Stock Market & Economic Commentary - January 2025

“The greater the difficulty, the more the glory in surmounting it” Epicurus, 341bc-270bc. Ancient Greek philosopher and sage and founder of Epicureanism, a highly influential school of philosophy.

Welcome to our first Commentary of 2025:

Will stock markets have another good year?
Will bitcoin see another all-time high?
Will inflation be tamed?
Will interest rates fall – or rise?

No one knows – and frankly no one should care.

For long-term, intelligent investors (as opposed to short-term speculators), the answers to these questions are largely irrelevant.

If markets rise, it’s happy days as your portfolio grows.

If markets fall, it’s happy days – a chance to invest more at lower prices.

Armed with a comprehensive financial plan and a Trusted Adviser to help you navigate the options and keep you on track you can’t really go wrong.

Economic Update

It may not feel like it, but 2024 was a pretty good year for the global economy. Inflation receded, central banks cut interest rates, and growth came in as expected and at around trend, or normal levels. Risks that were widely discussed a year ago – persistent inflation, an economic hard landing and geopolitical shocks that hit growth – failed to materialise.

The consensus view is that 2025 will be another decent year, with global GDP growth coming in around 3.2%, in line with the performance in 2023 and 2024. In many respects it will be more of the same.

The US is likely to remain the growth leader of the rich world, with Europe, especially Germany, lagging far behind. Southern, central and eastern Europe and the Nordics are likely to outperform Germany, France and Italy again. The headwinds that weighed on Chinese growth last year persist and, with the Trump administration promising new tariffs on China, may mount. India is likely to post another year of around 6.0% growth, making it by some margin the world’s fastest-growing major economy. Inflation and interest rates should continue to decline.

UK activity has been choppy over the last 18 months – a mild recession in the second half of 2023, then a rebound in activity in the first half of 2024 followed by near stagnation in the second half of the year. Business optimism spiked in July in the wake of the election but has since fallen away. Inflation has proved stickier than expected while UK interest rate expectations and bond yields have been pushed higher as part of a global move reflecting the strength of the US economy and concerns about the impact of tariffs and high government borrowing in the US. October’s UK budget saw the government announce the largest tax rises in over 30 years creating an additional headwind for the corporate sector which will bear the brunt of the increases.

The rise in yields, or interest rates on government bonds, intensified in December and the first half of January. UK bonds came under particular pressure, with markets worrying that higher borrowing costs could wipe out the £10 billion of headroom built into the government’s budget arithmetic, forcing the chancellor to cut expenditure or raise taxes again. At the time of writing this commentary, yields have declined slightly, easing the pressure, but the episode highlights the problems facing the chancellor as she seeks to square the circle of improving public services, strengthening the public finances and boosting growth.

UK economic activity is likely to remain sluggish in the opening months of this year. Beyond this, growth should pick up over the summer and into the second half of the year. Rising real incomes and falling interest rates should bolster consumption. Growth will also be boosted by increases in government spending announced in October’s budget. Despite a lacklustre start, the UK economy is forecast to grow by about 1.0% this year, slightly ahead of last year’s growth rate.

The US delivered a major surprise on activity last year, with GDP growth coming in well above expectation and fears of a “hard landing” fading. The US economy seems to have it all – a vast and growing tech sector, rapid productivity growth, cheap energy and easy fiscal policy (the US’s fiscal deficit last year, at over 6.0% of GDP, was at levels that until recently would have been deemed appropriate only in a period of serious economic weakness).

To this the new US administration is likely to add a heady mix of tax cuts and a broad programme of deregulation. Other policies, notably deporting unauthorised workers – in excess of 8 million people – and levying tariffs of up to 60% on Chinese imports and 10% – 20% on imports from other countries, are viewed by most economists as likely to weaken growth.

Given the costs and the political and logistical challenges involved in large-scale deportations the new administration may focus its efforts on reducing immigration. Goldman Sachs, for instance, assumes that tighter policy will lower net immigration into the US from a pre-pandemic average of 1 million a year to 750,000.

