Rudi’s View: A Cautious Preview Into 2025

This story features CSL LIMITED, and other companies. For more info SHARE ANALYSIS: CSL

By Rudi Filapek-Vandyck, Editor

Traditionally, the final weeks of each calendar year trigger educated predictions about what the year ahead might have in store for investors and financial assets, and this year is no exception.

What is different, however, is most predictions this time around are overwhelmingly dominated by restraint and caution, mostly because of historically high valuations for American equities.

No surprise thus, the most preferred scenario is for the current bull market driven by AI and large cap growth stocks to broaden out towards lagging cyclicals and smaller cap companies, with Europe and emerging markets ready to narrow the gap with the Almighty USA.

Not everyone is on par with that scenario. Certainly not everyone thinks US markets cannot continue to lead the rest of the world for another year, or longer.

President Trump’s America First policy approach draws a long shadow over next year’s prospects for non-US markets, with further China stimulus likely on hold until more clarity is gained on US import tariffs.

In Australia, the absence of RBA rate cuts and very little on offer in terms of earnings growth (current consensus 0.9% EPS growth) probably means direction and momentum for the ASX will be even more dependent on what happens in both major global policy centres.

While many a forecaster feels uncomfortable with current valuations for US equities, the lack of earnings growth in Australia doesn’t make the local market any cheaper, with similar observations being made about the local banks.

So what should investors expect? Is the future upside from central bank rate reductions and from AI-driven productivity already reflected in this year’s share market rally? Will Donald Trump’s additional stimulus reverse the bond market and crash today’s multiples? Are import tariffs the poison that ends global momentum?

Simple is not always correct

A lot of this year’s anxiety revolves around share market valuations. Last week, Robin Griffiths, Editor of US-based investment newsletter The Adaptive Asset Allocation Report announced he’d pulled out all his personal money from US equities to go all-in for gold instead.

“My nerves cannot handle it.”

Valuing equities isn’t that simple, however, as those investors who have failed to participate in this year’s rally because of perceived too high multiples can confirm.

Back in 2020, when PE multiples were as high as today, markets did not correct until 2022 and only because bond yields triggered a valuation reset on the back of central banks reversing policies.

This time around, central banks are cutting rates, not increasing them, though there is a lot of debate going on whether markets will need to scale back their projections for further reductions next year. The RBA locally hasn’t even started yet.

Hence, the first conclusion needs to be that simply isolating high PE multiples and declaring share markets overvalued and ready to fall into a deep black hole is, at the very minimum, an incomplete assessment; sorry, Mr Griffiths.

Potential for 2025 upside

You don’t have to be an uber-bull a la Edward Yardeni to discover that sometimes the broader context supports these high valuations, and continues to accommodate ongoing gains.

Yardeni sees multiple years of strong gains ahead on the back of accelerated corporate earnings growth from deregulation, less taxation, economic recovery and higher profit margins from AI-driven efficiencies.

But ignore the ‘everything will be perfect’ scenarios and US equities might still have another year of double-digit return in front of them, predict strategists at Morgan Stanley with ongoing economic growth, falling inflation, central banks continuing to cut and extra stimulus from the Trump administration combined creating a favourable background for US equities.

Other commentators maintain the view that simple share market averages are heavily skewed because of a small group of technology mega companies that justifiably trade on premium valuations, while the broader market ex these leaders is less stretched valuation-wise.

In the same breath, these outlook statements also highlight how the equities bull market might stumble in 2025:

-inflation stops falling
-bond yields rising
-central banks policy pivots in the opposite direction
-economic recovery weaker than expected
-returns and efficiencies from investments in AI disappoint
-corporate earnings growth loses momentum
-high and broad-based US import tariffs (?)

US correction overdue?

Irrespective of all of the above, global equity markets have performed unexpectedly well this year and high valuations, justified or otherwise, do make market participants more nervous.

Australia’s ASX200, for example, is trading on 18x-plus FY25 EPS estimate with large market sections, the banks included, enjoying very little if any upward earnings momentum.

That might change by the second half of next year, but a lot can happen in between, and markets do not necessarily have the patience to wait until better things arrive, as they may not.

An average multiple this high has only been recorded during the late 1990s-early 2000s and during covid-lockdowns in 2020. Most importantly: the exact same situation applies to US equities too (with the key differences of much better earnings growth and a central bank that is loosening).

