In our 2024 outlook we saw fit to be cautious on the likely trajectory of global economic activity and markets. During the course of this year, we wrote about the extent of global stock market concentration and the implications thereof for the golden rule of investing, which is of course diversification. A related piece explored the relationship between the Japanese Yen, American mega-tech stocks and the August unwind of the ‘carry trade’.
Notwithstanding what we wrote, the global economy has remained resilient and global stocks have delivered double-digit returns. Yes, the return investors have enjoyed has to some extent come from a narrow group of stocks but since the late summer the rally has enjoyed broad [1] participation.
Striking a balance in portfolios
A year is a somewhat arbitrary and often inappropriate unit of time in investment terms because we are investing money for the long-term [2]. Nevertheless, with the benefit of hindsight we have been too cautious. Throughout the year we have been trimming our positions in tech stocks as they became increasingly more significant constituents of portfolios. The proceeds of these sales have been recycled into a combination of what we consider to be better value stocks, bonds and alternative asset classes such as precious metals. Instead, it would have been better to have remained bullish.
How serious is President Trump about tariffs?
In the immediate aftermath of Trump’s victory, global stocks and in particular those listed in America have enjoyed a strong run. This was to be expected because Trump is generally pro-business and has pledged to extend the tax cuts he introduced during his first term. We think he will actually keep his word on this matter and the sharp increase in the cost of borrowing for the United States Treasury suggest that the bond market believes this [3] too. The US, like many Western nations, has been borrowing more than it collects in tax revenues for some time and lenders are beginning to ask for higher interest rates to compensate them for the additional risk occasioned by the increase in their debt load.
The Trump administration is aware that taxes will need to be raised from somewhere to bring borrowing costs under control. Tariffs are a type of tax levied on imported goods made abroad. They are Trump’s preferred method for raising government revenue. In addition, the populist message is clear. We are taxing foreigners, particularly the Chinese.
Ignoring the economic case for their imposition we would argue that tariffs have been politised by Trump to champion an isolationist agenda and win an election. Consequently, the risk of another serious escalation in the ongoing trade conflict which begun in 2016 is high. The last time tariffs were increased and trade rhetoric between countries became heated stock markets reacted badly.
Weighing up the evidence
On the one hand we have an accommodative fiscal stance in the shape of an extension of the first Trump administration tax cuts, or perhaps even a further reduction thereof, monetary policy that is loosening and a US consumer that appears to be in good shape. In contrast, the geopolitical and trade/tariff set-up is not great. Furthermore, we are starting to see some weakness in the employment market and this coupled with higher mortgage rates can’t be helpful for US consumers.
The Chinese factor
The Chinese were in a better position in 2016 to counteract the harmful impacts of tariffs through a combination of economic stimulus and currency intervention. At the time this involved further inflating their property bubble, which is now slowly deflating, whilst simultaneously reducing the value of the Renminbi. These interventions are less feasible today and the probability of a ‘shock and awe’ intervention is almost certainly lower.
American exceptionalism and market valuation
Given the extent of US equity market outperformance over the last decade and the preeminent position US stocks have in the global context, one could be forgiven for asking whether investing elsewhere is worthwhile [4]. We have some sympathy with this sentiment. A cursory online search of ‘are US equities overvalued’ returns a plethora of opinion pieces. Sensible people can make the case either way and a diverse range of investor views is actually healthy. We would go as far as to say that they are not cheap. Their inherent earnings quality and profitability is probably in the price. Therefore, in the face of the various risk we have articulated above it makes sense to continue to be cautious going into 2025.
[1] See a comparison between MSCI ACWI and MSCI ACWI Equal Weighted
[2] Ordinarily, we would define this as being 5+ years
[3] Yields on the US 10-Year Treasury Bond spiked post-election and reached a high of 4.45%
[4] US equities are now 66% of global equity market capitalisation
