Outlook 2025
Falling interest rates and robust GDP growth form a generally positive backdrop for global equity markets. However, we’ve seen equity market performance disconnect from macroeconomic fundamentals many times over the past few years, making it ever more important to assess markets granularly.
Equity market valuations are not cheap, and the US market seems particularly stretched in certain sectors. Historically, high valuation starting points have led to lower forward-looking returns (Figure 1).
Source: Macrobond (November 2024). P/E ratio = price-to-earnings ratio.
However, compared with other bull markets over the past 75 years, the current one looks neither particularly long nor particularly strong, at least not yet (Figure 2). While valuations warrant some caution, the arguments are balanced by a solid economic underpinning and the potential for the bull market to mature.
Source: Macrobond (October 2024).
One defining characteristic of a constructive market backdrop is the frequent occurrence of new all-time highs. As we publish these words, this year has already seen the seventh-largest count of new highs for a calendar year. While markets reached new peaks, companies were also able to record unprecedented profits. Strong earnings and high margins could provide the fundamental support to ‘earn into’ high valuation multiples. Figure 3 shows that, in addition, corporate profits tend to roll over before a recession starts, and this hasn’t happened yet.
While earnings multiples are elevated in certain pockets of the market, the equity risk premium currently sits comfortably at its long-term average (Figure 4), suggesting equity investors should still get rewarded for taking additional risk in this cycle. While the now higher level of interest rates has helped make fixed income assets more attractive from an absolute perspective, the relative comparison suggests there are still plenty of opportunities in global equities.
Sources: Macrobond, Bloomberg Finance LP (October 2024). In Figure 3, shaded areas represent recessionary periods.
Naturally, the equity risk premium is influenced by the strong performance of the US equity market compared with the rest of the world, meaning that while the US is somewhat expensive, other countries look cheap based on that metric. However, 'US exceptionalism' has strong fundamental support: strong US relative performance has been a feature of prolonged cycles in the past, and this cycle has seen considerably better earnings growth in the US than in other regions.
The Trump 2.0 campaign has suggested a few measures that look supportive for US companies, however for investors who want to diversify away from the US, a look at valuations on a sector level can be revealing. While some sectors in the US are expensive, real assets such as real estate and energy are still reasonably valued (Figure 5). Financials, utilities, and consumer staples are where the valuation gap is largest, and these sectors may represent interesting areas of investment opportunity outside the US.
Sources: Bloomberg Finance LP (October 2024). The Z-score is a statistical measurement that describes a value’s relationship to the mean of a group of values. Z-score is measured in terms of standard deviations from the mean. In investing and trading, Z-scores are measures of an instrument’s variability and can be used by traders to help determine volatility.
A similar picture emerges when looking at the exceptionalism of the mega-cap technology stocks, which has led to a significant dispersion between value and growth and between small- and large-caps. We make a few interesting observations. First, the value-growth dispersion has historically been mean-reverting (Figure 6). If that remains the case going forward, it should give support for value in the coming months and quarters.
Second, we have recently seen exceptional swings in the value-growth performance dispersion between large-caps and small-caps. Normally, when growth outperforms, it does so across the entire market-cap spectrum; however, we have recently seen two consecutive episodes of negative correlation (Figure 7). With the next Trump administration possibly engaging in tariffs and corporate tax cuts, this could be a catalyst for small-cap outperformance.
Source: Macrobond (October 2024).
Two other equity markets could be supported by global developments in the coming months: emerging markets (EM) and listed real assets. First, EM stocks are fairly valued relative to their own history and are cheap compared with developed markets. However, policy improvements in China appear to be a critical factor for investors to go overweight the region in the near term and the threat of tariffs remains.
Listed real assets continue to be an interesting asset class in an environment in which inflation becomes more of an ongoing, structural challenge.”
Second, listed real assets continue to be an interesting asset class in an environment in which inflation becomes more of an ongoing, structural challenge. For reasons outlined above, the coming 10-15 years of inflation could look radically different than the past 10-15 years. In such an environment, companies that can pass inflation on to their customers should have a comparative advantage. Many real assets companies have contractual or indirect links to inflation. Amid reasonable valuations, investors might want to diversify their portfolios by reducing some of their more growth-oriented assets in favour of these more defensive, inflation-protecting stocks.
Linda Bakhshian
Deputy CIO of Equities & Multi-Asset
Stefan Löwenthal
Head of Global Multi-Asset
Jürgen Wurzer
Deputy Head of Global Multi-Asset
