Bond yields rose materially after the “hawkish” US Federal Reserve meeting on 18 December. The accompanying Summary of Economic Projections revised up both GDP growth and inflation expectations over the forward horizon while simultaneously lowering the expected number of US interest rate cuts.
This move follows the aftermath of the November election, underpinned by the expectation of material tariffs and expansionary budgets under the incoming Trump administration.
That has weighed on longer-duration assets, ranging from property and infrastructure to the ultra-long duration iShares 20+ Year Treasury Bond ETF. Australian bond yields, which had been moderately higher to begin with, have not moved as aggressively, and the weaker AUD has supported unhedged international equities.
Global shares
Uncertainty over “just how much” support China’s monetary and fiscal authorities provide to the economy weighed on the various China equity markets. The support measures are an impressive-sounding collection of ideas (bank recapitalisations, pull forward in consumer durables), but tallying it all up is leading to wildly different estimates of the size (is it 5% of GDP, 10% of GDP) and over what time frame.
Australian shares
In the local market, energy stocks bounced higher, although this is very much a “new year” phenomenon, and isn’t going to be as noticeable in the December monthly reports. US natural gas prices (Henry Hub) have risen given a colder seasonal start and European energy prices (TTF) are up materially given geopolitical developments, as gas pipeline flows to Europe from Russia via Ukraine dropped to zero.
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Investment outlook
Investment bank forecasts for US equities to the end of 2024 were way too conservative. The 2025-year-end price target expectations for US equities are about where they usually are, some 10% higher than whatever they ended the year at.
They get there, broadly speaking, by saying something like “nominal GDP at 5%” should be proportionate to sales growth, plus some operating leverage and financial leverage, and you get roughly towards the high-single-digit / low-double-digit range for earnings growth. Assuming no change in the Price-Earnings multiple, that’ll be your year-end price target.
Consensus themes for 2025 are as follows:
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Cautious Optimism for Risk Assets: Equities are favoured over bonds, but volatility may rise.
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Interest Rate Easing Cycle: Central banks are likely to continue cutting rates, supporting bond markets and consumer demand.
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Selective Sector Focus: AI, infrastructure, and energy transition will drive sector performance.
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Global Divergence: The US is expected to outperform, while Europe and China lag.
This broadly matches our views; however, we think bonds are very underrated at this stage of the cycle. Yields are high and compelling across cash, credit and government bonds, and as such we have a material allocation, even if the expected total return for stocks is a little higher.
We do see further rate reductions by central banks across the globe, but we don’t require material cuts to have this positive view on fixed income. However, it is likely required to keep economic momentum intact, which is, in turn, necessary to keep the stock market momentum going.
We are less constructive on the tech/AI theme, thinking it is largely priced in. This is mostly a US phenomenon, where the “Magnificent 7” trade at very high multiples, predicted on earnings growth from AI-related products that haven’t yet been built/monetised. However, the AI/tech angle has also driven Australian tech and tech-adjacent stocks to very high valuations, and we don’t see that continuing in 2025.
Regarding the global divergence, we do have small exposures to Europe and China in the portfolio, mainly on lower valuation grounds. Since the market is firmly of the view that Europe and China underperform, the odds that it is “priced in” are higher than they would otherwise be. The economic data for both regions is poor, although China is at least doing something about it (via stimulus, but even here we don’t really know how much or how effective such stimulus will be). These small positions within international equities really just amount to acknowledging, “we are underweight the US, which is ~75% of global benchmarks, on the grounds that having 50-60% is still a lot.”
Housing also remains something of a wildcard for 2025. In the US, interest rates are driving a clear correction in housing activity, although prices remain resilient. In Australia, interest rates are also driving a correction in activity, such as in Sydney and Melbourne, where prices have rolled over. Perth and other parts of the country are holding up, but housing and housing-related weaknesses will be key to watch regarding contagion to other parts of the economy.
We are optimistic for 2025 and acknowledge that successful long-term wealth creation relies on the principles of time in the market, adapting well-diversified investments as market conditions change, and maintaining the right mix of investments to achieve financial goals and objectives.
EWK Investment Committee
This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial advice prior to acting on this information. Investment Performance: Past performance is not a reliable guide to future returns as future returns may differ from and be more or less volatile than past returns.
