- Equities: supportive macro mood music meets sky high US valuations
- Bonds are back in the room
- Waning cash rates are unlikely to seriously dent demand
- Gold is on a tear
- Bitcoin posts middling performance of 150% in 2024
Laith Khalaf, head of investment analysis at AJ Bell, looks at the prospects for equities, bonds, cash, gold and Bitcoin as we enter 2025:
Equities: supportive macro mood music meets sky high US valuations
“70% of developed stock market capitalisation, as measured by the MSCI World Index, currently resides in the US. Whether we like it or not, the US isn’t just the bellwether for the global stock market, it’s now most of the herd. The likelihood is that Donald Trump will push through lower corporate taxes and deregulation, which should be positive for US stocks, though at least a portion of the Trump bump is already in the price after the market posted stellar returns in 2024. The AI bandwagon also continues to whizz along, though there seem to be an increasing number of voices questioning how much fire there is under all the smoke.
“Markets are also looking forward to an easing of US monetary policy in 2025, albeit to a lesser extent than they were. As a mark of the shift in short term interest rate expectations, the US 2 year Treasury Bond is now trading at 4.2%, up from 3.6% at the beginning of October. This partly reflects monetary policy expectations getting ahead of themselves, but the prospects of sticky inflation have also contributed to higher yields. Trump’s policies on tariffs and immigration could lead to higher consumer prices, and the Fed pushing off interest rate cuts as a result.
“It may be boom time in the US stock market, but investors should also be cognisant of the historical context for the current valuation of the S&P 500. Robert Shiller’s Cyclically Adjusted Price Earnings Ratio (CAPE) current stands at its highest level since the Dotcom boom, and its more recent peak during the pandemic. The ratio had started to return towards the historical average during 2022, but the market took off again at the back end of that year following the launch of Chat GPT, and the subsequent frenzy for all things tinged with the promise of Artificial Intelligence. At the time when Chat GPT was released by Open AI, the S&P 500 stood at a little over 4,000. It is currently trading at over 6,000. This highlights the tremendous stock market hopes which have been pinned on AI.
“Undoubtedly Artificial Intelligence has the capacity to be a transformative technology, but the questions for stock investors are for what return, when, and at what cost? Alphabet, Amazon, Microsoft and Meta are already writing huge cheques to support the rollout of generative AI, which is a step change in the capital intensity of these businesses. Against a background of high valuations in the tech sector, and higher costs, any failure to meet revenue growth expectations in 2025 could be severely punished.
Source: http://www.econ.yale.edu/~shiller/data.htm
“Here in the UK equity valuations remain much more modest, reflecting the less growth-orientated sectoral make-up of the UK stock market, shallower pools of capital than the US, and an antipathy to investing in the UK which is no doubt partly due to its lesser performance when set against US stocks and funds. Nowhere is this more evident than in the relentless retail outflows witnessed by UK equity funds in the last eight years, which have accelerated sharply since 2022.
Source: Investment Association
“Rachel Reeves is trying to arrest this trend by corralling pension money into UK equities. Even if this proves successful, it’s a long-term game. It also flies in the face of the secular trend towards passive investing which allocates money to global stock markets in relation to their size. You can argue the toss about whether that’s a sound long term investment strategy, but it’s simple, it’s cheap, and people understand it. What’s more it’s delivered outstanding returns over the last ten years.
“Domestically-focused UK companies also have to deal with the squeeze on profitability stemming from the hike in National Insurance and minimum wage, while also selling into an economy which is forecast to pootle, at best. Falling interest rates should be mildly positive for the cost of servicing corporate debt, and might persuade some investors out of the familiar warmth of cash in a savings account back into the riskier world of stock investing. But, as long as the US stock market continues to motor ahead of other regions, money allocated to risk assets is likely to find its way across the pond.”
Bonds: back in the room
“Now interest rates have normalised and inflation has fallen back, bonds are back in the room and on the radar for investors looking for a balanced portfolio. They’re paying decent levels of income, and while prices can of course fluctuate, they don’t carry the huge valuation risk they did when interest rates were close to zero. Falling interest rates should be positive for bond markets but prices will depend on the extent to which policy actions meet expectations which are already baked in.