Thus far in 2024, the local market has taken most of its leads from US equities (see also banks and technology stocks) so it’s probably wise to look over there for any signals of a pending market correction.

Such a ‘correction’, it has to be said, if it eventuates, should still only be a blip in an ongoing uptrend given the broader favourable background, as described earlier.

One popular method to predict the next correction is by measuring the time since the last occurrence and currently US equities are two years running without a serious pullback.

History suggests such uninterrupted rallies seldom stretch beyond three years, hence the year ahead, from a statistical point of view, should see equities correct to the downside at least once.

While interesting, this doesn’t provide investors with much insights into what might trigger a notable risk-off period, other than an as yet unknown event or the as always unpredictable tariffs-loving Donald Trump.

It’s the economy, stupid!

Recent analysis by Macquarie suggests a strong correlation between US economic data surprising positively and US equities rallying higher. In average performance terms, the S&P500 tends to perform materially better when data surprise to the upside than during times when they are not.

The difference between both scenarios is 14.4% versus 6.2% respectively in annualised performance terms. Macquarie’s data gathering also confirms the Australian share market usually manages to keep up with US momentum during the good times, but it underperforms noticeably when things get tougher.

The correlation is not 100% and doesn’t always result in a pullback for the share market, but in the current context it might add further trepidation for a market that already is keeping a number of participants near the edge of their seats.

On Macquarie’s assessment, positive momentum in US economic indicators might have peaked in mid-November, implying the weeks/months ahead might become trickier for US equities that are up some 28% year-to-date, following a return of 24% in 2023.

That argument for more caution might look even more apposite when we realise the up-cycle from July until mid-November has added nearly 9% to the ASX200, with the local index outperforming the 7% return of US equities during that period.

Macquarie’s FOMO Meter has returned above 1 (at 1.18), indicating investor sentiment is yet again very bullish.

Macquarie strategists have turned more defensive for the weeks ahead, shifting preferences to Healthcare (CSL ((CSL)) and ResMed ((RMD)), Gold (Newmont Corp ((NEM)) and Northern Star ((NST)) and REITs (Mirvac Group ((MGR)) and Charter Hall ((CHC)).

Among sectors that could be negatively affected, including from lower bond yields, are the banks, insurers and yield beneficiaries including Computershare ((CPU)) and Challenger ((CGF)).

The FNArena-Vested Equities All-Weather Model Portfolio, as reported previously, had increased its cash holding ahead of the US presidential election and is in no hurry to re-allocate it back into the local share market.

While we do not expect to see major mayhem ahead for equities, we are prepared to wait for opportunities opening up, also keeping in mind another reporting season is due to start in February.

****

Today’s Weekly Insights is the final one for 2024. The next update will be for late-January, ahead of the February results season.

I hope you’ve all enjoyed my writings as much as I enjoyed writing them, but now it’s time for recharching the battery and enjoying some of the finer things in life.

FNArena will continue its service up until Christmas Day. For ongoing updates on Conviction Calls and Model Portfolios, including the All-Weather, see my upcoming writings on Thursdays.

All-Weather Model Portfolio

FY24 review for the All-Weather Model Portfolio:
https://www.fnarena.com/index.php/download-article/?n=DE2A4552-E2C7-4DC7-0A896CE5CF68ACD8

Prior years:

FY23: https://www.fnarena.com/index.php/download-article/?n=DFC11150-CB36-C777-1AA3EDA640E2F5BF

FY22: https://www.fnarena.com/index.php/download-article/?n=DFE7241B-9CD8-61F1-1602C581A8E539C4

FY21: https://www.fnarena.com/index.php/download-article/?n=DFF82691-E53E-3CF5-17A2337D72CDB54F

Video: Why FNArena & All-Weather Stocks

I’ve used my participation to the InvestmentMarkets’ conference in July to explain how/why FNArena started & what investors get out of it, including research in All-Weathers and Gen.Ai

The video: https://bit.ly/3A1pLuz

Model Portfolios, Best Buys & Conviction Calls

This section appears from now on every Thursday morning in a separate update on the website. See Rudi’s Views for the archive going back to 2006 (not a typo).

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (21 since 2006); examples below.

(This story was written on Monday, 2nd December, 2024. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena’s see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: contact us via the direct messaging system on the website).

Click to view our Glossary of Financial Terms