Heading into 2025 we remain confident we will see another year of solid performance across global equity markets. While we may not see the large, outsized returns we have become used to in the last 2 years, there are enough catalysts and tailwinds to drive mid-teens earnings growth. In our view, earnings growth will take over the mantle from multiple expansion; leading to our expectation of 13-15% return in global equities for 2025, led primarily by U.S. related companies.
Looking back on the past year, it was undeniably a strong year for equity markets, particularly in the U.S. The S&P 500 posted its second consecutive year of returns above 20% – rising over 23%.
Equity performance last year was always going to be driven by interest rate cuts. In October 2023, Fed Chair Jerome Powell signalled that the next move by the Federal Reserve would likely be an interest rate cut and that provided a catalyst to the next leg up for global equity markets.
At the start of 2024, our expectation was for six rate cuts beginning in early March. As the U.S. economy proved to be stronger than anticipated and inflation remained more persistent, the first rate cut of 50bps didn’t occur until September. Two additional cuts of 25bps each followed in November and December. As we look at 2025, the rate-cutting cycle appears likely to be shorter and more shallow than forecasted in 2024. We anticipate just one 25bps cut this year in September – though this timeline remains fluid.
AI and technology related stocks were once again significant contributors to the upside in 2024, encouragingly the broader market also played a crucial role. Excluding the performance of the “Magnificent 7” stocks, the S&P 493 was still up nearly 20%.
Looking globally, it’s clear that the performance was largely driven by the U.S. Surprisingly, Germany performed well, up over 18%, driven in part by strength in industrial sectors.
2025 Will Be Denominated by Trump
Looking ahead to 2025, the outlook essentially comes down to two key factors: Firstly, Donald Trump, his policies, and how the market anticipates these will play out. Secondly, whether the other major developed markets can get their economic houses in order and compete with the U.S. as an investment alternative.
You may be familiar with the acronym TINA, There Is No Alternative. This encapsulates the current situation where the U.S. remains the standout performer.
U.S. GDP growth consistently outperformed expectations and is proving to be remarkably resilient. In contrast, Europe and the UK have grown largely in line with forecasts, showing little upward momentum.
We expect these growth trends to continue into 2025, with the U.S. forecast to grow well ahead of other developed economies. While many developed markets are grappling with slow growth or even facing stagflation, the U.S. economy remains strong; offering promising investment opportunities.
Productivity – specifically, the ability to extract more output from workers – is a major factor in driving growth and controlling inflation. Once again, the U.S. stands out in terms of productivity.
President Trump’s policies are likely to have a positive impact on GDP. Key policies such as tax cuts and deregulation can be significant drivers of growth. Over the next two years, Trump’s policies could contribute an additional 0.5% to U.S. GDP growth.
Valuations Not Too Scary
Market pessimists will point to the fact that valuations are currently significantly above average; posing a risk to future equity returns. We don’t find these valuations concerning.
On the one hand, looking from a top-down level, a P/E ratio of 22x earnings does seem to suggest that valuations maybe a bit stretched. And over the past 24 months, much of the market’s return has been driven by multiple expansion.
However, digging below the surface, the composition of the market has shifted over the past few years, with big tech companies becoming a much larger component of the index.
These companies are experiencing exceptional growth, and their higher multiples are justified.
When we exclude these tech giants, the S&P 500 trades at a more typical level, in line with the 5-year average of 19x.
Another way to assess valuations is from a growth-adjusted perspective using the PEG ratio (Price-to-Earnings Growth ratio). When we adjust valuations for growth, it becomes clear that they are actually in line with historical averages. Therefore, we are not concerned by current valuations.
Earnings Growth Will Be the Main Determinate of Market Performance
As we look into 2025, we expect earnings growth rather than multiple expansion to be the main driver of performance moving forward.
After a period of moderate, mid-single-digit growth, expectations are for earnings growth to accelerate to the mid-teens in 2025 and 2026.
It’s also worth mentioning that the baton is now being passed to the rest of the S&P 493 companies, following the remarkable performance of the Mag 7. The Mag 7 are massive companies, growing at over 30%, and have delivered a phenomenal performance. While they will continue to experience strong growth, we expect that to moderate to around 20%. The rest of the 493 companies are now contributing more significantly, with their EPS growth accelerating from the low-single-digits to mid-double-digits.
This is particularly exciting for us, as a broader, more inclusive market is far more resilient and offers greater potential for sustained investment returns.
We are Forecasting 13-15% Returns for the S&P 500 in 2025
The million-dollar question is: what can we expect this year? We don’t anticipate further multiple expansion – any such expansion would be a bonus. Instead, we are expecting earnings growth in the range of 12-15%, and ultimately, we are forecasting market performance in line with earnings growth. This falls more in line with historic average returns for the U.S. market of around 13% per year.
The Trump Effect
President Trump will play a significant role in how equity market performance progresses this year. While Trump’s rhetoric can at times be daunting, it will be his actions that truly matter to equity markets.
Lower Corporate Taxes – Reducing the corporate tax rate from 21% to 15% would add approximately 4.7 percentage points to S&P 500 net income; particularly benefiting high-tax companies with larger U.S. based sales.
