Quarterly market commentary
Most commentators had expected market turmoil in the face of an unconstrained Trump White House. Instead, equity markets rallied and related volatility fell. Investors, it seems view the president-elect less as a source of instability and more as a potential catalyst for growth. This sentiment has translated into action: US equities have seen the largest monthly inflow on record during December. Quietly however, Treasury yields have pushed higher and China’s need for stimulus is becoming more acute. The Federal Reserve Chairman spooked markets, leading to equity falls just as investors ended the year for the holiday season.
Wall Street is the most important stock market in the world, but Chinese treasuries are (probably) the most important bond market, given China’s huge economic footprint and dominance of global manufacturing. That Chinese bond yields are plunging (prices soaring) should be flashing an alert on every trading screen around the globe. 10-year Chinese government bonds ended 2024 yielding a measly 1.78%. The fact that this latest fall is largely driven by debt deflation, rather than expectations of policy rate cuts, is more disturbing. As stated here in previous missives, China is suffering more acutely than other economies from colossal debt mountains. In a deflationary environment debt grows in real terms making matters worse.
Domestically, the ageing population tends to save more than it spends and the aggressive export drive pushing green energy infrastructure and electric vehicles at low cost into foreign markets has been met with tariffs in economies where the most active consumers reside. A particularly strong US dollar renders interest payments expensive and central bank stimulus packages have so far been modest in nature. Something altogether more potent is required by the Chinese authorities to kick-start growth. We anticipate further Yuan devaluation, further central bank support and the real potential for a deal with the United States once president-elect Trump takes office.
Meanwhile in the United States, equity investors have enjoyed another vintage year with leading indices up over 20% in 2024, albeit powered by fewer companies than we would like. Of course, this has pushed prices to expensive levels and further progress will rely on ever higher profits from corporate America. Current pricing relies on earnings growth in double digits to power further expansion. Can lower interest rates, corporate taxes and a focus on domestic rebuilding and onshoring under President Trump maintain GDP growth, stimulate economic activity and employment at home? If so, the prospect for further US equity growth has legs. We know around $7 trillion of debt will be refinanced during 2025 and necessitating balance sheet capacity from banks and the Federal Reserve. Physical and digital gold (Bitcoin) enjoyed a strong year. Linked to the refinancing cycle, the provision of liquidity will be ongoing for much of the year ahead, although a strong dollar will lessen the positive impact to risk assets. Indeed, the US currency at such robust levels is truly established as “King Dollar” on the global stage. This fact makes life difficult indeed for all with dollar denominated debt.
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The Federal Reserve cut rates as expected to 4.25-4.5% during December. A hawkish press conference narrative from Jerome Powell, Federal Reserve Chair, focusing again on inflation which had nudged marginally higher as well as unemployment figures made for an unsettling month end. Hawkish comments from the Federal Reserve Chairman effectively “blew the froth off” the Christmas stock market rally into the year end.
The appointment of Scott Bessent to lead the US Treasury could mark a shift in US funding policy. The implications of a policy shift away from raising funding via short-dated Treasury Bills to longer dated coupon paying Treasury Bonds would be scrutinised by markets and we keep a close eye on developments during the important weeks ahead when new policies will likely be revealed. An ongoing need to raise the US debt ceiling will play out early this year and the extent to which this process descends into farce will be interesting to observe with a Republican dominated government body.
In Europe the euro / dollar exchange rate is heading closer to parity marking out economic difficulties within the Eurozone. Energy security remains a critical concern, with German companies laying off staff and energy prices expected to rise further in 2025. Russian gas will be cut off to Europe by Ukraine during January. Germany has posted negative GDP growth in 4 of the last 8 readings and recession across manufacturing sectors throughout Europe is a real concern. The ECB continues to cut rates ahead of the US Federal Reserve to support Eurozone economies, but Europe's energy costs and security hinge on geopolitical developments. The cost of energy led to a nudge higher in Eurozone inflation whilst wages fell, shown in the chart below. We anticipate some form of QE like stimulus from the ECB during 2025. The fact so many of the world’s leaders assembled for the ceremonial reopening of Notre Dame surely marks out the critical confluence of economic fortunes beyond America’s shores and the changing of the guard at the White House.
At home in the UK, we saw inflation push higher provoking the Bank of England to leave interest rates unchanged and making life tougher yet for an economy in desperate need of lower borrowing costs. Economic growth is forecast by the Bank of England at lower levels than had previously been suggested. We remain unconvinced by Labour’s de facto plan to tax the economy back to growth. Mr Elon Musk fired a meaningful shot across the bows of the UK Chancellor by openly commenting that Government policy will act as a deterrent to inbound investment and growth. Escalating debt woes are manifest in Gilt prices where yields have pushed to 4.6% for 10-year stock, now at levels last seen immediately following the infamous Liz Truss / Kwasi Kwarteng budget. The UK stock market offers undeniable value for brave and patient investors although reliable dividend stocks remain appealing for income seekers and related portfolios.
The Bank of Japan faces a trilemma with increasing imported inflation due to currency weakness (USD/JPY currently trades at 158). The Bank of Japan remains reluctant to raise rates, with medium-term inflation expected around 2.6%. Higher interest rates could undermine affordability of further debt financing. With a debt/GDP ratio of 264%, rate hikes could exacerbate Japan's fiscal deficits. As China likely devalues, we expect pressure on Japanese manufacturers whose share prices have delivered strongly over the past year or two.
So, a critical year in prospect for global economies and their related markets. America stands alone in its robust economic health whilst all other major markets are ailing albeit to different degrees. The overt strength of the global reserve US dollar is perhaps unsurprising set against this backdrop. However, global debt, global trade and therefore equities would all benefit from the green back being less strong. Having cut equity exposure modestly late last year and taking profits, for now, at portfolio level, we are maintaining our positions, as this decision has proven to be rewarding. Looking forward into 2025, we suggest balancing optimism with caution.
Written by the Alpha Beta Partners Investment Team.
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