and a greater regulatory burden than other regions, the outlook remains challenging. The opportunity in Europe derives from its cheapness relative to the US. A Forward Price / Earnings ratio of 14% versus US of 22% and forecast earnings growth of 8% may attract investors should the US falter and European growth surprise to the upside. Moving into 2025, we favour exposure to quality companies with a global footprint that stand to benefit from growing demand for their services in areas such as data centre construction and specialist materials manufacture. We will watch the German elections with interest in February since if France and Germany can regain political stability in 2025 and the EU engages successfully with President Trump, then European markets could begin to recover.
Japan – Steady Improvement
The Nikkei 100 has seen gains approaching 4% this quarter but remains below levels reached earlier this year when the index finally broke through its previous all-time high mark set in late 1989.
Japan is another country that has experienced upheaval in politics, with Prime Minister Ishiba calling a snap election in October, which his LDP party lost, although he remains in power in a minority government. The outlook for Japan remains positive buoyed by a return to mild inflation that now appears to be sustainable, and the broadening of the corporate sector shift in focus from chasing market share to improving profitability and returns for shareholders. As a key US ally, Japan is also seen as largely likely to escape the threat from Trump’s tariff plans.
Asia and Emerging Markets – The Good, the Bad and the Ugly
There has been significant dispersion in Asian and Emerging Market performance in the fourth quarter. The Indian stock market has given back some of its gains year to date, dipping slightly leaving the Sensex up around 10% for the year, although the long-term story of a growing domestic economy and increasing integration in global trade remains intact. Brazil remains challenged with a weakening currency and a central bank raising rates again to combat resurgent inflation. Mexico’s economic outlook is exposed more than most to the uncertainty in policy developments of its neighbour, the US, under Donald Trump.
And what of China? Sentiment remains extremely depressed following an extended period of poor economic data, the continuing debt overhang in the property market, frugality among the domestic population, and the nascent threat from the new Trump presidency. The question then is what is in the price and who is left to sell? Government stimulus measures have to date been viewed as inadequate, but we recognise potential value in companies such as Alibaba and JD.com where strong fundamentals are now available to buy at low valuations. If further stimulus measures do lead to even a small improvement in sentiment, these valuations could re-rate upwards rapidly. However, until the path of US/China relations is clear with the new Trump Presidency and potential tariffs China remains high risk.
Government Bonds and Fixed Income
2024 has continued to see decent returns for fixed income investors. The best performance has been seen in US high yield markets where default risk has remained low as the economy remained strong. Investment grade has also performed well with spreads over government bonds tightening to post pandemic lows.
Higher starting yields and a strong backdrop for credit bode well for further positive returns in excess of cash in 2025.
Uncertainty over the scope for longer dated yields to follow central bank rate cuts lower in the absence of recession highlights the continuing risk in owning longer duration government bonds. Any persistence of inflation is likely to amplify this risk, such as the UK where gilts have been under pressure since the Budget in October.
With corporate bond spreads tight, a further value opportunity is seen in securitised instruments such as asset backed securities. These include Agency mortgage backed securities that provide an income and sit at attractive valuations with greater capital appreciation potential.
Commodities
Ordinarily, we would expect to see commodities perform well in an environment where growth is positive and inflation remains a concern and continues to persist above the ubiquitous 2% target of key central banks. This has however not been the case. The oil price has been trending down with surplus supply (Mr Trump plans to exploit US oil reserves in particular) despite the ongoing Ukraine war and the broadening geopolitical upheaval in the Middle East. Industrial commodity prices of copper and iron ore remain depressed with low growth forecasts in China. Agricultural commodity prices have also been mostly drifting lower with more supply.
The strongest performance has been in precious metals with the spot gold price up over 30% year to date in US dollar terms (with greater gains in currencies that have fallen against the dollar). There is a suggestion that liquidity that ordinarily may have found its way into commodities has in part been chasing cryptocurrencies such as Bitcoin, proponents of which advocate its value as a hedge against a loss of purchasing power via “dollar debasement”. The gains in cryptocurrencies following Trump’s election have been remarkable with the Trump presidency seen as crypto-friendly. Similar spikes in the past have however been followed by declines in the order of 70%. Please note, whilst the marketing of cryptocurrency is regulated in the UK, cryptocurrency investing is unregulated, highly speculative and very high risk; accordingly, we do not give any advice on cryptocurrency or include it in client portfolios.
Planned Positioning Changes in the New Year
As we move into 2025, the impact of policies from the incoming Trump administration in the US is likely to come to the fore. The nature, sequence and timing are uncertain at this time, with few firm details beyond the campaign rhetoric. We are likely to see tariffs implemented, but the extent and impact is unclear. Despite uncertainty, there are reasons to remain optimistic moving into 2025 with scope for global growth to broaden, inflation risks to subside, and central banks to progress with rate cutting cycles.
In this environment, we anticipate US markets will continue to lead and for performance to broaden beyond large cap growth. In core portfolios, we plan to increase US exposure slightly using existing low cost funds which provide a combination of market weight and equal weight exposure.
We plan to reduce slightly UK exposure to a neutral stance and exit dedicated smaller companies adding active exposure with a special situations and mid-cap focus alongside FTSE exposure.
In Europe we plan to exit the high conviction and concentrated Blackrock fund that has seen stellar long-term performance slipping of late in favour of a less volatile strategy focused on quality and dividend growth. Such a strategy is generally more resilient across the business cycle and defensive in challenging markets. Positioning will be marginally underweight.
In Japan, exposure will be moved marginally underweight retaining the current active Fidelity fund that has outperformed medium to long term.
Asia and emerging market exposure will also be moved to a marginal underweight with exposure via existing holdings. The Artemis Emerging Market fund is dynamic in its country and sector allocations and seeks a high margin of safety in holdings via its valuation screen. We see this as the optimal way to access exposure to the potential recovery in Chinese markets. Some dedicated exposure to India will be retained in higher risk portfolios, potentially supplemented with modest exposure to some frontier markets.
Dedicated holdings giving exposure to the global pharmaceuticals and energy sectors will potentially be switched into some new ideas to maximise growth in the New Year.
In fixed income, we retain a preference for shorter dated bonds, adding to existing positions via a reduction in money market exposure. This is in expectation that the general trend for interest rates is lower, albeit the pace is hard to predict. Lower rates at the short end of bond yield curves should see some compensation for lower rates via modest capital gains which is not the case in money markets. We also remain underweight government bond index exposure, avoiding greater duration risk (interest rate sensitivity), in favour of balanced exposure to active unconstrained bond funds that can invest in a broader range of securities and react to changes in the macro environment.
We are also reviewing our exposure to alternatives that provide diversification in portfolios through returns that are lowly correlated with equity and bond markets. There remains a risk that longer term rates continue to rise if fiscal deficits grow at pace and negatively impacts both stocks and bonds.
Please note that the content on this page is based on our understanding and the available information; we cannot be held responsible for any errors, and you should not act on the basis of the information in these articles, nor do they constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. Overseas investments are affected by currency movements and exchange rates. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch via telephone at 01392 875500 or email at info@SeabrookClark.co.uk.