Tariffs – While it’s difficult to predict exactly how this will unfold, it’s likely that tariffs won’t increase to the levels initially threatened. Trump’s 2016 campaign demonstrated his use of tariffs as a strategic tool and negotiation tactic.
Using his first term as a guide, Trump proposed significantly higher tariffs than were ultimately imposed. While there is little doubt that new tariffs will be introduced, we believe they will be more measured and targeted than is currently being speculated. Any better-than-expected developments could lead to positive upside.
Interest Rate Risk – It is important to consider the potential impact of tariffs on inflation and its implications for the interest rate cycle. We expect inflation to be affected by approximately 0.5-1.0%, with a short-term impact lasting around 12 months. While we don’t anticipate dramatic long-term effects, this could lead to a pause in the rate cutting cycle.
As mentioned earlier, we see the ultimate outcome of all these new Trump policies as a net positive for the U.S. economy and U.S. oriented stocks.
What Could Cause Investors to Move Out of the U.S.?
As global-focused investors, it’s important to recognize opportunities across all investable markets. While we believe There Is No Alternative to the U.S. in the next 6-12 months, there are several developed markets that screen very cheap with investor sentiment at historic lows. These factors provide the foundations from which significant upside can be realized.
We have dubbed these regions “Tina Turners”, given their potential to attract investment away from the U.S. Currently, regions like Europe, the UK, and China are trading at or near all-time lows, with investors remaining significantly underweight these markets. For now, low valuations are justified given some idiosyncratic factors.
- The UK faces significant fiscal challenges, with a mismatch between government fiscal spending and tax income, putting pressure on the new Labour government and already stretched fiscus. Investors have put pressure on the Pound and pushed treasury yields higher; reflecting concerns about the government’s ability to either cut fiscal spending or raise taxes. The BoE is also constrained in its ability to cut rates to stimulate the economy in the face of stubborn inflation.
- Europe. Subdued GDP growth is placing pressure on political incumbents. Both Germany and France are experiencing significant political pressure from right-wing factions. With elections in both countries this year, it’s crucial for political leaders to align and find ways to stimulate the economy.
- China. Presenting a significant challenge on the global stage. Consumer sentiment remains weak, primarily due to weakness in the property market, which is a major store of wealth for consumers. As the housing market remains depressed, consumers sentiment is negatively impacted, reducing their incentive to spend, and resulting in a large pool of savings. Thus far the government’s attempt to stimulate the housing market has fallen short of investor expectations, and the consumer’s savings rate remains at record levels.
What are the Catalysts?
China could be the panacea for all developed market woes. Any meaningful stimulus that accelerates growth could trigger valuation expansion. The Chinese government needs to stimulate demand, either via supporting the property market or direct payments to consumers to encourage spending. Counterintuitively, harsher tariffs from Trump could push the government to implement domestic stimulus to offset the impact and meet its 5% GDP growth target.
In Europe, political stability is crucial. Furthermore, the Draghi report outlines reforms, which aims to improve EU competitiveness by boosting innovation and R&D, as well as integrating the EU ecosystem to increase productivity. Any solution will likely take time.
The UK needs a boost in GDP growth and fiscal stability. The Labour Party will face difficult decisions in the coming months, likely involving tax increases or spending cuts, to address these challenges.
Addressing these issues is no small feat, which is why we remain particularly focused on U.S. companies or those with significant U.S. exposure.
Investment Focal Areas
1. AI Revolution
AI will continue to be a big driver of investment capital and market returns. We are still in the early stages of AI development – the build-out phase – which includes building data centers, manufacturing chips, and developing power systems. This has been driven by the likes of Nvidia, Microsoft, Alphabet, Meta, etc. which are spending more $200bln a year on infrastructure build out. As an example of the spin offs from the AI revolution, electricity demand needed to power AI data centers needs to double from current capacity (17GW); equivalent to 3 New York City energy grids.
The next stage, the Adoption phase, will involve real life application that will generate enormous productivity gains across businesses. App Developers will drive this next wave of growth.
Going forward we believe the revenue growth rates within the AI sector are sustainable, and companies that directly benefit will continue to be major contributors to performance upside.
2. Trump Policies Beneficiaries
Several new policies implemented by President Trump will provide a tailwind to certain market segments. Identifying these beneficiaries could hold the key to outsized returns.
Tax cuts: These will boost discretionary income, with domestically focused companies being the main beneficiaries. On average the cut in corporate tax rate from 21% to 15% will drive a 4.7 percentage point increase in net income.
Deregulation: Investment and Mergers & Acquisitions (M&A) are key drivers of the U.S. economy, and this deregulation will likely increase risk appetite. Sectors that will benefit most from deregulation include banks – who act as partners and introducers – along with tech and healthcare.
Tariffs: Incentivizing onshoring, as companies will seek to protect themselves from the impact of tariffs. The prime beneficiaries will be domestically focused capital expenditure (capex) plays.
2025 offers many opportunities which we hope to capitalize on. The NVest Securities team wishes everyone a prosperous 2025.