View From The Top: Can the bull keep running?

View from the very top: calling the top on bubbles is hard. We think further expansion of the US economy and its stock market relative to the rest of the world seems much more likely than any imminent reversal of this trend. Positive narratives can be self-perpetuating. However, do not expect returns in 2025 to be comparable to 2024’s levels, particularly given the current high starting point. The path forward may also be more volatile. A new and potentially polarising US administration may be a cause of major uncertainty. Nonetheless, it has substantial flexibility in terms of policy implementation. Fiscal stimulus could plausibly serve to offset monetary policy that is forced to remain tight owing to still stubborn inflation. It is hard to see the US economy entering any form of recession in 2025. Better growth combined with potential AI-led productivity gains and lower taxes could help drive further corporate earnings momentum and support valuations. Our counsel: step back from the noise, be opportunistic (especially around inevitable pullbacks), focus on the longer-term and keep diversifying.  

Asset Allocation:

• Equities: The c70% return in the S&P 500 Index since its October 2022 low has been accompanied by upgrades in earnings equivalent to only c30%. This implies that significant multiple expansion has already occurred, which sets a high bar for further gains. 2024 did not see a single peak-to-trough move in excess of 10% for the S&P 500 Index throughout the whole year (all data per FactSet). Such an act may be hard to repeat in 2025. There are good reasons why the US stock market should continue to outperform other indices, based on superior growth and earnings prospects, even if the pace of momentum slows from here. For the rally to be sustained, it needs to broaden. Expect gradual rotation away from the mega-cap tech names. Small and mid-cap businesses should benefit, helped particularly by lower taxes.
• Fixed Income/Credit: As positive as the past two years has been for equity investors, it has been challenging for those investing in the fixed income space. The yield on ten-year US Treasury debt climbed c60 basis points in 2024 and could conceivably go higher should inflation remain stubborn and interest rates elevated. Longer-dated bonds may also be pressured were the new US administration to further erode US fiscal credibility. At the same time, it is noteworthy how credit spreads (high yield versus Treasuries) are at their lowest in two decades. This speaks to current risk appetite.  
• Currencies: Almost all roads lead to a higher US Dollar, despite the currency having been the best-performing in the G10 over 2024. The new US President may advocate for a lower currency, but current economic divergence between America and the rest of the world means that the interest rate differential will either stay at current levels or widen, implying ongoing relative Dollar strength.
• Gold: The precious metal remains the obvious safe haven asset, in our view. Gold can continue to play a crucial diversifying role in investors’ portfolios. It acts as a clear hedge against geopolitical uncertainties (as well as the risks attached to a growing fiscal deficit). Central Banks across the world are also continuing to buy gold.
• Alternative Assets: We see such assets as providing another useful form of diversification. Many alternative assets can deliver collateral-based cashflows. At the same time, they benefit from an illiquidity premium too. We advocate being highly selective across this broad and diverse area, favouring differentiated and uncorrelated strategies.

2024 was a remarkable year, at least if you were an equity investor, and especially if you owned mega-cap US tech businesses. Most notably, almost every forecast made at the start of last year – be it economic or where the major stock market indices might close in December – proved incorrect. Consensus opinions were wrong, once again. The US economy did not witness anything close to resembling a recession and its major equity market (the S&P 500 Index) recorded a 23% gain, despite multiple geopolitical curveballs that could not easily have been foreseen.

The most pertinent question for 2025, therefore, that we believe investors need to answer is whether the bull can keep running. At the least, assume that the coming 12-month period will be volatile, with multiple policy crosscurrents – on trade, immigration, tax and regulation – none of which will likely develop in an even fashion. It does not seem unreasonable to expect lower (equity market) returns in 2025 relative to 2024, simply given the high starting point and the gains recorded in the last two years. We wonder how much good news may already be discounted. Nonetheless, we believe positives outweigh negatives and would use any meaningful dips to add to conviction ideas, while constantly diversifying.

The sceptics would assert (with a degree of validity) that the US stock market is overvalued and overhyped like never before. Add in concentration in a small number of winning mega-cap tech stocks and corresponding lack of market breadth, and the argument gains more credence. It is as impressive as it is inescapable that the S&P 500 Index saw a record of 57 new closing day highs recorded in 2024. No surprise then that Fund Manager allocations to US equities are close to all-time highs, while assets in leveraged long ETFs exceed inverse products by a record amount (per Bank of America Merrill Lynch and Bloomberg, respectively).

