Despite ongoing concerns that global growth would weaken later in the year, driven by a downshift in US activity, this proved not to be the case, and, in fact, the US economy ended 2024 on a firm footing. Consumption has remained supported by solid hiring and wage growth, and any softness in the manufacturing sector has been more than offset by the strength of the service sector.
The US central bank (Federal Reserve) cut its key interest rate by 0.25% at its November and December policy meetings, but the resilient economy narrative and sticky service sector inflation have prompted it to pare back its interest rate guidance to just two more rate cuts in 2025.
Outside the US, economic data have remained mixed. 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. Whilst we still expect long-term structural headwinds to growth from weakness in the real estate sector and soft consumption, the outlook for the next few months looks reasonably bright.
Eurozone growth has been 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 November’s 0.25% Bank of England Base Rate cut, and with UK growth likely to pick up relatively strongly this year - reflecting front-loaded fiscal stimulus - there is now a somewhat shallower path of UK rate cuts anticipated in 2025.
After a weak start to 2024 driven by a sharp contraction in residential construction, 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, there should be more scope for the Bank of Japan to increase interest rates on a measured basis from their current 0.25% 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 the quarter the prospects of less monetary policy support from the Federal Reserve, reflecting the risks to inflation from tariffs and curbs on immigration, did create a modest pull back in US stocks (which still finished the quarter in positive territory) but nonetheless left the US Dollar as the prime beneficiary, rallying 6.4% versus Sterling over the quarter.
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 in 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, 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 rally into year end.
As we look to the year ahead, we do need to recognise that there has been a significant shift in the thinking of policy makers around the globe. In the post-Global Financial Crisis period the focus of policymakers was on shrinking debt/GDP via the numerator. Now policy is set to boost the denominator, 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 broadly supportive of broad-based asset price reflation as we head into 2025, with equities the main beneficiary.
Consistent with this 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 the unwind of cross shareholdings to enable businesses portfolio restructuring and increased corporate investment. This should help ensure that business and earnings cycles are less correlated with the rest of the world.
Elsewhere, we are bullish on Asia Ex Japan on favourable prospective growth differentials 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 mid-caps based upon the prospects of stronger corporate earnings delivery leveraged to this year’s anticipated pick up in domestic growth.
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”.
However, on the other hand is the prospect of less take up 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 yield 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 on to fixed income. We expect 2025 to be a year of “coupon clipping”, with short and intermediate dated yields remaining broadly stable. 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 bond duration.
The value of securities and their income can fall as well as rise. Past performance should not be seen as an indication of future results. All views expressed are those of the author and should not be considered a recommendation or solicitation to buy or sell any products or securities.
