We are optimistic on UK utilities and consumer staples, while European equities are attractively valued relative to other regions.
For global equities we are continuing to see idiosyncratic opportunities across defensives, cyclicals and the market cap range.
Opportunities exist in North Asia’s tech sector, while China, India, Southeast Asia and Latin America are hotbeds of consumer demand.
By John Surplice
We are coming from a period of US dominance of financial markets which has continued unabated for the last 15 years. US dominance has evolved into increasing concentration with the Magnificent 7 at the forefront.
Even if you expect strong US GDP growth to continue, there is good potential for growth to recover outside the US which should help those overseas markets. Global equities can offer the benefit of diversification.
Looking outside of the Magnificent 7 there are some very exciting opportunities. Perhaps, the greatest is in the global small cap area, which is trading at a multi decade discount to large cap.
Similarly, more stable politics in the UK should encourage investors to dig a bit deeper, some cyclical improvement in Europe should help whilst less concerns over China should be supportive for our Asian funds.
Areas we will be keeping an eye on in 2025 include the manufacturing sector. Manufacturing companies, even more so those exposed to China, have struggled this year. Any pick-up in end demand could be very powerful given customer inventories are already at extremely low levels.
But 2025 is not without risk. Geopolitics are no easier post the US election and we are likely to have to contend with now verbal as well as physical conflict. With worse budget deficits and higher underlying inflation, it may be that bond markets reassert themselves as the constraint on fiscal largesse.
We share the thoughts of our experts across our UK, European, Global, Asian and Emerging Markets Equities teams, as well as the views from our ETF team. Please read on for their insights and analysis.
Martin Walker, Head of UK Equities
We are particularly optimistic for UK equities in 2025. The UK offers exposure to many high-quality companies trading at valuations below global peers, even after taking account of differences in return on capital.
UK equities offer attractive exposure to the value factor. They also currently offer compelling income streams that together with capital growth can provide a valuable defence against inflation.
Sector exposures in the UK are very different to other global equity markets – bringing important additional benefits to international asset allocation decisions, in terms of diversification. The UK has minimal direct exposure to technology, but greater exposure to cash generative financials, energy, and basic materials. We are particularly excited about the opportunities in growth utilities, and in internationally orientated consumer staples.
The key risks to UK equities mainly relate to the global economy and geopolitics. A global recession, a collapse in the price of oil, or significant escalation in conflict would all be negative for UK equities.
Putting to one side any partisan views, the UK election result in July 2024 has at least delivered a platform for stable government over the next 4 years, and the Autumn Budget set out the direction of economic policy that will be pursued. That stability has been lacking for a long time and ought to result in greater investor confidence.
Oliver Collin, Co-Head of European Equities
European equities are attractively valued relative to other regions. The region has delivered minimal growth over the past 15 years. This is reflected in the stock market.
When expectations and valuations are low, that leaves a lot of room for material share price upside when expectations are beaten. We believe this is a likely scenario for European equities.
What has driven many of the market’s concerns in 2024 has been mixed macroeconomic indicators. But there are meaningful positives, which we believe get lost in the noise. Inventories appear to be bottoming, which is supportive for manufacturing. The consumer has enjoyed significant real wage growth and so will have considerable spending power when confidence returns. Plus, Europe is highly sensitive to interest rates, and although there’s a lag, GDP should respond positively as monetary policy loosens.
All of these factors indicate that the outlook for growth in Europe may not be as bad as the markets fear. This would suggest that the relative valuation difference between European stocks and those of other major global economies, is overdone.
In the longer-term, and as per Draghi’s competitiveness report, there is an increasing need for investment in Europe across areas including energy security, defence, decarbonisation and digitalisation to name a few.
We believe that this investment together with a continued tightness in labour markets, will lead to persistent moderate inflation. This in turn will likely bring about a ‘normalised’ interest rate environment. A more pro-active fiscal backdrop would be a very solid setting for stock picking with a focus on valuation.
Stephen Anness, Head of Global Equities
Stock market indices are not obviously cheap on traditional valuation measures. We would expect returns going forward to come more from earnings growth and dividends, rather than further re-rating.
The economic environment remains tough. Many industries including industrials, housing, healthcare and transport are going through extended downturns as consumer demand is tempered by exhausted personal savings and high interest rates.