In a similar vein, increases in tariffs may be more targeted than suggested on the campaign trail. Even in a diluted form, new US tariffs would be likely to weigh on growth in 2025, especially in the two countries with the largest export surpluses, China and Germany. Tariffs would also keep inflation higher for longer.

For the US economy the negative effect of tariffs and reduced migration would be countered by the boost from tax cuts, but it is impossible to gauge the overall impact in the absence of precise measures. In any case, 2025 seems likely to be another good year for the US, with growth coming in around the 2.0% mark. Strong real income growth and positive wealth effects (US equities have risen 50% in the last two years) should keep US consumers spending. Meanwhile, business investment is likely to show its fifth consecutive year of growth fuelled by lower interest rates and tax incentives.

Euro area GDP growth is likely to grow at around half US rates, about 1.0%. Germany, the region’s dominant economy, has stagnated for the last five years and now faces the threat of US tariffs. Chinese industry, having moved up the value chain, is providing serious competition for German manufacturing especially in the auto sector. Energy prices are significantly higher in Europe than in the US, particularly in Germany. The mood in Germany is downbeat. In December the Ifo survey of German manufacturing confidence dropped to the lowest level since the pandemic. Commenting on the reading Timo Wollmershäuser, head of Forecasts at the Ifo Institute, said, “Germany is going through by far the longest phase of stagnation in post-war history. It is also falling behind considerably in… international comparisons”.

Things look rather better elsewhere in the euro area. A weak recovery unfolded last year and rising real incomes and high savings point to a further increase in consumer spending and GDP growth across most countries. Prospects are brightest among the smaller and medium-sized euro area countries, with Poland, Ireland, and Spain likely to do well.

The Chinese economy is continuing to contend with an ageing population, greater protectionism and moribund construction and housing sectors. 70% of growth last year came from exports. Despite a more challenging environment, China’s trade surplus reached a record of nearly $1 trillion last year. The consumer economy is weak with consumer confidence at the same level as in the pandemic when China’s population was dealing with draconian lockdowns. Greater policy stimulus should help counter some of the negative effects of likely US tariffs. The IMF sees China’s economy growing by 4.6% this year, slightly less than last year and about half the average since the turn of the century.

There are three main risks to the global economy this year. First, large increases in US import tariffs could trigger retaliation, adding to inflationary pressures, delaying interest rate cuts and dampening growth. Second, even leaving aside tariffs, inflation could yet prove more persistent than expected, with wages and core rates of inflation holding up. A strong US economy, soon, it seems, to be boosted by tax cuts, and the recent rise in gas and oil prices, poses particular inflationary risks. The third threat comes in the form of geopolitics, the issue that CFOs see as the principle external threat to their businesses. While not all geopolitical shocks have pervasive economic effects, some, such as the invasion of Ukraine, which triggered an energy crisis in European prices, do. Shocks that destabilise trade and financial markets, or raise prices, pose the greatest economic risks.

If the world manages to avoid these sorts of shocks, the global economy may expand by around 3.0% – a respectable, if hardly rapid, pace of activity. More telling is how much of that growth is likely to depend on the US and how little will be generated by Europe. Boosting growth is perhaps the greatest challenge facing policymakers in the EU and the UK.

Stock Markets

“Predicting rain doesn’t count; building the ark does”. Warren Buffett, aged 94. Renowned American investor and philanthropist and chairman and CEO of Berkshire Hathaway.

Climate change and stock market highs.

The Lancet, the weekly peer reviewed medical journal and one of the oldest of its kind, recently published a new Countdown report on health and climate change. It couldn’t be more serious.

10 of 15 indicators of hazards, exposures or impacts hit record levels last year. For example, global data show that almost half the earth’s land surface suffered at least one month of extreme drought – up from 15% in the 1980s.

Likewise, extreme rainfall was above the study’s baseline, defined as the average between 1961 and 2000, in almost two thirds of the world, another first. On the 28th of October, in the town of Chiva near Valencia in Spain, almost a year’s worth of rain fell in under eight hours, causing death and destruction on an unimaginable scale.

