Market performance in 2025 will depend on two things: economic growth and inflation. The dominant player in the investment world is still the USA and investing in any other country or region will increase your risk. The best outcome for us as investors will be if the US economy continues to grow at around 3% and inflation comes down to around 2%. This will enable companies to grow their earnings, supporting their elevated share prices, and allow the federal reserve to lower interest rates. The biggest risks for us as investors is the current high level of US government debt and any material weakness in the dollar. Looking at some specifics, we see the following:
1. The 10-year Treasury yield spiked up to 4.77% after the most recent employment figures, the highest since November 2023. The market is sending a clear message to the Fed: Stop cutting interest rates.
2. The market is now pricing-in a single rate cut in all of 2025: a 25 bps move down to 4.00-4.25% by year end.
3. US average hourly earnings has moved up from $31.42 in 2021 to $35.69 in 2024. That is double the targeted inflation rate in the US.
4. The debt in the US is a problem that makes the economy vulnerable towards dollar weakness.
5. “We will not allow inflation expectations to drift upward,” stated Jerome Powell after cutting rates last year. So we can be sure they will stop rate-cutting or even increase them again if inflation goes up again.
6. The US is outperforming and there are good reasons why.
7. Outside of the Mag7 there are 493 large-cap companies where fair valuations still exist. Perhaps an equal weighted S&P500 will carry less valuation risk in 2025.
8. With Trump the rules have changed and less regulation, lower taxes, adoption of Bitcoin and more tariffs will necessitate investment portfolios to change. Risk of persistent higher inflation and a growing debt burden is a
reality, even if the new efficiency department of Elon Musk (DOGE) can cut $1 trillion expenditure. With AI, thousands of jobs will be made redundant but that will take years to impact on the near state of full employment
currently. AI will also make business more efficient which will save costs and lower inflation.
9. The US economy is still strong, resulting in company earnings matching the valuations. This should continue on average for the next few years.
Higher interest rates will stall the benefit of capital gains from bonds. It will also reduce the earnings of companies, resulting in the falling or stagnation of share prices. On the positive side, you get a good yield on US bonds with higher interest rates; and the new Trump policies, coupled with the introduction of AI, can support US equities, thereby mitigating some of the negative effects of higher interest rates. SA shares are still cheap, but see it as a value play due to the high risk attached to the SA political environment. The rand will always be volatile and any true, long- lasting strength against the $ is very doubtful.
We should all guard against perpetual negative sentiment publicized by the media. When the war in the Ukraine started two years ago, every media outlet warned us about the impending collapse of Europe due to shortages of natural gas, famine and other disasters. Now, two years later, shares in the US is 50% higher. There are other apocalyptic predictions that have been hanging around for years, like China invading Taiwan, etc., but history has proven that even if these things do come to pass, the actual impact on good quality investments is much lower than prophesied by the media, and usually the recovery is much faster than expected.
We have seen two very good years in equity markets and it will be prudent to manage your expectations for this year. Even if growth in the US remains robust and inflation comes down, having another 20%-plus year is very unlikely.
