Equities in the US continued to defy gravity in 2024, rising 26% in sterling terms to back up a 19% increase in 2023.
As we move into 2025, some of the economic tailwinds that propelled the market higher in 2024 are receding. The rate of monetary policy easing is slowing, inflation has become sticky, long-term interest rates have swung upward, and the US economy is slowing.
Even more importantly from a sentiment standpoint, spending on artificial intelligence hardware is moderating.
Brian Colello, an equity strategist for the technology sector at Morningstar, said: “Spending on AI graphic processor units and hardware is less likely to provide anywhere near the massive positive surprises we saw in 2024 as this fast-moving megatrend is better understood.”
This time last year, I described the US equity market as running not too hot, and not too cold. Following the 2024 rally, the backdrop today is somewhat different with valuations above long-term averages, putting more pressure on US companies to deliver on their earnings forecasts.
But the biggest wild card in the first quarter will be what President Donald Trump may or may not do regarding his assertions to implement new tariffs on imports.
How much of this tariff talk is campaign trail rhetoric? How soon will these tariffs be implemented? How big will they be? What countries and products will be taxed? And just as importantly, what countries and products may be excluded?
If we look back at Trump’s pledges from his past presidency, of the 100 or so promises he made to the electorate in 2016, around 25 were enacted, another 25 came to pass but with amendments, and around half never made it to legislation.
As ever, it is helpful to assess what is priced into US equities via the intrinsic valuations of the more than 700 stocks that trade on US exchanges. Our estimates show a 4% premium to our fair value estimates.
While this might not sound like much of a premium, the market has traded at this premium level or higher less than 10% of the time since the end of 2010. With the market trading at the high end of our fairly valued range, we are becoming progressively cautious, and positioning is increasingly important.
There are areas of interest in the US, despite this headline valuation. Our assessment of small-cap stocks are they trade at a 14% discount to fair value.
There is also divergence across sectors.
Real estate was the second most undervalued and, following a sluggish 2024, is now the most undervalued.
By contrast, utilities was one of the more undervalued sectors coming into the year. In 2024, the sector rose almost 27% as utilities became a second derivative play on AI growth; AI requires multiple times more electricity than traditional semiconductors. As such, it is now one of the more overvalued sectors.
This article first appeared in our sister publication, Portfolio Adviser.
