Following an excellent year for investors, we expect lower returns in 2025, with increasing opportunities for active managers.
The major themes dominating markets:
- US stocks continue to dominate global markets, at 74% of global market capitalisation. The ‘Magnificent 7’ now equates to an unprecedented 34% of the US market and over 50% of the S&P 500 returns.
- Australian share market returns have been dominated by Bank and Technology stocks, however, the share market faces headwinds from weak economic growth and falling productivity.
- Continued weakness in the economies and markets of Europe and the UK.
- China’s economy continues to suffer from a cautious consumer and weak property market.
- While short-term volatility is likely, active management opportunities are emerging outside the mega-caps.
Where are we now?
The December quarter 2024 was a reminder that markets never move in a straight line. Despite milder inflation and continued US and European Central Bank interest rate cuts, both global share market returns and the ASX 200 ended slightly down in US dollar (USD) terms. The significant fall in the Australian dollar (AUD) against the USD, turned the Q4 global share market return of -0.9% in USD into a solid 11.1% in AUD.
Global central banks reduced interest rates in 2024, with Australia being an exception
In February 2025, the RBA cut rates for the first time in 5 years reducing the cash rate from 4.35% to 4.10%. The positive move in bond prices in Australia reflected optimism that the Reserve Bank of Australia (RBA) will cut rates several times in 2025. It is unclear whether long-term rates will fall in the US.
The 12-month returns were exceptional for global, US, and Emerging markets.
Despite a solid performance, the ongoing weakness in the Australian economy explains the relative underperformance of Australian shares.
Asset class returns to end January 2025
Implications of the Trump Presidency
Commentators expect that while the Trump presidency will be pro-growth within the US, the impact on global growth may be negative. Trump has surprised the world with the speed of implementation of his agenda.
While there are considerable uncertainties for 2025, our base case is that there will be negotiated / delayed tariffs and a soft landing in the US. This implies that the US Federal Reserve would continue to reduce rates, the US economy should grow modestly (2.5%), and inflation will moderate slightly.
However, should US inflation increase significantly, or a trade war occur, this would hurt global share markets. Geopolitical tensions remain high and much depends on Trump’s approach.
Outlook for economies and markets
Most feel that investor sentiment is unlikely to send large cap share prices much higher in the US as this would require high and very optimistic company earnings to materialize. The Wall Street consensus is for a stock market return of 8-10% in the next 12 months.
Similarly, the outlook remains difficult for Europe, the UK and China.
Australia is in a more difficult position because, despite some evidence that we have hit the bottom, our economic outlook is uninspiring, with GDP growth and productivity continuing to fall.
Investment opportunities
The good news is that there are positive signs for a broadening out of returns beyond the large cap stocks globally (especially for the US). Likewise for Australia, as interest rates are cut and the Chinese Government stimulates the economy. This provides opportunities for active managers to find stocks, especially in the mid and small cap sectors.
We think Australian bonds could provide good returns at current income levels of 4.5-5% with the potential for capital gains when long-term rates fall. Likewise, investment-grade credit provides good returns for the low level of risk.
Conclusion
While headline index returns may be modest, we remain positive as there are increasing opportunities for active managers who look beyond the obvious mega-cap names. However, the combination of high starting valuations and economic uncertainty means diversification is crucial.
Our preferred approach is:
- Quality stocks over speculation.
- Active management over passive.
- Maintain exposure to bonds and high-quality credit for income and stability.
- Regular rebalancing to maintain target allocations.
The key is to remain invested. While short-term volatility can be uncomfortable, maintaining a long-term perspective and diversified approach remains the best strategy for most investors.
