Fireworks, but only for a few
Despite strong corporate profits and a robust economy, our stock market assessment is mixed. In fact, only a handful of stocks are responsible for the price fireworks, while the rest of the market is trending downwards. We are cautious about this unusual divergence and the high valuation of the US equity market.
Text: Nicola Grass
Good corporate earnings, a robust economy, interest rate cuts and strong momentum continue to support equities. The year-end rally is therefore back in full swing, but this time only for a few stocks such as Broadcom, Tesla, Alphabet and Amazon. These were able to increase massively in value in December, with Broadcom leading the way with a price increase of around 50 per cent. The market capitalisation of the US semiconductor manufacturer is now over USD 1,000 billion, making it one of the eight largest companies in the world.
Too much market euphoria
The rest of the market, however, is trending lower. Such a wide divergence is rare. It is even more unusual for more stocks in the index to be falling than rising over such a long period and for the index performance to still be positive. Momentum is therefore crumbling somewhat beneath the surface. Our sentiment indicators provide another warning. According to Bank of America, the cash allocation of global fund managers has never been lower and the allocation to US equities has never been higher. At the same time, the proportion of Americans who believe that stock prices will continue to rise is at an all-time high. The valuation of the US equity market also remains high. Only during the dotcom bubble in 1999 was the market more expensive.
Focus on emerging market equities and global government bonds
Despite the supportive factors mentioned above, we therefore reduce our equity allocation at the end of the year and start 2025 with a neutral equity allocation, favouring emerging market equities over European and US equities. We remain underweight in bonds, favouring global government bonds over very expensive corporate and CHF bonds. We remain overweight in alternatives such as gold, real estate and catastrophe bonds.
What is our current view of financial markets and how are we positioned?
Better market breadth in the USA
- In our market outlook for 2025, we argue in favour of better market breadth in 2025.
- After the extreme divergence in December (Nasdaq 10% better than S&P Equal Weight), we also expect a tactical turnaround in January.
- We are therefore reducing the global heavyweights and thus reinforcing our style (value) and size (small caps) bias within equities; in the US in particular, we are significantly more diversified than the index.
Not all shares are expensive
- Although the global equity index is extremely expensive from a historical perspective (the risk premium to bonds is now zero, as such almost three standard deviations below the ten-year average), there are still cheap sectors and regions.
- Among the developed countries, we favour the more cyclical Japan and the defensive UK. Valuations there are below the historical average and the fundamentals are supportive.
- Swiss equities are not expensive either; after the biggest correction in its history (-45%), index heavyweight Nestlé, for example, now trades at just 16 times earnings and has a dividend yield of over 4%.
- In terms of sectors, we are increasingly attracted to the heavily penalised healthcare sector, but are holding back from buying in view of the political situation in the US and the extremely weak momentum.
Patience required
- Throughout 2024, we maintained an overweight in government bonds at the expense of corporate bonds. Admittedly, not a good decision. But we are sticking to it.
- With US investment-grade spreads currently at a record low of 78 basis points, the upside is now very limited. The downside is much greater. For example, an increase in spreads to the historical average of 155 basis points would result in an underperformance of around 5%. For us, this is too unbalanced a payoff profile.
- Although lower-quality debtors such as high yield or emerging markets have historically offered below-average yield premiums, we expect an increased appetite and search for relatively high-yielding bonds as interest rates on liquidity become increasingly low.
- The situation with the Japanese yen is similar. Momentum is not good and the currency has been extremely cheap for a long time. In terms of the interest rate differential, the USD/JPY should be trading around 140 (10% upside). However, the downside to the record low of 160 is only half that at 5%.
Tactical Asset Allocation in January 2025
For more information, see our 2025 market outlook and our articles on equities and bonds.