Against that, central banks (outside of Japan) are now reducing rates as inflationary pressures continue to ease. The announcement of stimulus measures by the Chinese government could be another significant development supporting consumption recovery.
Our focus remains on bottom-up stock picking, and we continue to see idiosyncratic opportunities across defensives, cyclicals and the market cap range. We maintain a broadly diversified portfolio of businesses by geographic and industrial exposure.
Although stock specific research remains our focal point, it is important to be mindful of the economic and geopolitical risks that can influence stock sentiment. We watch with interest the policies pursued by the incoming US president and how the fast-escalating events in the Middle East could push oil prices higher.
However, perhaps most importantly, we continue to monitor whether the Fed can deliver the economic soft landing, avoiding recession without an uptick in inflation in 2025.
William Lam, Co-Head of Asian and Emerging Markets Equities
While investors will remain mindful of geopolitical risks, the double-digit earnings growth outlook and reasonable valuation levels across much of Asia and emerging markets are compelling going into 2025.
The equity risk premium narrowed in 2024 with global rates easing, corporate earnings delivering, and markets being enthused by India and the AI supply chain. Fundamentals across the asset class remain healthy, and the implementation of China’s stimulus measures provide upside risk next year. Significant valuation disparity across markets, and genuine improvements in shareholder return policies provide fertile ground for active stock pickers.
World leading manufacturing and technology companies in North Asia include the ‘picks & shovels’ of AI-related growth. China, India, Southeast Asia and Latin America are the hotbeds of consumer demand growth, including innovative internet and e-commerce businesses.
Exposure to rising incomes and a growing middle class is also accessible through well capitalised financials, while commodity producers play an important role in the energy transition. Asia and emerging markets have some of the most exciting investment opportunities in the world and provide diversification benefits.
Given the disparity in valuations across markets and sectors, a selective approach is recommended. There are signs of exuberance in Indian equities and parts of Taiwan tech. But there are compelling opportunities across markets in consumer-related sectors including e-commerce, internet, financials, leading manufacturers, and commodity producers.
Geopolitical tensions, trade disruptions, global inflation, and currency volatility are key risks. However, robust fundamentals, healthy balance sheets, and reasonable valuations makes emerging markets a valuable contribution to portfolio diversification.
Shekhar Sambhshivan, Investment Director, Asia (excluding Japan) Regional Equity team
India is currently in the early stages of its growth trajectory and has significant potential for further development. The country has undergone rapid economic expansion fueled by strong corporate earnings and impressive GDP growth.
Corporate earnings are robust and are projected to grow in the mid-teens by 2025. As we look to the year ahead, we expect it will provide substantial support for Indian equities.
We see opportunity in the consumer discretionary sector. The country is approaching the threshold for becoming a middle-income economy. In the near future, we are anticipating a surge in consumption.
With rising incomes and a young population in India more willing to spend, we see investment opportunities in weddings and festivals. This discretionary spending is creating vast investment potential across various sectors including jewellery, hotels, clothing, luggage, and transportation.
However, if economic data fails to meet market expectations, we anticipate short-term volatility in the India market.
Raymond Ma, CIO - Hong Kong and China, Asia (excluding Japan) Regional Equity team
China’s equity market presents an extremely attractive valuation opportunity. Chinese stocks are priced appealingly compared to both historical averages and developed markets.
We anticipate a gradual recovery in earnings, which will serve as an extra layer for growth. Ongoing stimulus measures, we believe, will be supportive of the economy and domestic demand will recover.
We favour Chinese companies that already have a leadership position and are well-placed to expand overseas. These companies have cost advantages stemming from economies of scale in the domestic market. This ultimately benefits shareholders.
We believe benefits are broad based, particularly among companies in e-commerce, online gaming, white goods and industrials, which have the potential and capability to expand overseas. We believe they will benefit from the recovery in domestic demand and their expansion plans into overseas markets.
We also see investment opportunities are in companies with strong cash flows that have significant potential for dividend growth and share buybacks, supported by favourable policies. We believe investors can benefit from rising shareholder returns.
We have also observed the Chinese government's recent commitment to reviving growth following the announcement of a comprehensive policy package. The effective and adequate deployment of this policy support is crucial, as it may influence the pace of economic recovery. We believe it will take time for these policies to impact the real economy.
