In the last quarter, the US stock market rose by 9.6% significantly outperforming non-US markets. Outside the US, the best performance came from the Japanese equity market up 3.3% whereas the UK, the Chinese and European ex UK equity markets were down 0.2%, 1.1% and 4.1% respectively.
The last quarter of 2024 saw an almost complete reversal of the market dynamics of the third quarter. In the third quarter, lower inflationary pressures led to a reduction in interest rates in the US and Europe and expectations of further interest rate cuts. This in turn led to a broad market rally and strong performance from fixed income and other interest rate sensitive assets such as property, infrastructure and dividend paying companies. The cut in US interest rates in the third quarter also led to a weakening of the US dollar and a strong performance of non-US assets.
The election of Donald Trump combined with the Republican party gaining control of the Congress have led to concerns about inflation resurging as a result of Trump’s proposed economic policies. The main concerns are that the trade tariffs that Donald Trump is expected to raise on imports from China, Mexico, Canada and other countries are likely to create inflationary pressures. They may also lead to lower economic growth if China and other countries retaliate with their own tariffs on US imports or take other measures such as China’s export restrictions on rare earth minerals.
In addition, Donald Trump’s plan to curb immigration would also lead to higher inflation as it would reduce the pool of cheap labour in the US. Significant immigration in the US since the end of the pandemic has been a significant contributor to the strong economic growth in the US.
The other concern about Trump’s policies is the plan to reduce taxation which if not matched with corresponding budget spending cuts or sustained economic growth would lead to higher government debt. The US government debt currently stands at around 120% of GDP (Gross Domestic Product), a historically high level, and any further increase in the debt level may lead to higher bond yields as investors seek higher returns to compensate for higher risks.
In this context, the US Federal Reserve indicated in December that it would slow down the pace of interest rate cuts. The Federal Funds rate which was expected to fall below 2.8% by the end of 2025 is now expected to remain close to 4% throughout 2025 indicating higher for longer interest rates in the US.
As a result, the 10-year US Treasury yield, which acts as a benchmark for other financial assets, has risen by more than 1% from 3.63% in mid-September to just under 4.7% in early January 2025. This has led to a sharp fall in interest rate sensitive financial assets such as property, infrastructure, dividend income equities and a fall in bond prices in the last quarter.
The other effect of higher US government bond yields is a higher US dollar as the higher return available on US government debt attracts more investors to US dollar assets. This explains the sharp reversal of the US dollar since the US presidential election in November. The US dollar which had fallen by 4.5% against a broad basket of currencies in the third quarter, rose by 8% in the last quarter. This is a significant change in the value of the US dollar and has meant that non-US dollar have performed very poorly in US dollar terms in the last quarter reversing the gains made during the previous quarter.
In the UK and Europe, economic momentum has slowed in recent months as governments have tightened fiscal spending and households have reduced consumption due to the higher cost of living and high interest rates. Lower inflation in the Eurozone should allow the European Central Bank to cut interest rates in 2025 which should boost the economy and support both bond and equity markets. The situation in the UK is trickier as core inflation remains stubborn and there is significant uncertainty about the economic impact of the proposed Employer National Insurance and other tax increases.
In China, the government continues to announce new measures to boost domestic consumption and improve consumer sentiment including measures to improve the social safety net. The government is also heavily investing in new technologies including Artificial Intelligence to maintain its competitive position with the US. The threat of US tariffs may accelerate China’s shift away from an export led economy to a more sustainable consumer led economy. Domestic consumption accounts for only 53% of the Chinese economy compared to 75% globally. Higher domestic consumption and improved household sentiment should provide support to the Chinese stock market.
The strong performance of US equities in the last quarter has further increased the gap between the highly valued US stock market and other stock markets which are generally fairly or undervalued. Based on historical evidence, the starting valuation of a stock market is one of the main drivers of its long-term performance and a high starting valuation is usually correlated with lower long-term returns.
In this context, we continue to be cautious about the long-term prospects for the US stock market despite the positive short-term momentum. In the US, we continue to diversify our equity exposure away from the highly concentrated S&P500. We remain positive about other stock markets given attractive valuations.
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T: +44 (0)20 8334 9953 E: investments@pkgroup.co.uk O: PK Wealth, 1 Parkshot, Richmond, Surrey, TW9 2RD
The information in this document does not constitute advice or a recommendation and is for the information of the recipient only. Past performance is not a reliable indicator of future returns. The value of investments and the income derived from them can go down as well as up and you may not get back the amount invested. PK Wealth Ltd is a limited company registered in England and Wales (number 08991126) and is authorised and regulated by the Financial Conduct Authority.
