Trends confirmed
A look at capital-market history reveals that leadership often transitions from one decade to the next, driven by economic and political events that shape the asset class performance hierarchy. It is therefore crucial to periodically reassess the gravitational forces in the system that result in structural trends, bearing in mind that they typically take a few years to emerge.
The early 2020s were marked by two major external shocks: the Covid-19 pandemic and the war in Ukraine. These events led to supply disruptions, which significantly impacted Western economies and blurred the line between cyclical effects and structural changes. In 2024, we have witnessed the normalisation of many economic variables, notably inflation and growth, clearing the path for monetary policy easing in the US and Europe. After careful analysis, we have concluded that the secular trends we projected at the end of 2023 can now be confirmed.
US and out-of-system assets are in the lead
The world will remain multipolar in 2025, and active industrial and fiscal policies will continue to steer economies in a context of strategic reshoring, as is evidenced by the increasing number of large government-spending programmes in the US, Europe, and China. China has reached the point where the government is prepared to intervene to counter the deflationary forces affecting its private sector, yet high savings and weak domestic demand may persist, keeping the country in a balance sheet recession for much of the decade. The innovation super cycle theme remains valid, with a broadening of the sectors that will benefit from advances in artificial intelligence (AI). Finally, the best performances since the start of the decade remain attributable to US assets and out-of-system assets (e.g. gold and digital assets), which are characterised by limited supply and insulated from potential Western sanctions.
Equities continue to be our preferred asset class
The current market pricing reflects a benign macroeconomic outcome across almost all asset classes. We view investing as a relative exercise and therefore focus on relative rather than absolute valuation metrics. From a yield perspective, relative to long-term US Treasuries. US equities are less attractive than they have been since the Global Financial Crisis. The free-cash-flow yield advantage of large-cap US equities relative to the yield on 10-year US Treasuries has disappeared. Ultimately, however, the relative race between the two asset classes will largely depend on future inflation. The risk of supply shocks is structurally higher in a multipolar world where the peace dividend has morphed into a conflict tax. As a result, we expect US inflation to settle at a higher average of 3% rather than 2% over this decade, coupled with higher volatility around that level. So, while government bonds may look attractive from the outset, equities remain our preferred asset class strategically, which is in line with our fundamental view that real assets should outperform nominal claims in such an environment – as they have indeed done so far this decade.
A pivotal element in post-World-War-II financial market history is the succession of secular US over- and underperformance cycles. Secular US equity bull markets have been underpinned by major technological innovation cycles, such as the personal computer and the internet from 1982 to 2000. Since 2009, the US has been in another secular bull market, which was initially propelled by smartphones and their ecosystems. More recently, however, applications supported by generative AI, particularly large language models, have paved the way for an extension of the primary secular uptrend for large-cap US equities.
Until 2024, leading US information technology stocks, with their historically unparalleled return on invested capital and record free cash flow, were chronically undervalued, as investors did not believe in the sustainability of their free cash flows. This is no longer the case, and today the valuation of the major digital platforms reflects the prospect of a continuation of the historical growth and free-cash-flow generation trends. The shift from a technology cycle to a commodities cycle, and thus from a secular US bull to a US bear cycle, typically occurs alongside a US recession (e.g. 1974, 1983, 2001, 2008). Until such a recession materialises, it is likely that the trends in force since 2009 will continue, although with a reduced amplitude due to current absolute valuation levels.