Insights
Navigating certain markets in an uncertain world
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Global Equity Observer
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February 13, 2025
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Navigating certain markets in an uncertain world
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February 13, 2025
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Navigating certain markets in an uncertain world
Navigating certain markets in an uncertain world |
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2024 was a very strong year for markets overall, with the MSCI World Index up 19% in USD, making it five out of the last six years with returns above 15%1. However, this success was far from equally shared, with the “Magnificent Seven” stocks delivering close to half the global index’s returns, and the “Magnificent One”, Nvidia, generating 20% of them all on its own. There was also a serious variation by geography, with the U.S. returns of 24% a full 20 percentage points ahead of MSCI EAFE Index’s (EAFE) 4%.2
Earnings explain much of this hierarchy in 2024 returns. The S&P 500 Index’s forward earnings rose 12% in the year, but this was made up of the “Magnificent One’s” 38% earnings’ surge alongside a mere 6% for the “S&P 493”. However, even this long tail of the U.S. market was well ahead of EAFE’s 2% earnings fall. The strength of the dollar helped the U.S., as did the country’s stronger economic growth. U.S. gross domestic product (GDP) growth reached a very healthy 2.7% in 2024, in contrast with the shrinking German and Japan economies3. There was also a significant multiple gap: the U.S. market rerated by 10% to almost 22x forward earnings, while EAFE’s multiple edged up by just 3% to 13.8x, a record 36% discount to the U.S.
Looking forward, the U.S. economy continues to look healthier than other developed markets. Its 2%+ expected GDP growth for 2025 is twice that of EAFE, despite the continued softness in some areas such as low mortgage issuance and weak manufacturing PMIs (purchasing managers’ indexes). However, positive surprises for the U.S. economy may be tougher to find than in the last two years, given the higher starting base for economic growth. Optimists point to the potential for further corporate tax cuts, deregulation, and M&A liberalisation to boost corporate profitability under the Trump presidency. The flip side is fears that his policies may aggravate already sticky inflation, be they tariffs increasing consumer prices or deportations raising labour costs. The U.S. policy environment is unusually fluid at present, with a lack of clarity about the incoming administration’s plans, never mind their ability to actually implement them.
The economic factor not receiving as much attention as it should is the U.S. budget deficit, which is running at an unprecedented 6%-7% of GDP at a time when the economy is at close to full employment. The macro purists cite the Kalecki-Levy equation, pointing out how U.S. fiscal profligacy boosts corporate profitability. To put it less abstractly, either the U.S. budget deficit will be cut significantly by the new DOGE’s (Department of Government Efficiency) efforts outpacing tax cuts, which could suck demand out of the economy, acting as a major dampener on economic growth and thus corporate profits, or the deficit will remain very high, growing debt further from the current $36 trillion, which could put pressure on long-term Treasury yields and even the mighty dollar. The 10-year Treasury rate rising 100 basis points as the U.S. Federal Reserve has cut policy interest rates by 100 basis points is perhaps an ominous sign.
Our real concern is how the expected 2025 earnings growth of 15% for the U.S. gets delivered. The expectation is not that we are dependent on the “Magnificent Seven” to deliver this but that the earnings growth will be broad-based, with the “493” stocks, excluding the “Magnificent Seven”, growing earnings at 13%. Given revenues are only expected to grow 5%, in line with nominal GDP growth expectations, this double-digit earnings per share (EPS) growth implies a sharp further improvement in margins from what are already at near-record levels, even excluding the “Magnificent Seven”.
It has not been the easiest time to invest in steady, high quality compounders in relative terms, due to the twin issues of GenAI excitement and the elevated level of profitability in lower quality companies. In 2024, the challenge for our global portfolios was around multiples. Our high quality, global portfolios saw their forward EPS grow either in line or ahead of the overall index, but performance lagged the MSCI World as the portfolios did not rerate to the same extent. The good news is that the portfolios are now relatively well placed on valuation, despite their far higher quality and better top-line growth prospects.
Credible earnings growth given healthy top line
The portfolios also looks well placed in terms of earnings. They are very likely to be far more resilient than those of the index in any economic downturn, given their holdings’ strong pricing power and recurring revenues, as was shown most recently in the COVID crisis, the only recession in the last 15 years. Arguably more importantly, the portfolio looks well placed in both absolute and relative terms even in the absence of a downturn. For our global portfolios, consensus EPS growth estimates for the next two years look achievable, with decent annual revenue growth helped by some modest gains from operational leverage, acquisitions and buybacks. This seems much more credible than the margin-driven double-digit annual EPS growth expected for the index, which is supposed to come off relatively lower revenue growth – a noteworthy delta when margins are already close to peaks.
The claim that “prediction is very difficult, particularly about the future” is attributed to both the Nobel Prize winning physicist Niels Bohr and the baseball Hall of Fame member Yogi Berra. Despite their differing backgrounds, they would probably both agree that prediction is particularly difficult in 2025 given the heightened geopolitical and U.S. policy uncertainty combined with wildly varying prognostications for GenAI. However, the markets do not seem to be afflicted by any such doubt, given the elevated equity multiples, modest VIX and, most starkly, BBB-rated bond spreads at their lowest this century. Given this market obliviousness to the world’s volatility, we believe a strategy that seeks to deliver steady compounding through decent top-line growth and resilient earnings, which is trading at a reasonable multiple, offers an important role to play in clients’ portfolios.
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Head of International Equity Team
International Equity Team
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Managing Director
International Equity Team
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