As we head into 2025, a New Zealand fund manager says the proverbial “elephant in the room” is the level that valuations have reached within equity markets.
Harbour Asset Management says valuations in the United States market, which makes up around two thirds of the world-wide MSCI ACWI Index, are at two-decade highs.
That optimism has led to equity market positioning and sentiment entering 2025 at relatively full levels.
“This confidence permeates through most 2025 outlooks with the median price target for America’s S&P 500 coming in at high single digits,” Harbour said in a report.
The fund manager has listed some of the themes that it believes will dominate portfolios in 2025.
1. New Zealand’s period of underperformance may end
The New Zealand share market rallied in the second half of 2024, outperforming the MSCI ACWI.
The local market was a world leader in the decade to 2020, as low starting valuations combined with steady economic growth, and a generally fallingto lowinterest rate environment.
“Three years ago, the starting valuation of the New Zealand equity market was close to 30 times earnings.
“Expensive by most measures, the New Zealand market was susceptible to the impact of higher interest rates.
“The market de-rated to a valuation of closer to 20 times, and the median stock valuation fell further to almost 16 times earnings.
“The recent economic recession and higher interest rates have bitten into sales so margins and net profits for many cyclical companies have been downgraded sharply.
“We think the earnings cycle may be forming a bottom.
“Better valuations, lower interest rates, and underweight positioning suggest we may get a follow-through in demand for local shares,” Harbour said.
2. Tariffs, Taxes, and Trump
Changes to US economic policy represent some of the biggest risks and opportunities to financial markets in 2025, Harbour says.
President-elect Donald Trump will be inaugurated on January 20 and has promised several changes that are likely to support US growth, including deregulation, tax-cut extensions, and additional tax cuts.
Immigration into the US is likely to drop a lot under Trump and may be inflationary via reduced labour supply placing upward pressure on wages, but deportations are expected to be much less than promised during the campaign.
He has pledged tariffs of 25% against Canada and Mexico, with an additional 10% tariff on Chinese goods – measures that are likely to add to US inflation and reduce global economic growth, particularly if these countries respond with tariffs of their own on US imports.
3. What if US exceptionalism does not continue?
Most analysts forecast the US economy to outperform the rest of the world in 2025, allowing the US dollar to remain expensive with little weakness expected by the median forecaster.
The US economy is expected to grow 2.1% in 2025, almost double the growth expected in the euro area, Japan, and the United Kingdom. Effective interest rates, however, are still rising in the US, placing downward pressure on consumption.
“Trump’s economic agenda carries stagflationary risk if he is to prioritise tariffs, restrict immigration, reduce Fed independence, and seek a weaker US dollar,” Harbour said.
4. Can Australia remain the lucky country?
Australia may have yet again proven itself to be the lucky country, avoiding recession when many others have not been as fortunate.
It is widely recognised that the Reserve Bank of Australia left interest rates too low for too long, resulting in persistently high core inflation that means its rate cutting cycle is unlikely to begin until April next year – seven months behind the US Federal Reserve and 10 months after the European Central Bank (see chart below).
In the meantime, households continue to feel the pinch of lower real wages and high mortgage rates. Pressure is building on the housing market as these dynamics combine with declining population growth to cause some of the first house price declines in Sydney and Melbourne that we have seen this cycle.
5. Has inflation sustainably returned to 2%?
Harbour said inflation has probably turned the corner but a global trade war is an obvious risk to further progress on re-anchoring inflation and inflation expectations.
In the US, Trump’s pro-growth policies are likely to place upward pressure on inflation and limit the degree of further Fed easing.
Longer term, changing structural inflation forces may create even greater uncertainty for investors, including de-globalisation, demographics, and de-carbonisation.
6. Why equity returns probably will not be high single digits.
Many see America’s S&P 500 returning circa 8% from current levels.
“While this is entirely possible, it reminded us of one of our long-term returns charts which plots calendar year returns.
“While the return from US equities since 1928 (when our records begin) is 9.8% per annum to the end of 2023, the number of times US equities has returned between 0 and 10% since 1928 is only 14 times.”
7. Climate impact on AI intensifies
The 2024 year is on track to be the warmest year on record according to the World Meteorological Organisation, even warmer than 2023 which currently holds the record.
Electricity usage in the US was flat from 2007 – 2022, however the Energy Information Administration is predicting a step change.
AI and data centres are expected to represent about half of the increase with electric vehicles the next largest contributor.
8. Will macro continue to beat geopolitics?
The 2024 year was not short of geopolitical events but, at the end of the day, it was global economic developments that dictated the market narrative.
Energy and oil prices, for example, have responded more to the slowing global economy and additional oil supply than the ongoing conflict in Ukraine or the intensifying situation in the Middle East, but next year could be different.
“The conflict in the Middle East continues to spread, with Iran’s oil facilities a possible target. Iran produces about 3% of global oil supply and UBS estimates further escalation could lift Brent oil prices to as high as US$90/barrel, 30% above September 2024 lows.”
9. Is 2025 the year NZ invests more in private markets?
As the world has invested more and more into private markets, New Zealand has been a notable laggard.
Some 18% of superannuation funds under management in Australia is allocated to private markets and alternatives.
In the US, public pension plans had allocated 34% of their holdings into alternative assets.
However, we may be reaching a tipping point due to a combination of factors.
“Firstly, private credit has emerged as an asset class, with multiple funds available in New Zealand and a bank capital backdrop that could see more lending made in private hands,” Harbour said.
“Secondly, the New Zealand venture capital landscape is growing in maturity and the number of successful exits is increasing.”
10. Beyond the horizon risks may also emerge in 2025 as influences on markets.
Bird flu, an acceleration of climate change, solar flares and, on a positive front, a break-through in nuclear fusion are among the many low probability but high impact events that could occur, Harbour concluded.
Jamie Gray is an Auckland-based journalist, covering the financial markets and the primary sector. He joined the Herald in 2011.
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