This week in the markets: 2024 ends with a bang - will 2025 be a third year of gains or the end of the party; and the final week before Christmas clears the decks with inflation and growth data and the last interest rate decisions of the year.
The last full week before the Christmas and New Year break sees stock markets powering ahead at or close to their all-time highs. The US market, which has led the charge, is up nearly 30% year to date, fuelled by its biggest companies. But even the equal-weighted index is up by nearly 20%.
That’s been driven by a Goldilocks scenario of strong earnings growth, still rising valuation multiples and falling interest rates. The biggest mistake an investor could have made in 2024 would have been to be too cautious.
A year ago, it seemed as if investors had already front-loaded some of the expected gains from easier monetary policy and a still buoyant economy. But, as has been the case for much of the post-financial crisis period, the best approach has been to buy the dips and to keep the faith in American exceptionalism.
The rally started to broaden out in 2024, but not hugely. This remains a Magnificent Seven dominated bull market. And looking into 2025 that remains the key risk for investors. If they decide that the big tech stocks have gone too far, any correction in the shares that account for more than a quarter of the value of the entire US stock market will make it hard for the market as a whole not to follow suit.
That said, there is still reason to be optimistic. Corporate profits continue to rise, share buy backs are putting upward pressure on earnings per share and there is a wall of cash still sitting in money market funds.
However, valuations are historically high, the Presidential cycle is moving into its historically weaker period in the two years following an election, and it seems improbable that earnings and valuations can both continue to improve in tandem. The usual template is for one to rise while the other falls. 2025 is likely to see a reversion to rising earnings but moderating valuation multiples.
There is growing talk of a stock market bubble. But, as ever, these are hard to identify in real time. Bubbles can inflate for longer than anyone expects, and the final months can be the most profitable for investors. Missing out on 1999’s gains would have been expensive and 2025 may well turn out to be fuelled by the same FOMO.
But the end of cycle red flags are starting to flutter. The concentration of the US market is as great as it was at the peak of the dot.com bubble and the Nifty 50 period in the 1970s. At the very least, such a highly valued, concentrated market is likely to lead to lower long-term returns for equity investors. The temptation is to chase returns at the top of the market. It should be avoided.
What are the big risks for 2025. The first is that investors lose faith in the Magnificent Seven. This actually feels unlikely because the big tech stocks are continuing to deliver strong, and often above expectations, earnings growth.
A second risk is that inflation refuses to lie down. Look back at the late 1960s and early 1970s and the pattern of inflation looks very similar. An initial rise then a fall back but to a higher low than before the first spike and then a big surge after a failure of policy to really ensure that the threat had been neutralised. The market is just not expecting this possibility, which is a worry.
A related risk is that bond yields don’t fall as expected. Rising inflation and a demand by investors to be compensated for the long-term risks of holding fixed income investments could push yields higher, creating a headwind for shares in the process.
Anyway, that all lies ahead. The risks are clearly rising but momentum remains on the side of investors.
Before we get to 2025, we’ve got one more week of this year and it looks like being a busy one. Top of the agenda are rate-setting meetings from three of the big central banks - in the US, UK and Japan. The Federal Reserve goes first on Wednesday, with an expected quarter point cut taking the US cost of borrowing to between 4.25% and 4.5%. Another 50 basis points of cuts are forecast by next September, although much will depend on what happens early in the new Trump term. Many of his proposed policies are understood to be inflationary, which might make it hard for the Fed to go much further than it already has.
The US economy has been remarkably resilient through the rate-hiking cycle and the final estimate of third quarter GDP this week is expected to see growth of 2.8% confirmed.
Here in the UK, there’s plenty to keep an eye on. Following news that the UK economy contracted for a second consecutive month in October, focus will be on Wednesday’s inflation number and then the Bank of England’s interest rate call the following day.
Inflation is expected to have pushed a bit higher again to 2.5% from 2.3% in October. That could make it hard for the Bank to cut rates again, although any further deterioration in the economy could shorten the odds of bigger cuts early next year. A guide to how the economy is faring will be provided by retail sales figures on both sides of the Atlantic.