Tadao Minaguchi, Chief Investment Officer and Chief Portfolio Manager for Japanese Equity Advantage strategy
While Japanese equity markets staged a significant rally in 2024, with the TOPIX Price index finally surpassing its previous peak from the 1989 asset bubble era, we have also observed corrections.
This was initially triggered by a monetary policy pivot in both Japan and the US during the summer, which changed the direction of the Japanese yen from significant depreciation, hitting a 38-year low, to appreciation. Additionally, the ruling Liberal Democratic Party was unexpectedly defeated in the autumn general election, causing political uncertainties.
Despite this, we believe that Japan’s exit from the extraordinary deflationary situation will continue. Economic indicators have been pointing to a transition from domestic price and wage stagnation to a more stable economic environment, with positive growth prospects.
This will allow the Bank of Japan to carry on the long-awaited monetary policy normalisation. More importantly, the ongoing corporate governance reform is a secular trend in Japan, with more and more companies demonstrating a commitment to improving capital efficiency and shareholder returns. These improving fundamental factors should underpin Japanese equity performance.
In this context, bottom-up stock picking is key, in our opinion. To capitalise on these structural changes evolving in Japan, investors should broaden their stock search beyond top-down macro or theme play, which dominated the market for the last several years, and identify which company can benefit the most.
Chris Mellor, Head of EMEA ETF Equity Product Management
We expect demand for ETFs to continue to grow in 2025. US and global equity exposures have dominated equity ETF usage for many years.
This has been helped by the outperformance of the US equity market and the growth in the use of global exposures as a one-stop-shop for investors.
Mega cap tech has been the dominant driver of equity returns in recent years, leading to increased market concentration (35% of the weight in the S&P 500 is in just ten stocks!).
There are signs that the market is beginning to broaden out once again, with equal weight ETFs seeing a surge in demand. That is likely to continue. Ongoing monetary loosening may also help to drive a revival in the growth oriented thematic ETF space. This was hit hard by higher rates in 2022.
The key risks for ETFs are driven by the underlying assets to which they are exposed. As such, the risk of a more difficult economic outlook could weigh on equity markets and the ETFs exposed to them.
In 2023, we saw some of the inflationary pulses of the post Covid era begin to moderate. Growth began to slow, prompting a debate as to when interest rates might peak and eventually reduce. We believe this debate will stay live for some time, with each economic data point being examined minutely.
While rates may moderate from current levels, the era of near zero rates is over and a higher cost of capital is a factor that governments, corporates and households will need to contend with. We expect there’ll be more inflation tension in the system from fiscal spend on the energy transition and commodity costs. Furthermore, complex geopolitics are putting more ‘grit’ in the system of supply-chains and shifting demographics in China will have implications for global labour costs.
From an investment perspective, company fundamentals are likely to become more important in terms of performance. Without the tailwind of ever-falling rates and ‘free money’ the ability of management teams to manage balance sheets, pricing, supply chains and deliver profits and cashflow in forecastable time periods will be vital. The previous era made asset allocation relatively simple – US, tech, growth factors. From here we expect factors to be less dominant, and stock-picking opportunities more diverse. It’s a challenging backdrop, but an exciting one for active managers.
We expect a challenging global macroeconomic backdrop ahead. Central banks and governments will continue along a path of monetary and fiscal policy, that is likely to result in the next decade looking very different to the past 10 years. This will be characterised by higher interest rates and inflation than we have experienced since the global financial crisis (GFC).
Despite macroeconomic concerns, we remain optimistic for UK equities. We believe they offer an attractive source of real income. Higher inflation and volatility are both likely to continue, but dividends should keep pace with inflation over time, affording valuable protection to investors seeking income.
Over 2024 we’ll be keeping an eye on the utility sector. We believe there are still attractive opportunities associated with energy transition, and the need for further investment to improve infrastructure in both power and water.
Among industrials, the past year has been particularly challenging for several businesses. These companies were caught out as complex supply chains re-adjusted to life post pandemic, resulting in sudden and unexpected shifts in customer orders. As we look out into 2024, we’d expect the strongest to survive, prosper, and outperform from a lowered base of expectations.
Just as it was this time last year, the outlook for European equities is complicated and, as before, our strategy is based on fundamental stock picking that is well placed to navigate the challenges.
