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Equities normally go up and the economy usually grows at 2% to 3%. I think most annual investment outlooks could be reduced to that sentence and save the reader and writer a whole lot of time. That said, we are looking forward to 2025 here at IPS. If the economic backdrop remains benign (as we currently expect it to), is there anything else we should be worrying about?
The year so far has reminded me of 2017 and 2021. These were both good years for equity markets with a continual drift higher and you had the feeling that prominent bears were slowly throwing in their towels along the way. This week, one of the most well-known perma-bear analysts I follow (David Rosenberg) publicly gave up on his belief that the US equity market is in a bubble. He has been bearish (and mostly wrong) for the last 10 years and more. This does not make me feel good!
One other feature of 2017 and 2021 is that the years following them were both much tougher. And those negative market moves started happening almost straight away in January. So we are thinking here about 2025 and if there are any changes we want to make it would be better to make them now, rather than wait for the mood to change next year. In that light, the risk feels pretty obviously to me centred on the US which is the best-performing, most consensus overweight there is and which is trading at the highest valuation (even compared to its recent history). The chart below is always worth repeating. Anything that knocks the current story of US exceptionalism could, I think, see US stocks re-rate lower pretty quickly.
But it is worth remembering that for all the talk of Trump and tariffs and de-regulation, it has really been better earnings growth, and better earnings growth from a small number of technology giants that has been driving the market higher. As an example here is the earnings growth for the US Magnificent 7 technology stocks for the last 2 years vs the rest of the market:
A few observations on this:
- To get the US market right, you need to get US technology earnings right.
- The UK and Europe don’t look that different to the 493 US stocks that are not technology giants. They both have underwhelming earnings growth combined with underperforming equity returns. US exceptionalism is really about their (growing) lead in software.
- For all of the talk of the UK (say) being cheap, you will need better earnings growth than we have seen in the past for the UK to outperform. What is the catalyst for this growth? I am not sure Labour increasing employee tax for companies is helping much. Where else will it come from?
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- Finally, I am showing the last 2 years above but this trend has really been in place the last decade or more. One lesson in markets is that trends can go on much longer than you think possible at the start. It is always tempting to take profits and cut your US exposure but I could name some high profile competitors of ours who did this 10 years ago. Spoiler alert: this was not a great decision. The S&P 500 is up 250% over last 10 years in US dollars, compared to a 50% return for the UK and a 90% return for Japan.
It is very clear to me what the risk is (disappointment in US tech earnings) but it is also very clear what the trend is (US tech earnings are out-growing other sectors). After another good year for our US equity holdings we are taking some profits here but this is really just a re-balance back to our longer-term targets rather than a more strategic cut in our allocation.
Our strategy for a while has been to balance the much-loved US with much-unloved companies and funds in the UK and Europe. Our core UK and European funds both still trade at less than 10 times price to earnings (compared to a 23x P/E for the US today). We also added China a couple of months ago to our unloved basket. If US tech momentum does indeed continue into 2025 then I think we own enough of it to continue to make gains. But if and when a tech roll over does happen then I am hoping our much cheaper equity investments, along with our continued fixed income overweight, will offer some diversification. As ever, we shall see. But either way, 2025 promises to be another interesting year.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