More recently the Financial Times reported that the world breached 1.5C of warming last year for the first time in history. Only a few weeks ago, across the Santa Monica mountains in California, flames propelled by heavy winds were raging in what would become the most damaging fire in the history of Los Angeles.

And there is, it seems, little hope. Recent analysis from the United Nations (UN) revealed that greenhouse gases are accumulating at a faster rate than at any time in human history. Emissions will barely decline by 2030 versus 2019. Yet we need a 40% or so reduction by the end of this decade to keep global temperatures in check. The UN warned “national climate plans fall miles short of what is needed to stop global warming from crippling every economy.”

Crippling EVERY economy! Crikey! No wonder asset values all over the world are reeling under the threat of such an existential catastrophe… BUT of course, they aren’t!

The US S&P 500, the Nasdaq and the Dow Jones were all hitting record highs for most of 2024 and as I write are still near all-time highs despite some volatility in recent weeks. The same is true for the stock markets in Europe as well as Australia and Canada. Shares in India also hit successive highs in 2024 and despite Africa and South America being particularly exposed to climate risks, shares in Brazil hit another all-time high last September. Nigeria’s index tripled in value last year.

The list goes on. Global house prices, precious and industrial metals, cryptocurrencies, and artworks, to name just a few, are also at or near to all-time highs.

Record climate risks. Record asset prices. If we are all doomed, how so? There are three possible answers to this puzzle: either climate related investment risk is negligible, it is already discounted in current prices, or financial markets are delusional.

Option one is the likely answer which also makes Option two correct. But the argument raises another crucial question: is it ever right to invest in equities when markets are near their all-time highs. It certainly feels wrong, and finance theory would concur. Expected returns mathematically drop when prices rise. And vice versa of course.

Speculators always welcome a significant pull back in stock prices to provide a better entry point, but they could often be waiting for months, even years, and in any case investing at all-time highs isn’t necessarily a bad thing. One reason is obvious: if equities go up, which they do, record levels will occur often. Last year alone, the US S&P 500 clocked up more than 50 of them. Yes, timing the ups and downs might help returns but even if you are unlucky and only invest whenever markets hit a new peak the chances are you won’t suffer too much compared to investors who are lucky enough to get their timing right or who invest on a regular basis to average out buying prices.

According to data produced by RBC Global Asset Management, “buy at the top” returns only trail the returns from indiscriminate buying by half of one percentage point per annum. More amazing is how infrequently share prices collapse after reaching one of the 1250-odd peaks.

In other words, don’t fear the highs. Share prices soon recover. Indeed, a huge chunk of returns come from rebound days which tend to closely follow sell offs. Miss these by trying to be too clever and your returns will suffer.

Bond Yields

30 or so years ago, fixed income markets (by that I mean government bonds and corporate debt – IOU’s issued by governments and companies from all over the world) were considered dull and boring. Stocks and shares were thought by most people to be the best place to protect against inflation and grow their hard-earned savings. Yields on UK government bonds were circa 14% per annum. You could double your money in a little under five years – guaranteed.

Little did we know at the time that fixed income securities were about to embark on a multi decade bull run as yields fell.

Yes, stocks and shares have done brilliantly over the period also. The MSCI world index is up six-fold since 1995 but compare a long run chart of 10-year treasury yields with the S&P 500 or any other bond and equity market. While equities have whipsawed their way to glory, bonds have gained in a relentless march upwards as yields fell.

This has always made me ponder; what has produced more millionaires, rising equity values or rising bonds prices? Shares have superior risk-adjusted returns, but fixed income markets employ more people, and the asset class is $30 trillion bigger!

In the latter, we have the mega money managers such as BlackRock and Pimco that owe their riches to ever falling bond yields. And those football pitch sized fixed income trading rooms at investment banks – printing presses as bond yields embarked on a never-ending downward path and prices rose year after year after year.

Of course, the long decline in bond yields did more than lift the prices of fixed income assets. It also turbo charged anything reliant on gearing as the cost of debt cheapened. Welcome the fortunes made in private equity, venture capital and real estate.

I mention all of this to explain why the recent sell off in global bonds is so important. 10-year UK gilt yields, which rise as prices fall, at close to 5% pa are the highest they have been since 2008. Likewise, US 10-year treasury notes save for a blip in 2023.

