Despite concerns that global growth would weaken in the latter stages of last year, economic activity ended 2024 on a solid footing, with the long-anticipated US slowdown yet to materialise. Consumption growth has remained supported by solid hiring and wage growth, and any softness in the manufacturing sector has been more than offset by a strong service sector.
The US Central Bank (Federal Reserve) cut its key interest rate by 0.25% at its November and December policy meetings. However, the resilience of economic growth and stickiness of service sector inflation has prompted it to pare back its interest rate guidance to just two more rate cuts in 2025.
Outside the US, however, economic data has remained mixed. On a bright note, China has seen a cyclical pickup in activity on the back of the People’s Bank of China’s dovish monetary policy pivot in September. We still expect long-term structural headwinds to growth from weakness in the real estate sector and soft consumption. The latter will require targeted fiscal support and the outlook for the next few months looks reasonably bright.
Eurozone growth continues to be dragged down by weakness in France and Germany, with the latter challenged by weak export growth and intense competition from the state-subsidised Chinese electric vehicle (EV) sector. The European Central Bank (ECB) cut its key interest rate by 0.25% at both its October and December meetings and whilst there remains a generally better growth dynamic in peripheral Europe, the ECB looks set to deliver another four 0.25% rate cuts by year end.
The UK has seen business and consumer confidence deteriorate in the wake of the October Budget. Projected government borrowing exceeded expectations and the increase in employers’ national insurance contributions landed badly with industry. After the Bank of England Base Rate cut, and with the implementation of front-loaded fiscal stimulus measures, there is now a somewhat shallower path of UK rate cuts anticipated in 2025. Whilst we expect at least three 25bps rate cuts in the UK this year, the Monetary Policy Committee (MPC) could probably do more, not least because growth estimates are being revised lower. However, a more aggressive MPC could cause long-term inflation expectations to lose their anchor, particularly if there is Trump-induced weakness in long-dated US treasuries.
Elsewhere, Japan has experienced a more favourable growth dynamic. Wages have been rising in real terms and consumption growth has picked up. Furthermore, it looks like the economy has finally exited the deflationary trap it entered in the 1990s. With the US Federal Reserve less dovish than last Autumn, there should be more scope for the Bank of Japan to increase interest rates on the measured basis from their current 0.50% level.
With Donald Trump’s decisive victory in the US Presidential Election, the US equity markets initially focussed on the positive impact of his tax cutting and deregulation agenda and recorded strong gains. Towards the end of last year, the prospect of less monetary policy support from the Federal Reserve, reflecting the risks to inflation from tariffs and curbs on immigration, generated volatility in US stocks which continued into the new year. Outside of the equity market, the biggest beneficiary of this Trump-fuelled US exceptionalism was the US Dollar, which continues to be well supported versus other G8 currencies.
It looks like the economy has finally exited the deflationary trap it entered in the 1990s.
Outside of the US, we have seen a reduction in growth expectations for its trading partners. The effect of tariffs is to create a form of supply side shock which will be most keenly felt in China, but also the Eurozone, and the key risk is a tit-for-tat trade war which creates a stagflationary economic environment. This risk was initially felt in a noticeable underperformance of Chinese and European equities during the autumn, but towards the end of the quarter, a nascent belief that the threat of tariffs could prove a bargaining tool for the incoming US administration saw these regional equity markets perform relatively better.
As we look to the rest of the year ahead, we need to recognise that there has been a significant shift in the thinking of policymakers around the globe. After the global financial crisis, policymakers focused on shrinking debt/GDP. Now, policy is set to boost growth, with monetary and fiscal policy aligned to support nominal GDP growth and inflate away the government’s debt burden.
In the round, this policy mix is reflationary and supportive of broad-based asset price appreciation, with equities as the main beneficiary. Notwithstanding this, we do recognise uncertainties around the US administration’s delivery of its policy agenda, which are likely to cause periodic bouts of higher-than-average market volatility.
Consistent with this reflationary outlook is our view that we will see a broadening out of corporate earnings delivery both by region and sector. With this in mind, we also expect equity performance to be less highly concentrated than in 2024, which saw earnings delivery and market performance heavily concentrated in the “Magnificent 7” US mega-cap tech giants.
Our regional equity preferences continue to include Japan, which in addition to a much more favourable domestic growth outlook is benefitting from long overdue corporate reforms to facilitate business portfolio restructuring and increase corporate investment. This should also help ensure that its business and earnings cycles are less correlated with the rest of the world.
Elsewhere, we are relatively bullish on Asia Ex Japan because of its favourable prospective growth differentials compared to the rest of the world — relatively high levels of operating leverage in the corporate sector make these regional markets 'growth-facing'.
We also favour UK equities based upon the prospects of stronger corporate earnings delivery leveraged to this year’s anticipated pick up in domestic growth, weaker Sterling, which boosts the overseas earnings of large-cap stocks, and attractive valuations.
The view on US equities is a closer call. On the one hand, the so-called Artificial Intelligence ecosystem may deliver sufficient earnings growth to justify the future earnings expectations of the most highly rated technology companies. In this case, the valuation gap between these and the broader corporate universe could begin to narrow as the latter essentially play catch up.
Trump’s policy agenda could cause a further, potentially unsustainable, rise in the budget deficit.
However, on the other hand, there is the prospect of lower adoption of new AI technologies, with companies less willing to invest in them. In this scenario, the valuation gap would narrow via a de-rating of the most highly-rated stocks.
At this juncture, it is hard to say which way this will play out, so we have favoured a modest underweight to US equities. This reflects the risk that highly-rated equities come under pressure as long-dated US government bond yields rise sharply to capture the risk that Trump’s policy agenda could cause a further, potentially unsustainable, rise in the budget deficit.
This leads us to fixed income. We expect 2025 to be a year of solid returns in bonds, with short and intermediate-dated yields falling modestly. We are slightly more cautious on longer-dated bonds, reflecting the fiscal concerns above, but would nonetheless use any material increase in yields as a platform to increase the interest rate risk of our bond allocation.
