After the “year of democracy”, markets look for policy in action
Some commentators heralded 2024 as the “Year of Democracy”, as more than 70 countries around the world voted in elections.
The main outcomes for us were the formation of the Government of National Unity (GNU) in SA and the re-election of President Trump in the US.
For South African investors, these two events have resulted in windfall gains for markets.
While we now have clarity, and maybe even stability in government, we require clarity on policy and execution to sustain gains and drive markets higher.
Multi-Asset Scenarios
At the outset of 2025, our highest probability is the ‘New Regime’ scenario, where we postulate that US growth must remain robust, which would keep corporate earnings growth strong.
Inflation in developed markets ought to remain above central bank targets, but not uncontrollably.
We anticipate treasury yields will remain elevated and South African government bonds will be attractive only for their running yield.
When we review the ‘evidence’, we consider various lenses, whose relative importance varies over time.
Currently, the key lenses are macro, momentum and valuation.
1. Macroeconomics (and geopolitics)
Consensus forecasts for real US GDP growth are 2.1% for the 2025 calendar year.
Our ‘New Regime’ scenario is more optimistic, assuming Trumpian policies should be pro-business and that there are productivity gains to be unlocked from AI.
‘New Regime’ also assumes inflation will be above central bank targets but should not be out of control.
Of course, good growth and warm inflation doesn’t mean anything for investors if it is not translated into equity market earnings.
For 2025, earnings per share (EPS) growth is still expected to be over 12% in nominal terms.
Presently the 10-year US Treasury is around 4.5%, roughly inflation expectations plus real-growth expectations.
But if the Trump administration is as tough as its rhetoric on tariffs, the concerns about a potential re-ignition of inflation worries are a real risk.
While higher inflation impacts corporates via their “cost-of-capital”, that is only a negative if increased borrowing costs are not matched commensurately by increased earnings.
Domestically, stability in the GNU has been a positive and so far markets have provided the benefit of the doubt.
But policy action, outside a few areas like the Department of Home Affairs, has been slow to materialise, which will impact global investor sentiment towards SA.
2. Price and earnings momentum
If we consider the long-term trend, positive price momentum remains intact. However, our quantitative signals give a more nuanced picture.
The magnitude of December’s moves turned our momentum indicator neutral on Global Equity, from long previously.
Similarly, the back-up in bond yields leaves our signals neutral on Global Aggregate Bonds as an asset class.
Qualitatively, these shifts happened on what we would consider relatively thin volumes towards the end of the year.
Domestically, equities underperformed in the fourth quarter but the sell-off was not large enough to move our signal off a “buy”. SA Government Bonds are also a buy.
3. Valuation
The general comment that “valuations are stretched” is broadly fair. Below is a plot of the equity-risk-premium (ERP) for the US, which is one way we can consider value.
A quick visual inspection shows that equities look relatively very expensive against bonds. But, like most value signals, the ERP operates on a long time horizon.
Source: Bloomberg
If we look at the chart for SA, we can see that SA Equity looks slightly rich relative to Government Bonds, but it is nowhere near the extremes in the US.
Source: Bloomberg
The Q1 2025 Tactical Asset Allocation View
Looking forward over the tactical horizon, the Multi Asset team is as constructive on risk as it has been since 2021.
As we look at the different paths the markets could take over the tactical horizon, most routes look positive, or at least neutral.
The ‘New Regime’ scenario should be bullish for global and domestic equity.
In fixed income, the carry available from SA Government Bonds can’t be ignored, but the yield has moved substantially since the election.
Globally, credit spreads in the investment grade and high yield space look extremely tight and arguably are not compensating investors for the risk they are taking.
While we are bulls at the beginning of 2025, there are potholes, some of which we have discussed here.
We’ll be concentrating on those, in case there is reason to swerve into a new lane.
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