As we turn the page on 2024, one thing is clear: the world we invest in continues to evolve. The past year defied expectations, surprising us with economic resilience even as markets braced for turbulence. So, what did we learn, and how can we better prepare for what 2025 might bring?
No imminent rate cut but one is on the horizon: The US Federal Reserve (Fed), Bank of England (BoE) and Sweden’s Riksbank all kept interest rates unchanged at their meetings last week. Unlike the Fed and BoE, who pushed back against the prospect of imminent rate cuts, the Riksbank signalled that a rate reduction could come in the first half of the year. We still think the Fed, European Central Bank and BoE will likely reduce rates close to mid-year.
Major equity indices at/close to all-time highs: Despite the pushback on rate cuts, US equities continued to make record highs, pushing European indices higher too. The Fed’s Chairman, Jerome Powell, said that strong growth is no longer an issue for inflation and monetary policy. This comment, along with a rebound in US manufacturing activity, much stronger-than expected US labour data and resilient earnings for the big tech stocks, helped US equities close higher on the week. That said, there was some profit-taking in European equity indices, while emerging markets equities underperformed, dragged down by the continued struggle of the Chinese equity market.
Bond yields volatile: Government bond yields rose (prices fell) on Friday after the strong US jobs report. This is likely due to the fact investors had likely priced in too many interest rates cuts. We think a moderation in rate cut expectations is still likely and will remain a source of volatility over the short term. Further out, when central banks start cutting rates, the downtrend in bond yields is likely to resume.
Solid tech company earnings fail to excite the market: After a strong rally in US tech stocks over the last 3 months, Microsoft’s, Apple’s and Alphabet’s statements failed to excite investors even though results for Q4 2023 were above expectations.
How we’re positioned in flagship portfolios
Getting to a more balanced allocation: We will detail our latest house views in our February Counterpoint (released next week). In sum, the most significant change is that we now think the US economy has better prospects and a lower recession probability, given solid data most recently and an improvement in the main leading indicators. As such, we are slightly increasing our allocation to equities and reducing our allocation to bonds. This is a continuation of our actions since early December last year, when we started to moderate our defensive bias as interest rates have now peaked and, going forward, are likely to decline, removing a major hurdle for equities.
Shifting equities to neutral: We believe equities now have a more balanced risk-reward over 12 months because of the lower probability of a recession in the US. Therefore, we’re increasing our equity positions. We’re investing in global small caps (smaller companies) as they tend to benefit when economic and earnings growth improves relative to expectations. We’re also adding more broad US equities due to the improved growth outlook and the prospect of rate cuts from mid-year. This means we’re selling our US low-volatility equity position.
Adding high-quality credit in Europe: We’re increasing our exposure to European investment grade credit as valuations are attractive. To fund this, we’re reducing our exposure to US bonds and European/UK government bonds, which are less attractively valued.
Staying cautious in riskier markets: Looking at our regional exposures and investment styles, and across asset classes, we still maintain a defensive bias. We own fewer European excluding UK equities than normal: valuations seem fair, but economic conditions haven’t improved yet. And we still prefer low-volatility, defensive sectors in Europe such as health care, consumer staples and utilities as these tend to be less impacted by economic weakness. In fixed income, we still hold fewer high-yield bonds compared to our strategic asset allocation.
Portfolio diversifiers remain key: We are keeping our broad commodities exposure, which we recently introduces in our strategic asset allocation as it can help protect portfolios from any short-term uncertainty in geopolitics and energy prices. We also continue to strategically own developed Pacific equities excluding Japan, also a recent addition to our universe of asset classes, as it provides extra portfolio diversification, has attractive valuations and the potential to capture Asia-specific dynamics.
What we’re watching
Will China stay in deflation? The change in consumer and producer prices (Thursday) is likely to be negative, indicating that China’s economy continues to struggle. Months of deflation have weighed on Chinese equities, in addition to other factors such as the ongoing property crisis (last week, a court ordered the liquidation of Evergrande, China’s biggest property developer). Recent stimulus has failed to prove a tailwind for equities as stocks continue to hover close to two-decade lows.
Will the Eurozone rise out of stagnating growth? We believe this week’s German industrial production data (Wednesday), combined with last week’s preliminary inflation numbers and a variety of retail sales and other consumer indicators released over the past few days, and are likely to reveal that the bloc continues to stagnate or contract marginally. While there’s a sense of stabilisation in the leading indicators, economic conditions aren’t improving yet.
Past performance is not a reliable indicator of future returns.
