As we reflect on the key developments of 2024 and look ahead to 2025, this article provides an in-depth analysis of the trends shaping both global and Australian equity markets.
Looking back, 2024 was a strong year for the Australian equity market as it trended higher with a strong performance by US equities being a key driver. The subsidence of inflationary pressures allowed the US Federal Reserve (US Fed) to shift to an easing monetary policy bias, cutting the official cash rate three times by a total of 100 basis points. This helped boost sentiment and asset prices in general as the market took comfort that downside economic risk was controlled. The US presidential election and the eventual Trump victory saw a strong finish to the year for markets. Equities, the US dollar, gold and cryptocurrencies were all aggressively bid as investor sentiment shifted into euphoric territory.
The Australian market was a little more subdued as resources were generally under pressure across the year with sluggish Chinese growth and a lack of material stimulus. The most notable feature of the local market was the strong performance by the banks with CBA rerating to around a 25x Price Earnings ratio and forming over 10% of the index, leaving even seasoned investors, including us, puzzled. This breakdown in market efficiency appears linked to the increasing dominance of passive indexation and the growth of superannuation funds, that have divergent goals to maximising returns.
As we look forward to 2025, Sage Capital sees a generally positive outlook for Australian equities, though several risks are emerging. The primary risk is the potential impact of new US trade tariffs, which may drive domestic investment higher in the medium term but could disrupt short term growth and intensify inflationary pressures.
Linked to this is the significant disconnect building between the bond market and the equity market. Bond yields have been pushing higher throughout the year as stronger US growth and more persistent core inflation have seen interest rate cut expectations pared back. There is also a supply-demand dynamic at play, with large budget deficits requiring funding, while the US Fed’s quantitative tightening―by not repurchasing its considerable holdings of government bonds as they mature, adds further pressure. This process of quantitative tightening and interest rate cuts has seen the yield curve steepen but may act to constrain growth given that US mortgage interest rates are priced off the long end. Further increases in US bond yields may challenge markets, particularly across growth stocks which were largely immune from valuation impacts last year.
We’ve seen similar dynamics at work in Australia where higher interest rates have largely been ignored by long duration growth stocks, across both healthcare and technology. Whilst this is the area of the market that is delivering the most consistent earnings growth with a combination of pricing power, low fixed costs and high margins, it’s also the area of the market which has become the most crowded and valuations have been pushed beyond historical extremes in many cases. It’s hard to ignore growth stocks when looking for high quality earnings compounders, but the risk of a sharp valuation correction is rising if these bond market dynamics continue. Our approach is to remain broadly neutral while identifying areas of relative valuation and earnings outperformance.
Commodity prices have been generally soft, hampered recently by the strength in the US dollar, but broadly reflecting softer growth in China. It is difficult to be positive going forward on bulk commodities as China’s population declines and an apparent lack of policy desire to stimulate the property and infrastructure sectors given the overbuilding that has already occurred. Our preference remains for base metals such as aluminium and copper where electrification demand is a key support for prices. Lithium remains oversupplied in the short term and western tariffs against Chinese EVs are unlikely to boost demand. However, the downside is also limited by cost curve support, so Sage Capital are relatively neutral and focused on stock selection. Energy has been unpopular as macro growth concerns and softening demand growth in China amongst a strong EV transition, although supply discipline by Organisation of the Petroleum Exporting Countries (OPEC) has helped provide price support. Energy stocks look cheap, and the space is heavily shorted so a contrarian move wouldn’t surprise, particularly if the incoming US government drives stricter adherence to Russian and Iranian sanctions on oil exports.
The Australian economy has remained reasonably strong, though higher interest rates have put pressure on heavily leveraged households. This has created a two-speed economy, split along demographic and generational lines, with older generations that have accumulated wealth benefiting from higher income flows, while younger generations, burdened by mortgage debt and higher rents, have faced greater financial strain. We expect this dynamic to persist in the short term, with a tight labour market and persistent services inflation likely keeping the RBA on hold until mid-2025. Even then, policy isn’t that tight, and absent a growth shock, interest rates are unlikely to be significantly reduced.
Sage Capital maintains a preference for travel stocks where older cohorts with wealth have an increasing preference to travel. While we don’t foresee a material downturn in spending, weaker terms of trade with softer commodity prices, higher interest rates eroding savings buffers, and uncertainty surrounding the federal election are likely to keep consumer spending constrained. While performing well, some discretionary retailers, much like the banks, have re-rated to valuation levels that can’t be justified by their growth outlooks.
A solid, if unspectacular, growth outlook for the Australian economy and a strong labour market suggest that a bad debt cycle isn’t imminent for the Australian banks. By the same token, banks have limited earnings growth potential as mortgage competition keeps net interest margins under pressure, book growth is limited given high household indebtedness, and rising costs are difficult to control amidst ongoing technology, security and regulatory demands. The valuation expansion doesn’t appear justified by fundamentals, presenting more opportunities for shorting positions.
Sage Capital’s preference within the Yield group has for some time remained with insurers and diversified financials, and this is unchanged. These stocks all have ongoing earnings growth, even as the insurance premium cycle nears maturity. Valuations are closer to fair than cheap given the broad re-rating across the last year, but they are still clearly preferable than those in the banking sector.
The portfolios are constructed using Sage Groups to minimise macro volatility with a focus on individual companies within these groups. Sage Capital maintains low net exposure to each Sage Group to limit the impact of unpredictable macro risks, and as always, the portfolios are well diversified and liquid.
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