“A resurgence in inflation as a result of tariffs, energy prices, or Trump’s clamp down on immigration could push interest rate cuts further out, putting downward pressure on bond prices. Questions of sovereign debt affordability could also start to figure more heavily in bond pricing, especially in the US where Trump’s fiscal loosening is expected to add to the already sizeable US debt pile. The US has the luxury of having the world’s reserve currency, which helps underpin demand for its dollar-denominated bond issuance, though strangely the next President seems quite keen to undermine the dollar by promoting Bitcoin as an alternative store of value.
“UK government bond yields have been rising at the back end of 2024, as investors weigh up some of the inflationary impact of October’s Budget, and pare back expectations of interest rate cuts. Rachel Reeves has also turned the borrowing taps on, albeit to fund more capital investment, which means more gilt supply coming to the market. It’s notable that on the demand side of the ledger, plans to encourage pension schemes to invest more in UK companies will require them to invest less elsewhere. Seeing as the favoured investment habitat of defined benefit pensions is government bonds, if the Chancellor is successful in driving pension monies into UK shares, she might find it reduces demand for gilts and leaves her paying more to borrow money on the debt markets.”
Cash: waning rates unlikely to dent demand
“UK consumers are absolutely in thrall to cash now interest rates have risen. 2024 was a bumper year for Cash ISA sales and, though the interest rate cycle has peaked, falling rates aren’t likely to peel off too many savers after over a decade when returns on cash were close to zero. At the margins some may be tempted to take more risk by investing in the stock market if rates continue to fall, but many will likely stay put in the sanctuary of cash, albeit the regulator reckons millions of people should be investing in risker assets instead. In 2021, the FCA identified 8.4 million people holding more than £10,000 in investible assets wholly or mainly in cash, and targeted a 20% reduction in that number as part of its strategy. But by 2023, this figure had risen to 11.8 million people. Lower rates will mean savers have less of a buffer against inflation, and possibly none at all if they’re holding cash in uncompetitive accounts. However, the fact that so many people have been willing to hold cash, even when it was losing money in real terms, suggests this is more about an engrained habit than a reasoned strategy.”
Gold: on a tear
“It’s been a rip-roaring year for gold, and the macro-economic conditions which have created the surge in the price of the precious metal still look intact, though a repeat of 2024’s blockbuster returns are probably too much to hope for as we enter the new year. The dollar price of gold has risen by 29% so far this year, putting it neck and neck with total returns from the S&P 500, which itself has been on a tremendous bull run. Geopolitical relations remain fragile, reinforcing gold’s safe haven status, and government debt levels, especially in the US, are high and rising, and unlike sovereign bonds, gold carries no credit risk. It can also be buried in a vault, which if you’re a country or individual worried about international sanctions, is a bonus.
“If Trump’s tariffs take a bite out of international trade flows that would weaken the global economy and be supportive of gold. But equally if those tariffs also push up inflation, and keep central bank interest rates higher for longer, that’s negative for gold, which pays no income. Gold is well-known as a safe haven, but it is volatile and has spent long periods going sideways, or backwards. It should be seen as a means of diversification for equity holdings alongside bonds and cash, and as such should not normally exceed 5% to 10% of a portfolio.”
Bitcoin: middling performance by its own standards
“2024 was a breakout year for Bitcoin, though the 150% return experienced by investors is only comfortably mid-table by the standards of the last ten years (see chart below). More substantially the US financial regulator giving the green light to Bitcoin ETCs in the first half of the year was an important step into the mainstream for the cryptocurrency. Clearly the election of Donald Trump as President and his promised support for the crypto industry has driven Bitcoin to fresh records at the back end of 2024, and fresh news of supportive US government policies in 2025 could continue to bump crypto higher.
“Of course, as we have previously witnessed with crypto, the whole pack of cards may come crashing down in dramatic fashion. Bitcoin could end the year at $20,000 or $200,000, and no one should be surprised based on previous price action. If Trump delivers on his promises to boost the crypto industry in the US, that should make for positive newsflow, which should in turn keep the plates spinning. But with no fundamentals to speak of, the price of Bitcoin is purely driven by what other buyers are willing to pay for it, and the sentiment of crowds is a fickle beast.
“Seven million people in the UK now own some crypto, according to the FCA, not far off the number who have some money in a Stocks and Shares ISA, a mainstream investment account that has been around for 25 years. No doubt many of the seven million crypto holders are taking a punt with a small amount of money, but every single one of them should be willing to accept steep losses if the market turns against them, and in the worst-case scenario, wave goodbye to their money altogether.”
Source: Refinitiv. *To 17 December 2024.
