THE YEAR THAT WAS
At the time of writing, global stocks are up 24% year-to-date, driven by the US equity market’s 29% return, while Europe (+6%), Japan (+11%) and emerging markets (+10%) all lagged, but were still positive. The South African market’s 13% return in rands (+15% in US dollars) has comfortably outpaced inflation by more than 8%.
At the start of 2024, markets were pricing in six 25-basis-point interest rate cuts from the US Federal Reserve (the Fed) given concerns over slowing growth. As it turned out, growth was better than expected, reducing the need to cut rates to bolster the economy. The US economy remained surprisingly robust throughout 2024, but Europe is showing signs of strain.
Inflation in the US remained in the 3-3.5% range during the first quarter but has since cooled steadily to its latest reading of 2.6%. This is close enough to the Fed’s target range of ‘around 2%’ for us to say that the post-Covid-19 inflation hike is behind us. However, we are happy to see that central bankers are not complacent.
With nearly half the world’s population heading to the polls, we knew that 2024 would be fascinating from a political perspective. What was most interesting, however, was the fact that in all 10 major national elections – including those in the UK, France, the US and India – the incumbent parties saw their share of the vote decline. This is the first time this has happened in over 100 years of records and is evidence of a worldwide decline of trust in government institutions.
So while stock markets fared well in both 2023 and 2024, electorates made it clear that, in general, they felt left behind. The core reason for this was probably the post-Covid-19 inflation spike, which eroded purchasing power and left many feeling poorer. The key lesson here for politicians is that if they want to be re-elected, they need to keep inflation in check.
The US election in particular was a clear illustration of low social cohesion in that country and that the average American felt ignored by politics. After the election of Donald Trump, the focus in the US has already turned more inward – we would expect this to continue. While we do expect tariff increases on goods imported into the US, we suspect that the final outcome will be less dramatic than the rhetoric suggests.
Thankfully, tensions in the Middle East appear to have eased after fears of a region-wide conflict for much of the year.
China’s inability to rebuild consumer confidence post the pandemic continues to drag on that economy. Interestingly, this seems to have had a greater impact on oil markets than the issues in the Middle East. With 2025 likely to see a surplus in oil production and hopefully a cooling in Middle East tensions, we see some downside risk to oil prices in 2025. This would be good for inflation and therefore global economic activity.
OUTLOOK FOR 2025
Looking towards 2025, markets present something of a dichotomy. On the positive side, the US economy remains healthy, global inflation appears to be largely under control, interest rates are likely to decline further, and energy prices should be supportive of economic activity.
On the negative side, we have fading impetus from US fiscal policy, the lagged effects of restrictive monetary policy, the likely imposition of new tariffs, as well as weak domestic demand in both Europe and China.
Overall, we expect real gross domestic product (GDP) growth in the developed world to be in line with 2024 at around 1.6% in 2025, with the US at just over 2% and Europe at around 1%. Unless we see major fresh stimulus, Chinese real GDP will likely slow further to ~4%. South Africa should see an encouraging lift to ~2.2%.
At the same time, inflation should trend slightly lower in most regions in 2025, with the US likely to be around 2.3%, Europe close to 2% and China barely above zero. In South Africa, we expect inflation to be around 4.3%, marginally below the midpoint of the SA Reserve Bank’s target.
As ever, the link between these assumptions and asset performance is somewhat tenuous as markets appear to have already baked such views into prices. Rather, markets are more likely to be moved by changes to the consensus assumptions. Our US numbers are slightly ahead of consensus, and we therefore see scope for a mild positive surprise, while if the Chinese government delivers consumer-focused stimulus measures, there is upside risk to markets.
A key factor to watch out for in both the US and Europe will be the extent of immigration policy tightening and the impact of this on inflation.
The US stock market is clearly expensive relative to history, trading at around 22 times expected 2025 earnings compared to an average of about 16.5 times. We are starting to see signs of ‘animal spirits’ in the US market as investors appear bullish on both the broader US economy and the continued possibilities for artificial intelligence (AI). This environment bears some resemblance to the late 1990s, when we also saw a soft landing and a lot of hype around technology.
As always when markets become expensive, there are logical arguments for the trend to continue. The US appears well placed to continue its dominance of global markets, but we note that this appears to have already been baked into prices. Recall that around 2000, the consensus view was that the US was untouchable, yet US markets struggled over the first decade of this century.
The US has apparent advantages over Europe and China in terms of innovation (where it leads in the AI space), demographics (it has both a younger and faster-growing population) and its economic system (there are greater incentives to innovate and take risk, as well as the capital markets to support this). The one area in which the US lags both China and Europe is that of social cohesion. Over the short term, we would expect the US market to continue to outperform Europe, despite its stretched valuation.
South Africa’s growing momentum should accelerate in 2025. The flywheel of lower inflation, lower interest rates, better electricity availability and the government of national unity drives confidence for both businesses and consumers. Assuming no major external shocks, this self-reinforcing cycle should be positive for our local stock and bond markets as well as our currency in 2025.
PORTFOLIO CONSTRUCTION
It is always interesting to understand the broader macro environment, and this obviously plays an important role in our views on asset allocation. However, when it comes to the selection of the individual assets in our client portfolios, we will, as always, focus most of our attention on bottom-up research to identify great businesses with sustainable moats at attractive prices. Whatever the world brings in 2025, our clients can rest assured that we will continue to construct investment portfolios that are robust to a variety of potential outcomes.
We wish our clients a restful holiday season – thank you for your continued support.
