Prepare for a wild ride in 2025
Between the ongoing bond bear market, the strength of the US dollar, narrow credit spreads, and the outlook for emerging markets, commodities, and currencies, there will be plenty of investment opportunities – and pitfalls – in 2025.
This is according to Philip Saunders, director of the Ninety One Investment Institute, who explained on The Investment Perspective with Ninety One that 2025 requires a new investment playbook.
This year’s investment landscape has been greatly impacted by the US and Chinese markets, in particular. The US economy has proved to be especially resilient.
“It managed to avoid a recession, which obviously caught a lot of people off guard because the odds were pretty high that that would happen – or at least a period of much weaker growth,” Saunders said.
This resilience is attributed to significant investments in AI, consumer spending supported by Covid-19 handouts, and a large government deficit funding various projects.
The US economy has maintained positive momentum, with real wages driving growth, particularly in the services sector, while manufacturing remains weak.
Productivity is also higher than in the past decade, suggesting strong growth without the typical inflationary pressures. Saunders anticipates continued positive momentum in the US over the next year, which he believes will support global growth.
In contrast, Saunders expressed scepticism about China’s forecasted 4.7% growth, pointing out that while official targets are often met, real growth in 2024 is weaker, largely due to subdued consumer activity and reliance on exports.
However, he expects the Chinese government to take significant action to stimulate growth, including quantitative easing and low interest rates, which may counter deflationary pressures and lead to better performance in 2025.
He added that a less confrontational trade stance from the US under Trump could support this recovery.
Interest rates and inflation
Saunders explained that apart from China – where bond yields continued to decline – most markets had experienced turmoil. He attributed this to a bond bear market that has been ongoing since 2020.
According to Saunders, the current inflation and interest rate regime reflects longer-term structural changes. However, he suggested that the recent turbulence in bond markets might be nearing its peak, with yields becoming more attractive for long-term investors.
On inflation, Saunders expressed a relatively optimistic outlook for 2025, dismissing concerns about growth-driven inflationary pressures and the potential inflationary impact of new tariffs under Donald Trump.
He argued that the cyclical dynamics of inflation were likely to decline. He also noted that the repricing of capital since 2020 has been constructive, with borrowing costs significantly higher than during the post-global financial crisis (GFC) period.
Saunders viewed the abnormal post-GFC era, characterised by capital misallocation and rampant financialisation, as unsustainable.
Higher bond yields, he argued, are enforcing greater discipline on governments and corporations, preventing the financial recklessness seen in the past.
Saunders added that if the US economy continues to grow at a steady pace, the Federal Reserve is unlikely to make significant cuts to short-term rates.
As a result, the yield curve will need to normalise, and investors will require a term premium for long-term lending. Weakness at the long end of the yield curve, he noted, is a logical response to these economic conditions rather than a sign of a financial crisis.
Fixed income
Saunders explained that credit spreads are currently very narrow, which means investors are not receiving much compensation for the additional risk they take when investing in lower-rated bonds.
“That is because the US economy, in particular, didn’t go into a recession, and there’s a lot of capital around that’s looking for a home, which has driven credit spreads to very low levels.”
However, Saunders believes this situation is unlikely to last forever.
He advised that investors keep their credit duration short now, as it is not the right time to take on long-term risks.
Instead, they should focus on areas that have yet to fully adjust to current market conditions, such as collateral loan obligations, which he sees as attractively priced.
“However, having said that, obviously, interest rates are now at a different level, and that means that you can earn attractive real rates of return,” Saunders said.
“If you’re a credit investor, you’re likely to enjoy your spread, and I get a higher yield, and you will not be punished for the lack of value, so to speak. That might be something for the future.”
In terms of emerging market fixed income, he explained that the dollar has been incredibly strong, and that tightens international credit conditions.
“Is the dollar really going to have another major leg on the upside? I’m really not so sure.”
“The US is running an enormous current account deficit, and other areas of the market, other areas of the world economy, if they do somewhat better than currently, discounted, then that’s actually going to be quite helpful in terms of helping to stabilise currencies.”
In relative terms, emerging markets are cheap compared to the dollar, with inflation generally falling and short-term interest rates expected to drop, regardless of what happens with the dollar.
Emerging markets
Despite a shrinking stock exchange in Johannesburg, some attractive investment opportunities have emerged in South Africa, and these were quickly seized last year.
While South Africa’s market is not particularly tech-driven, Saunders noted that as long as the country maintains reform momentum, controls inflation, and continues to attract international capital, it could experience a virtuous cycle.
However, there remain significant structural challenges that need addressing.
Looking at emerging markets more broadly, Saunders noted a shift, with tech becoming an increasingly important sector, particularly in China, despite the challenges investors face there.
For those who believe in the future of tech, he suggested diversifying some US tech exposure, particularly in companies like Nvidia, by looking for opportunities in emerging market tech, especially in China.
Commodities
Commodities are now a significant asset class for many investors, particularly in emerging market economies.
Put simply, if China and the United States drive economic growth, global demand for commodities will rise.
Despite China’s weakness, which traditionally consumes around 50% of many commodities, commodity prices have held up surprisingly well.
This period of stability reflects the industry’s consolidation over the years, with resource companies maintaining capital discipline, leading to relatively tight supply.
If global demand increases, Saunders believes resource stocks and resource-rich countries will benefit, although this is not guaranteed since various factors can influence the market.
He remains positive about industrial metals for the next year and beyond and maintains a constructive outlook on gold, appreciating its role as a reserve asset, particularly for central banks.
“Oil, interestingly, is one of the ones where there’s the potential for more supply than demand,” Saunders said.
“Therefore, we’re less constructive about oil prices. But they’ve been strong in the early part of this year, so we’re unlikely to see oil prices weaken significantly from here.”
Currencies
The US dollar has remained in a bull market for several years, and when viewed over a longer period, it becomes clear that currencies, like any other traded financial asset, go through distinct bull and bear markets.
“People tend to focus on the short-term volatility, but if you step back, you can see that they have very pronounced trends,” Saunders said.
“The dollar remains in the bull market. From a valuation perspective, it’s about as strong as it’s been since the Reagan dollar markets back in the 1980s.”
“It means that the oxygen – even if Trump turns out to be marvellous – is really getting a bit thin for the currency.”
In the first half of the year, US exceptionalism in terms of its relative growth rate is likely to continue, which typically supports the dollar. However, Saunders suggested that we are closer to the end of this phase than the beginning.
Ultimately, he believes that valuation will play a significant role, and the dollar is expected to fall back from its current levels or possibly from slightly higher levels in the future.
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