We’ve been here before. It’s normal for markets to act more erratically during the later stages of the cycle. Yet beneath the market’s jitters is a generally positive environment of continued economic expansion in the US, and signs the Chinese government is committed to deploying broad-based stimulus in an attempt to support its economy.
All this amounts to an encouraging backdrop for risk assets, even if it promises turbulence too. Our message is this: stay invested in equities, seek carry trades, and be prepared to take advantage of market volatility.
Financial conditions look supportive
Bright spots in the year ahead
The US’s continued resilience should serve as a tailwind for equities, but there are some areas we particularly like. One is mid-caps. These avoid the higher valuations of big technology giants, while offering decent profits and the chance to benefit from late-cycle reflation.
It’s not just the US either - the earnings cycle appears to be broadening and should revive other mid-cap names in places like Japan and Europe too.
Likewise, within individual sectors, the prudent approach is to look beneath the shiniest stars. Take AI: undoubtedly huge potential, but investors cannot ignore the sky-high expectations priced into the Magnificent Seven stocks. The risk is that market capitalisation-weighted portfolios become overly concentrated and exposed to disappointment. We prefer to look at the picks and shovels underpinning the trend - smart grids and data centres, for instance - where valuations look more reasonable.
Nor do you need to look to the tech giants for the world’s best structural growth. Positive demographics, economic reform, and a shift in production away from China will continue to underpin select equities for years to come in places like India and Asean.
Transition materials are also of interest to long-term investors, acting both as a key to decarbonisation efforts and an inflation hedge. For 2025, it will be difficult to separate their fortunes from the situation in China. If the country’s stimulus programme exceeds expectations, it’s likely to bolster the green energy market and boost metals’ value – and vice versa.
Elsewhere, selected REITs (real estate investment trusts) have attractive valuations, and our bottom-up research analysts envisage a biotech upswing after a tough few years.
Carry on trading
Easing policy in both the US and China, combined with a contained default environment, creates a positive backdrop for credit and ‘carry trades’. However, with credit spreads approaching the most expensive valuations seen historically – priced for perfection, just like the Magnificent Seven – we will be selective.
There are some high real yields on offer in emerging markets, where investors display much less optimism. We believe several EM central banks could move rates lower than markets expect. That means we like high-yielding local debt markets and select EM FX, such as Brazil and South Africa.
In developed markets, given the positive fundamental backdrop but rich valuations, we look for relatively high yields and lower sensitivity to movements in credit spreads. Our research analysts are positive on shorter-dated high yield, the illiquidity premium embedded in CLOs, and high-quality bank credit.
How to position for the unknown
An air of uncertainty still surrounds expectations heading into 2025, especially in light of the change in administration in the US. In circumstances like these, our approach is to position portfolios to take advantage of the current conditions while making them able to weather a range of different scenarios.
