Markets have been surprisingly stable in 2024, given the backdrop of elections and geopolitical disruption. However, there are a range of risk factors for the year ahead, including a new US president, inflation uncertainty, and sky-high valuations in parts of the stockmarket. Where are likely to be the pressure points in 2025?
US allocation
The concentration in US markets has reached all-time highs. The US is now 74% of the MSCI World index. All top 10 holdings are in the US. The S&P 500 has 34.8% in its top 10 constituents, the highest on record. The Nasdaq 100 has over half of its market capitalisation in just 10 stocks.
Those stocks will be familiar – Apple, Nvidia, Alphabet, Amazon, Meta, Tesla and so on. On most measures, they look expensive. Apple has a P/E ratio of 41x, double its level in early 2022. It is worth noting that revenue grew by just 6% in the last quarter. This is no Nvidia. Even non-technology stocks are expensive – Costco, for example, trades on a P/E of about 60x. This is, above all, a large-cap phenomenon and has been supported by passive inflows, which have continued throughout 2024.
There is nothing to suggest this is about to collapse – AI appears likely to be a revolution every bit as important as the internet. However, Ben Leyland, manager of the JOHCM Global Opportunities fund, said advisers need to reframe the question away from ‘should I sell because it’s too expensive’, adding: “The real question is how much of your clients’ wealth do you want to put there. Do you want portfolio returns to be so dominated by a single bet? How confident are you?”
At the very least, advisers need to know whether their asset allocators are considering diversifying within the US market. Are they looking to smaller companies, for example, or to alternative sectors beyond technology? Financials and utilities have been the stand-out success stories of the year, but form a far smaller share of the index.
Allocation to alternatives
Karen Ward, chief market strategist for EMEA at JP Morgan Asset Management, said investors face a more challenging diversification problem than during the pre-pandemic period. Back then, equities provided capital growth in good times, while government bonds rose in value when recession hit and central banks cut rates.
Bonds can still provide effective diversification to equities at times of weak market confidence and potential recession. This was seen over the summer, with bonds providing protection as equity markets sold off on recession fears.
Higher yields also protect against an inflationary shock. “If 10-year government bond yields were to fall by 100 basis points over the next 12 months, they would deliver a return of more than 10%,” said Ward. “This performance would provide the kind of meaningful diversification against equity losses that multi-asset investors rely on when constructing balanced portfolios.”
However, they won’t protect against inflation shocks. That remains a potential problem for the year ahead, as president-elect Donald Trump’s tax cutting, deregulation and tariff agenda comes to the fore. Ward added: “We expect that over the medium term a more fragmented global economy – and the potential for fiscal misbehaviour – will give rise to more inflationary impulses similar to those experienced in 2022. In this case, fixed income assets might be expected to experience a sell-off at the same time as stock prices are falling.”
Ward suggested an allocation to alternatives such as infrastructure, property and even hedge funds could be considered in this environment.
Fixed income allocation
There are mixed messages on inflation. On the one hand, the assumption is that Trump’s policy agenda will be inflationary. On the other, there are signs of real fragility in some global economies, particularly in Europe where growth continues to weaken. Even in the US, inflationary factors, such as government spending, excess savings and the wealth effect, are likely to dissipate.
Julien Houdain, head of global unconstrained fixed income at Schroders, said: “The key issues on the US political agenda, including stricter immigration controls, more relaxed fiscal policy, fewer regulations on businesses, and tariffs on international goods, suggest a growing risk. These factors may halt any improvement in the core inflation figures and could cause the US Federal Reserve (Fed) to cease easing monetary policy earlier than expected. In other words, we see a no-landing risk rising, a scenario in which inflation remains sticky, and interest rates may be required to be kept higher for longer, though it’s not our base case.”
A lot will depend on whether Trump’s rhetoric is matched by action: “The pace, scale and sequencing of these different policies will play a critical role in steering the direction of the markets,” he said.
Nevertheless, Houdain said bonds look cheap versus alternative assets, with current yields higher than that of the expected earnings yield on the S&P 500. It is relatively difficult to find fixed income managers that are long duration, with many preferring not to have interest rate sensitivity in their portfolios given the uncertainty.
Exposure to unloved assets
Areas such as China and the UK have been widely overlooked by asset allocators over the past two years. Both are starting to see a revival. China’s stimulus package has seen the Shanghai Composite revive since November, while the UK markets have been supported by merger and acquisition, plus buyback activity.
Mark Costar, senior fund manager of the JOHCM UK Growth fund, said: “We keep coming back to the UK because there are world-class disruptive businesses here that have really strong structural growth optionality, but they’re trading at table-thumping discounts.”
Costar said his strategy has received multiple bids for UK stocks this year, including two at triple-digit premiums. This suggests international private equity and corporate buyers believe the UK is undervalued. There are still concerns over UK economic growth, and the direction of travel for government policy, but the UK could claim to have more political stability than, say, France or Germany.
Gervais Williams, manager of the Diverse Income Trust at Premier Miton Investors, believes that large caps may not be able to dodge “the radically changing economic and political bullets. Clearly, quite a few small caps might get caught out as well. But there will be others that don’t just survive better but also happen to be in exactly the right place at the right time and deliver quite exceptional returns”.
For China, there are concerns that the stimulus does not do enough to support the country’s flagging property markets or support consumer confidence. However, there may be more stimulus ahead, particularly if the Chinese government decides it needs to do more to support growth in the face of US tariffs. The Chinese markets still look cheap relative to their international peers.
It is entirely possible that 2025 ends up looking exactly like 2024, with AI taking off and the magnificent seven – or whatever acronym emerges for big tech – leading the way. However, there are a range of factors that could disrupt this pattern in the year ahead, and asset allocators will need an alternative strategy.
This story first appeared on our sister publication, PA Adviser.