Perhaps we should all believe the headlines in Barron’s magazine from December, when its counsel is to “embrace the bubble” (13 December). A more sober perspective, however, might suggest that if people are suggesting that things are too good to be true, then they probably are already. We have long cautioned against complacency and are wary of ‘this time it’s different’ narratives. In bubble phases of the stock market, prices tend to go parabolic. If history is any gauge, then the bigger the boom, typically the bigger the corresponding bust too.

To the extent that we’ve learned anything from the recent past, then it is to expect the unexpected. Forget the possibility of another pandemic or heightened geopolitical turbulence (both of which remain highly plausible risks), but instead imagine a scenario where the bull market continues for a bit longer, driven by strong growth and tailwinds from the new administration. However, such a backdrop, combined with persistently sticky inflation may force the Federal Reserve to reverse course next year. This would have clear implications for asset allocation, albeit that fixed income investors would likely suffer more than their equity counterparts. Higher rates for longer could certainly impact risk appetite.

The turmoil (in both the equity and fixed income markets) after the most recent meeting of the Federal Reserve Open Markets Committee points to just how much faith markets continue to place in a steady stream of policy easing to buoy asset prices. This may not be the case. Jerome Powell says that the Fed “can afford to be cautious.” For sure, inflation is proving stubborn, and it is fair to cite policy uncertainty as part of the Central Bank’s caution. To assume, then, an absence of conflict between the incoming US President and the Federal Reserve would be naïve. Of course, the Fed cannot know accurately what the new administration will do, but investors need to recognise that Trump 2.0 is unchartered territory for all parties. Everybody thinks they know what the President will do, but as we have noted previously, his only constancy is his unpredictability. At the least, let’s suspend judgement for now.

All the above may, however, be over-analysing what remains a very simple (and compelling) dynamic: despite policy uncertainty, the US economy is outperforming the rest of the world – and will continue to do so.  It is very hard to see a recession on the horizon next year in America. If anything, upside surprises to growth seem more likely. Current fourth-quarter GDP growth is running at 3.1% (per the Atlanta Fed), well ahead of its long-term growth assumption of 2.0%. Consumers are still spending, and sentiment remains robust, according to the most recent data from the University of Michigan’s survey. Contrast the OECD’s 2025 projection for 2.8% GDP growth in the US with its forecast for 0.8% in the Eurozone and 0.3% in Japan. Even China will likely grow at ‘only’ 4.9%.

As unconventional as the incoming Trump administration may be, it is hard not to be optimistic about potential supply-side reform. There is a clear playbook from the 1980s and it should be logical for any government to seek to implement measures that boost capital, labour and productivity. It is notable that the US is, for now, the only major economy that appears set on pursuing such an agenda. Many of America’s G7 counterparts are in political disarray (Canada, France, Germany) or have new, unproven and unpopular governments (Japan, the UK). All the above implies a potential widening in divergence between the US and the rest of the world.

Beyond the fact that forecasters have shown a recent historic tendency to be too tepid in their projections especially as the market has continued to climb a wall of worry, the reality remains that financial conditions in the US are easy, while nominal earnings growth remains robust. Even were monetary conditions not to loosen (and even potentially to tighten), looser fiscal policy may act as an offset. In one scenario, AI could deliver some genuine productivity gains in the next 12 months, while lower taxes could act as another source of upside. Both factors could boost earnings and improve valuations. Further, a more benign regulatory environment may unleash a wave of deal-making, another kicker for sentiment.

Consider then a mediating position. Consensus can be right, and bubbles can keep expanding. It is hard, always, to call the top. History has rarely been an accurate gauge of whether to sell when markets are at all-time highs. Valuation has also tended to have very limited correlation with performance. As a reasonable bet what seems more likely: the US bubble to expand, or to pop? Positive narratives can be self-perpetuating. We are also mindful of Keynes’ dictum regarding the perceived irrationality of markets versus the need for investors to deliver returns.

Against this background, we think it is important to keep balance. Focus on the positives of potentially more deregulation and lower taxes in the US, but do not discount the negative impact of tariffs, should they be implemented. To the extent that we’ve learned anything, then it’s the idea that it’s almost impossible to time markets. Volatility is, arguably, the only safe prediction. Focus, therefore, on the longer-term, and keep diversifying.    

Alex Gunz, Fund Manager, Heptagon Capital