It has been a grim start to the year for global bonds, contrary to what the sharp suited analysts and professional investors told us to expect for 2025. From the US to Japan, and pretty much everywhere in between, developed market government bond prices have fallen, shoving bond yields and borrowing costs higher – a blow for countries going cap in hand to investors. And the UK has been in the eye of the storm.

At the start of the year everyone reckoned that the trend in yields would continue downwards as inflation was tamed and this had been the trend for decades. Any jump in yields has always prompted the question, is this the one? Is the super trend of ever lower yields finally over?

But it never was. Career graveyards are crammed with fixed income managers calling the top, or the bottom, for yields. Even bond supremo Bill Gross of Pimco never recovered from reducing his US treasury holdings to zero in 2011. Don’t expect leniency from bond market investors. They prey on weakness and demand public spending cuts.

If the best investors are clueless on the direction of yields, what should we make of this latest rout? A good place to start is with a simple question, “Is the rise in bond yields in response to good news or bad news?”

This seems to be the right question to ask because in the US higher yields have as much to do with increased confidence in Donald Trump’s pro domestic agenda as they do with other factors.

On the other hand, bond yields can rise for bad reasons. If inflation raises its head in any of its ugly forms or because investors worry about the indebtedness of a country and its ability to service interest rate costs.

Is the UK in this camp? Many believe so.

And bond yields do not just give a perspective on the macroeconomic picture – they should also affect our appetite for risk as equity investors. But does it really make any difference to the Clarion Portfolio Funds. If the UK is fine, then our exposure to UK equities will also be fine. If not and the pound cracks, a huge exposure to overseas sales insulates large British companies somewhat. And the UK is still cheap, very cheap by comparison to, for instance, the US.

Indeed, the storming dollar of late has helped all investments priced in dollars and translated into sterling. A lower pound helps US investments and acts as a cushion should the underlying investments fall in value.

Thank goodness also that the Clarion Funds’ exposure to fixed income is, deliberately, in short-dated securities which are less affected by a rise in bond yields. It is the yields on longer data securities that everyone is fretting about. I am also comforted that, based on history, if markets totally freak out, the US Federal Reserve Bank will rush to our aid by cutting policy rates. This disproportionately helps short duration bonds where prices will rise.

So, all in all we are very comfortable with the Clarion Portfolio Funds irrespective of where this bond market wobble ends up. The biggest risk is in the UK but even here we win if the pound takes a bath. Such is the negativity though that maybe a contrarian bet is worth thinking about.

Client Feedback—DIY?

In the feedback we receive from clients a classic standout is that you hate managing your life savings yourself. We understand the reasons. You are all super busy and yet you are expected to find space to generate high enough returns to retire. Meanwhile a fear of losses constantly gnaws.

The easiest answer is to get someone else to do it and barely look at your portfolio. This works for many reasons. Less tinkering means lower dealing costs. Staying invested makes sure you’re in the market on those massive rebound days that follow sell offs when everyone else has bailed out.

We often step back and remind ourselves about what we are trying to achieve with the Clarion Portfolio Funds. It is, quite simply, to have a basket of investments that have a high likelihood of a satisfactory return rather than the chance of a spectacular return which could be spectacularly good or spectacularly bad. Despite the recent ructions in the bond markets, we remain quietly confident that we are well placed to achieve that result over the medium to long term.

As always, we thank you for your continued support and we look forward to updating you regularly throughout 2025. Please get in touch if you have any questions.

Keith W Thompson

Clarion Group Chairman

January 2025

Risk Warnings

Any investment performance figures referred to relate to past performance which is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments, and the income arising from them, can go down as well as up and is not guaranteed, which means that you may not get back what you invested. Unless indicated otherwise, performance figures are stated in British Pounds. Where performance figures are stated in other currencies, changes in exchange rates may also cause an investment to fluctuate in value.

The content of this article does not constitute financial advice and you may wish to seek professional advice based on your individual circumstances before making any financial decisions.

Stock Market & Economic Commentary – January 2025