On all metrics, European equity markets continue to be attractively valued against other regional equity markets. With the recent rapid rise in yields, European equities are one of the few equity markets to still be attractively priced relative to bonds.
For the long-term investor, Europe is turning a corner. The financial backdrop has improved, regional politics are more cohesive, there’s more fiscal support and both domestic investment and consumption are increasing.
Moving into 2024, we’re not expecting any one single factor to dominate, though valuation may set pace. We’re finding many exciting opportunities across many different themes in our approach of looking for companies that are changing for the better. These businesses have been overlooked by investors and mispriced by the market. We believe these stocks will produce the greatest returns.
Cyclical, non-consumer facing sectors such as industrials, where earnings expectations are already at recessionary lows, are interesting. Traditionally defensive areas such as large cap pharmaceuticals are attractive given the growth potential from research and development. Energy names continue to benefit from high oil and significant cash generation. Higher interest rates are relatively supportive for capital-intensive sectors and banks.
The strong trend of an increasing number of people using ETFs has been fairly constant over the past decade, and in a variety of market conditions, so there’s no reason to think this won’t continue next year. If anything, the choice and fundamental characteristics of the ETF structure could be even more attractive given the unpredictability of markets in this uncertain economic environment.
Equity investors are likely to favour high-quality, large-cap market exposures but, when conditions improve, we could see more interest in some of the markets that have been shunned over the past year. We also may see increased interest in thematic exposures such as clean energy, which have long-term structural support from the transition to a low-carbon global economy. We should also see the continued trend of investors using ETFs for low-cost, transparent ESG exposures.
Investors often use ETFs to make immediate adjustments to their portfolios as conditions change, so monitoring ETF flows can be a useful barometer of investor risk appetite. It doesn’t alter what we do in our passive funds, but it could provide some short-term insight on market trends,
There could be a shift from lower risk ETFs to quality exposures in some of the more unloved markets. It will also be worth keeping an eye on markets outside the US, as some may fare differently with an end of interest rate hikes and different local economic conditions.
Since peaking in early 2021, Asian & emerging market (EM) equity markets have struggled amidst a liquidity tightening cycle and a crescendo of negativity surrounding China.
China’s post-covid recovery has disappointed, and faltering demand in its property market reflects weak consumer confidence, despite abundant household savings and solid balance sheets.
But valuations for regional indices trade below long-term historic averages, in terms of price-to-book. This financial metric indicates how much investors are willing to pay for each dollar of a company’s net assets. Regional indices are at a significant discount to developed markets, particularly the US. We believe there is scope for this gap to narrow.
Asian and EM equities are also well placed to benefit from an improvement in liquidity conditions, as we approach the peak in interest rate expectations, with US dollar strength likely to cease being a headwind.
Furthermore, compared to previous tightening cycles, Asian & EM economies enjoy relatively solid fundamentals, suggesting greater monetary policy flexibility should growth headwinds start to build.
In China, coordinated monetary and fiscal easing is underway, with greater urgency to boost confidence and support growth.
In our view, the continued divergence in performance and valuations between different countries and sectors within the emerging world will provide interesting investment opportunities.
The view from our Hong Kong based Asian equity team is the region is poised for stable growth, supported by lower inflation levels compared to developed economies.
This favourable economic climate offers conducive conditions for businesses to thrive and supports further expansion. We believe the resurgence of tourism in Asia will add impetus to the region's economic progress.
India continues to exhibit high growth potential, driven by robust private consumption and government-led capital expenditure. We’ve particularly got our eyes on companies that will benefit from domestic demand, as well as manufacturing and construction sectors that have strong government support and are relocating their supply chains to India.
We also see opportunities in the digital space, where there’s ongoing innovation. We believe India has a comparative advantage - its young demographics are increasingly adopting digital technologies, a fast-expanding middle class is boosting consumer spending. There’s also government support for infrastructure spending.
In China, we are witnessing signs of stabilisation and improvement in macro trends, thanks to the targeted government policies. This is a positive development anticipated to have a domino effect on the economy, reversing negative sentiments among consumers and corporations.
We believe China’s economy will be normalised in 2024, and we see opportunities from consumption patterns evolution and technological advancements in innovation and production.
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The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Data as at 18th November 2024.
This is marketing material and not financial advice. It is not intended as a recommendation to buy or sell any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication.
Views and opinions are based on current market conditions and are subject to change.
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