
If the post-Covid-19 years were about tensions building up on all fronts, 2025 is set to be about striking deals to release pressure and move things forward.
On the geopolitical front, the new administration in Washington is set to lead the way in addressing multiple pain points, including the war in Ukraine and the conflict in the Middle East. On the financial front, record-high interest rates previously created tensions in both public and private budgets.
The US consumer is back, but corporate balance sheets are also healthier than at any time in recent history. Lower interest rates on the horizon could thaw frozen activity in many areas. As a result, credit growth and corporate action could breathe some life into markets.
In 2025, global economic trends are expected to be characterised by a push towards growth, albeit with varying strategies and constraints in the major economies. In the US, the scope for further interest rate cuts has narrowed. The Federal Reserve faces limited flexibility due to robust economic activity, fuelled in part by the prospects of the Trump administration's fiscal policies and reaccelerating consumer credit growth.
Regarding the US dollar, Trump's anticipated reflationary policies -- triggering higher growth, higher inflation and higher interest rates -- are driving current support. However, the longer-term horizon presents possible downside risks for the dollar, as investors may start to demand a higher premium to hold US assets if fiscal risks become more pressing.
For traditional safe-haven currencies such as the Japanese yen and Swiss franc, fundamental challenges are expected to weigh on performance in 2025. The yen could resume its role as a funding currency for carry trades, while the franc could see further rate cuts from the Swiss National Bank.
FIXED-INCOME OUTLOOK
For most of 2024, the fixed-income landscape faced both heightened yields and sustained volatility, marking a period of considerable uncertainty for bond investors. While this volatility challenges traditional fixed-income investments, the rise in yields also offers potentially attractive entry points, especially in the range of 3-7 years, as extensive duration exposure remains unnecessary.
In the corporate space, BBB-rated bonds are the most attractive for the time being, with US high-yield bonds looking overvalued but likely to retain their premium for the foreseeable future.
Last year was a strong one for equities, driven by central banks embarking on a cycle of interest rate cuts, while economic growth held steady. Additional momentum came from the US election outcome, while enthusiasm for generative artificial intelligence kept investor sentiment high.
Unsurprisingly, quality growth stocks were the clear winners, especially large-cap information technology (IT) companies, while the defensive and commodity sectors lagged. Since mid-September last year, however, we have observed a notable rotation towards cyclicals, driven by a brighter economic outlook and a pro-growth policy backdrop following the US elections.
Regionally, we remain biased towards US over European equities, given the stronger growth outlook in the US. However, we believe it is time for investors to look beyond the Magnificent 7 mega-cap IT companies (Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia and Tesla). While this group has driven the S&P 500's earnings growth over the past eight quarters, we anticipate a broader base of earnings growth in 2025, a shift that has historically coincided with a more diversified market performance.
We downgraded the communications and healthcare sectors to neutral, taking some profits off the table. Cyclical sectors, which are more sensitive to economic changes and benefit from greater operating leverage, appear well positioned to benefit from the earnings rebound.
UPSIDE FOR CYCLICALS
Our midyear 2024 outlook encouraged an initial allocation to cyclicals, and we now believe it is time to increase this tilt. The rotation into cyclicals appears to be gaining momentum, particularly against a reflationary backdrop that favours the US. Cyclicals should also benefit from potential corporate tax cuts and deregulation under the Trump 2.0 administration.
On a parting note, we entered 2025 with an all-powerful US equity market. The outperformance of US equities relative to the rest of the world in 2024 has reached almost unprecedented levels. One may opine that the Magnificent 7 are no longer undervalued, however their exposure in the portfolio remain justifiable if those companies' investments in AI capabilities are monetised in the not-too-distant future. Moreover, there is always optionality hidden in their business models, as Alphabet reminded the world when it unveiled its microprocessor for quantum computing in December 2024.
In short, US equities are fully valued, while valuations remain fairly reasonable in the rest of the world. While we still see no risk of an imminent recession in the US, it is important to note we also entered the most delicate phase of the market cycle, when optimism borders on euphoria, with investor confidence and risk at their highest.
This year can be deemed one of capital preservation after two years of capital growth. We remain invested at the start of 2025, but are contemplating reducing risk at some point as the year progresses.
Kean Tan is Head of Investment Solutions, SCB-Julius Baer Securities Co Ltd in Bangkok.