Looking to 2025 with healthy optimism

Monetary easing, fiscal support and surplus liquidity should – absent any exogenous shocks – provide enough support for risk assets to overcome geopolitical risks, soft global growth and reinflation risks in 2025 – at least over the first half of the year. Our Chief Investment Office explains further.

2024 has been far from disastrous for investors. Multi-asset portfolios have delivered gains well in excess of CPI+ targets and historical annualised returns. Yet despite the punchy numbers, it has been far from smooth sailing for investors. Geopolitical tensions, global elections, and political posturing, combined with sticky inflation, stretched valuations, and technical meltdowns, have made tactical positioning, portfolio hedging, and rapid portfolio adjustments crucial to achieving strong risk-adjusted returns.

Casting our mind forward to next year, we hold a healthy level of optimism that markets can continue to rise through the early parts of 2025. Just as pleasingly, we have greater conviction that risk assets should have a more stable platform from which to deliver. Nonetheless, investors seeking risk-adjusted returns will need to be no less nuanced in their approach to investing as they navigate the year ahead.

From a valuation standpoint, US shares continue to look expensive, both historically and relative to global peers. The S&P 500 is trading at almost 23x forward earnings. Its 10-year average sits closer to 19x. While hardly cheap, it remains someway from the almost 30x forward earnings at the turn of the millennium. Expensive? Yes. Frothy? No. Particularly given the general health of the US economy and where we hold greatest conviction that those earnings can be delivered.

It's true that the stock market is not the economy, but the continued disparity between the US and the rest of the globe makes it difficult not to place a growing emphasis on the economic health of individual regions.

Until recently, we held a preference for European shares, premised on valuations and a belief that the outlook for the European economy, while sluggish, should improve thanks to rising demand and central bank support.

Last month we adjusted our view. At 13x forward earnings, euro area valuations remain cheap, both relative to history and global peers, with the market currently trading at a near record discount to the US. Nonetheless, geopolitical uncertainty has risen across the euro area, the threat of tariffs looms large, there is growing discontent within some member states and the economy is contracting – the S&P composite PMI fell from 50 to 48.1 in November, led by a sharp decline in the previously resilient services component that fell to 49.2 from 51.6 in October. By comparison, the US economy continues to expand, the composite PMI edging up 1.2pts to 55.3 in November, signalling the fastest expansion in business activity since April 2022, with service sector output rising at the fastest rate since March 2022. 

While the market continues to price out expected rate cuts in the US, we now expect the European Central Bank to take its deposit rate to 1.5 per cent and deliver monetary stimulus not only to stimulate growth, but to support its inflation target over the medium term. Despite this stimulus, risks now appear more elevated for European equities in the near-to-medium term.

At home, the ASX sits at an all-time high and trades on a multiple of more than 18x forward earnings. Relative to its own historical standards it looks amongst the most overvalued globally – its 10-year average sitting closer to 15x forward earnings. Unfortunately for investors, and even despite the record high, this valuation continues to be driven as much by negative earnings revisions as it does strong performance. Year-to-date, the Australian market has trailed the US by more than 15 per cent in local currency terms. Looking ahead, we continue to see a rather benign outlook for domestic earnings over 2025.

The Australian economy is mixed also. Unemployment remains historically low, hovering around the 4 per cent mark, while activity remains soft – the preliminary November composite PMI fell to 49.4, with both the services and manufacturing measures now in contraction. At the same time, annual headline inflation was steady at 2.1 per cent y/y in October, but monthly trimmed mean rose to 3.5 per cent from 3.2 per cent previously. ANZ Research recently pushed its expected timing for the first RBA rate cut to May.

Valuations don’t tell the full story

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Moreover, the outlook for China remains a key question heading into 2025. President-elect Donald Trump has voiced his intention to pressure China, both economically and politically. To what extent he follows through remains to be seen. Perhaps of greater importance for Australia and indeed global growth is whether China retaliates, doubles down on its own stimulus efforts, or does both. Domestically, we would consider signs of increasing fixed asset investment from China as a potential boon for the Materials sector and a likely catalyst to add to our Australian equity exposure where we currently position with a mild underweight.

The threat of tariffs is also casting a long shadow over broader emerging markets. As the table below shows, many emerging economies (particularly in Asia), run large trade surpluses with the US and appear at increased risk to tariffs. Year-to-date equity flows into Asian emerging markets ex-China have turned negative, with outflows having accelerated over October and November alongside the increasing expectations of Trump’s return to the White House. Even with emerging market equities cheap, we now see better opportunities within risk assets. 

Asia, in particular EM is highly exposed to tariff threats

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We continue to be selective within both risk assets and broader portfolio positioning, paying attention not just to valuations and the macro backdrop, but also place an increasing importance on market liquidity. We expect this should be a key support for asset prices as the US Treasury looks likely to inject almost a trillion dollars of net liquidity into financial markets over the first half of 2025.

Monetary easing, fiscal support and surplus liquidity should (absent any exogenous shocks), provide enough support for risk assets to overcome geopolitical risks, soft global growth and reinflation risks – at least over the first half of 2025.

But in a year when Donald Trump is due to return to the White House, surprises would be most unsurprising. Tactically navigating portfolios through these shocks will remain critical for investors.

Our 2025 Global Market Outlook will be available in January and provide further detail on how we intend to position throughout the year ahead.

What this means for our diversified portfolios

With the backdrop for Europe appearing more uncertain, and near-term support for US equities looking more stable, we recently cut our exposure to European equities to a mild underweight from mild overweight previously.

The funds were reallocated to US tech-related shares – a segment we have viewed positively for some time. While valuations here are expensive, many of these mega-companies have strong balance sheets and significant competitive advantages. Moreover, we expect structural forces, including the need for productivity growth to be favourable for the sector over the longer-term.

At the same time, we have trimmed our exposure to broader emerging market equities. In the months ahead we believe there is likely to be opportunities for investors to benefit tactically from the threat of tariffs. However, given near-term uncertainty, we prefer to position at benchmark.

Elsewhere, we maintain a positive outlook for gold given geopolitical turmoil, increasing fiscal deficits, and robust purchases from central banks. Likewise, while yields have fallen appreciably in recent weeks, duration and carry continue to be attractive for multi-asset portfolios. We are positioned with a mild overweight to long-duration and sit at benchmark to short-duration. Duration remains an important diversifier in a multi-asset portfolio and if inflation concerns continue to be supplanted by growth fears, then duration should act as a strong hedge in a risk-off environment.