Monthly Market Commentary - January 2025

Macro outlook

What’s happened:

Global equities enjoyed another exceptionally strong year of returns in 2024. US stocks were the standout performers due to higher economic growth rates and a greater weighting to the best performing sectors of the past 12 months, in particular technology. ­Although major central banks began cutting interest rates, the size of the reductions was smaller than many had anticipated at the start of the year, causing bonds to underperform.

Earnings growth and revaluation drove equities higher:

The MSCI North America index posted a 2024 return of 27.0%, outperforming the 20.3% for the MSCI AC World index (all returns in sterling, unless otherwise stated). This marked the second year running that US equities returned over 20%. Although higher valuations partly explain the strong US performance, stocks were also supported by rising earnings, driven by revenue growth and margin expansion.

While valuations have risen over the past year — the MSCI All Country World index traded at a 12-month forward price/earnings ratio of 19 in December — this is only slightly above the long run average and heavily skewed by the US. The gains mean that US stocks now account for more than two thirds of the MSCI All Country World index.

UK growth stalls:

US economic data continues to look solid compared to Europe, with the services sector especially strong. The UK economy is not faring so well, as growth has sputtered in recent months — Q3 GDP was 0% and the Bank of England (BoE) predict no growth in Q4. After solid growth in the first half of 2024 the subsequent fall highlights some of the challenges the Labour government face in delivering on its aim to put growth at the centre of its agenda.  This should not impact UK equities that much however as only 25% of MSCI UK revenues are derived within the UK.

Tax and borrow to grow?

Rachel Reeves’ tax-raising budget, with increased employers’ National Insurance Contributions and a higher minimum wage, is expected to hit the retail and leisure sectors hardest due to the relatively high number of low-paid employees. There are also some investment opportunities though, potentially around building products as the government aims to build 1.5m new homes in the next five years.

Strong absolute UK return but middle of the pack:

The MSCI UK returned a respectable 9.4% in 2024, underperforming the US but outperforming continental peers as the MSCI Europe ex UK returned 2.7%. Softer export demand due to China’s slowdown and political instability in Germany and France — the Eurozone’s two largest economies — weighed on performance. The pound ended the year 1.7% lower at US$1.26, towards the lower end of its 12-month range after the US dollar strengthened significantly following the US election. 

Interest rates fell, but less than forecast:

The outcome of the US election, and to a lesser extent the UK budget, have caused a move higher in bond yields and markets are now expecting Interest rates to be higher for longer. In 2024 the BoE lowered its base rate from 5.25% to 4.75%, the Federal Reserve (Fed) cut from 5.50% to 4.50% and the European Central Bank (ECB) reduced its benchmark rate to 3.0% from 4.5%. Derivatives markets are pricing in rates of around 4% for the BoE and Fed at the end of 2025, with the ECB expected to cut its key rate to below 2%. 

Yields rose in response:

The US 10-year Treasury yield gained almost 100 basis points since mid-September despite 100 basis points of Fed cuts. This move largely explains the comparable rise in the UK, with the 10-year gilt yield rising around 3.75% to 4.65%, suggesting higher UK yields are mainly due to external factors and not questions regarding the UK’s fiscal credibility. However, higher yields make debt more expensive and if they rise much further the government may need to reduce spending plans or raise taxes, in order to not break their own fiscal rules 10-year gilts returned -4.0% in 2024, although short-dated (0-5 years) bonds were positive, returning 2.5%. Investment grade corporates delivered a 2.1% return. We believe bond market valuations are attractive at current levels, but potentially sticky inflation and the strength of the US economy keeps us fairly neutral with regards to duration. Credit spreads tightened during the year and UK spreads are at their tightest levels since 2007.

Decent growth ahead:

We believe a global economic growth outlook of 3% real GDP for 2025 is reasonable and supports risk assets. The US economy remains robust and although labour markets have weakened slightly from tight levels this is little cause for concern at present. Inflation has returned close to target and core inflation is moving in the right direction. We see potential risks from inflation staying higher than expected and geopolitical tensions increasing. There is a lot of uncertainty surrounding the impact on trade and geopolitics from the implementation of tariffs and we are monitoring developments closely. However, we believe aggregate impacts on inflation from tariffs to be moderate compared to the inflationary backdrop of recent years.

After a couple of good years global equities have above average valuations due to the US market impact, but we take reassurance in that they remain supported by strong earnings growth and interest rate cuts. We also like bonds at current levels with attractive yields on offer and more interest rate cuts expected.