With the US election result having provided some welcome clarity to markets, focus now shifts to the broader macro environment as we head into 2025. Can the Fed continue cutting rates, and where will the opportunities come from as earnings broaden out from US large-caps? At BlackRock, we see some key themes driving market activity in the months to come.
1. 2025: The year of the rate cut?
At the beginning of 2024, markets were riding high on optimism that interest rate cuts were coming hard and fast from the Federal Reserve and other developed market central banks. Those rate cuts have materialised later in the year than many expected, but we do expect the Fed to continue on a dovish path heading into 2025 given that reasonable progress has been made taming inflation in the US economy.
The Fed’s focus has shifted to supporting the domestic labour market as we’ve seen softer jobs data out of the US, which we believe is the thinking behind the relatively rapid start to the rate cut cycle over their September and November meetings. However, we are of the view that markets may still have priced in too many cuts by the end of 2025, and recent CPI figures are a warning that inflation could still surprise to the upside – particularly given some of the policies floated by President-elect Trump are expected to put upward pressure on prices.
We saw the central bank soften their language around a rate cut to some degree in their November meeting, so the good news is that cuts are coming. But we expect the RBA to be much more cautious in their approach than the Fed, with just a handful of 25 basis point cuts expected to start early to mid next year.
2. Emerging markets: Don’t get China FOMO
China’s stimulus announcement in late September came as a huge surprise to markets, reversing year-to-date declines in Chinese equities and providing a short-term ‘sugar rush’ to China ETF flows. We see this trend as mainly being driven by fund managers seeking to rebalance their Asian equities allocations after years of going underweight China (see chart below), as well as Chinese investors re-entering the local equity market.
China underweight positions
Top 30 global mutual funds by category
The jury is still out on whether the stimulus itself is enough turn around China’s long-term challenges, and on which sectors in particular will benefit. But the momentum created by the announcement alone, combined with record low valuations in Chinese equities, creates a buy signal that is difficult for investors to ignore.
We see merit in jumping into the China trade in the short term with some basic index exposure, particularly if investors have been underweight China previously. But on a long-term basis, India with its demographic and export advantages, and tech-heavy Taiwan and South Korea present better prospects (see chart below).
Given the very separate structural forces at play across these emerging market economies, we think separating China from its EM neighbours makes sense from a portfolio allocation perspective. On a broader basis, we like EM as a diversification play in the months ahead – the long-term structural tailwinds for some of these markets are much different to the traditional commodity-heavy make-up of the EM index in years past.
3. Japan: Looking beyond the yen
With interest rates on their way down in the vast majority of developed nations, Japan may be the only outlier in this category, having recently seen its first rate rise in more than 15 years. While in August we saw Japan’s worst equity market downturn since the 1980s, this was primarily due to the unwind of the yen carry-trade, which has been extremely popular in recent years with hedge fund and quant managers taking advantage of Japan’s ultra-low interest rates.
Aside from this technical anomaly we believe the macro fundamentals in Japan still look extremely strong, with tailwinds from corporate structural reforms, US$7 trillion in household savings waiting to be deployed into markets, and inflation holding around the Bank of Japan’s 2% target. However, we do keep a keen eye to the effect of any further rate rises and currency fluctuations on corporate earnings – two key pieces to watch on Japan next year.
Japan corporate profit margins, 2004-2024
4. Commodities: The gold rush continues
This year we’ve seen gold surge to record highs on the back of continued central bank buying and geopolitical tensions. We think this momentum is likely to continue into next year, particularly with interest rates coming down in the US and Europe.
We’ve seen investors return to gold ETFs in 2024 as well, albeit modestly, so we do think there is plenty more to come from an inflow perspective next year.
Overall, we see a positive outlook for risk assets heading into 2025 as easing rates and a pro-growth environment in the US are expected to keep equity markets humming. Despite stretched valuations, robust fundamentals continue to drive large-cap tech growth in particular.
However, earnings are expected to broaden out to a wider range of winners than we have seen in 2024, as the global easing cycle gets underway and the AI transformation evolves into new areas.
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