2025 Global Market Outlook - Investing during transition

Part II: Factors impacting financial markets

Disclaimer

This podcast is for general information purposes only and is not advice. Outside the United States, this episode is intended for investment professional use only. Please listen to the end for complete information.

Arif Husain

So, the Trump trade is alive and well, until it isn’t, and the market rebels back against it. So, for me, I think it’s really important to focus on the signal rather than the noise, and unfortunately, we’re going to see a lot of noise, very little signal, certainly over the next two to three months.

Ritu Vohora

Welcome to The Angle from T. Rowe Price, a podcast for curious investors. Sharper insights on the forces shaping financial markets begin here.

I’m Ritu Vohora, a Global Capital Markets Investment Specialist, here at T. Rowe Price Associates. In this special edition of “The Angle”, we focus on our 2025 Global Market Outlook. I recently discussed the challenges and opportunities for the global economy and markets in the year ahead with some of our senior investment team. They included CIOs:

• Justin Thomson - Head of International Equity and CIO.
• Arif Husain - Head of Global Fixed Income and CIO.
• Sebastien Page – Head of Multi-Asset and CIO.
• Stephon Jackson - Head of T. Rowe Price Investment Management.
• and Blerina Uruçi – our Chief U.S. Economist, a regular on our podcast.

In this second episode, my guests take a deeper dive into the factors impacting financial markets. They consider the outlook for corporate earnings, and whether we will continue to see a broadening of equity markets into 2025. We hope you enjoy listening.

Ritu Vohora

2024 has been a remarkable year. The S&P 500 has hit 50 record highs and counting so far this year. Gold is on track for its best performance in 45 years, and bitcoin has crossed the $90,000 threshold. Meanwhile, bond yields have been on a roller-coaster ride as markets have tried to anticipate policy shifts. The much anticipated rate-cutting cycle has begun, with 71% of global central banks cutting rates this year. But all eyes have been on the Fed as good progress on inflation and a softening of labor markets enabled a move to less restrictive policy.

So let’s kick into the conversation, and before we get stuck in, I just want to get a sense of your view as we look ahead to 2025. The Trump trade is in play. Stocks seem to be in euphoria. But when I look at bond markets, we’re seeing high yields and a lot more volatility. So quick-fire round: Are you bullish or bearish? Justin?

Justin Thomson

Well, when I started my career, we had a third dimension. We had lots of Scots in our office, we used to say bullish, bearish, or Scottish. I would say Scottish trending bearish.

Ritu Vohora

Scottish trending bearish. Arif?

Arif Husain

I think both. Uncertainty is high. We’re going to see a lot of volatility.

Ritu Vohora

OK, and Seb?

Sébastien Page

Well, you’re both bearish and bullish?

Arif Husain

Of course.

Sébastien Page

OK. I’m moderately bullish.

Ritu Vohora

OK, that’s interesting, and it’s an interesting perspective not to have a consensus view because when you look at the broader market narrative, the bullish consensus is pretty much broad-based.

So Seb, maybe I could start with you. Let’s look at it from a flip side of the conversation. What’s the bearish narrative, and what are the bears missing?

Sébastien Page

OK, so you want me to play devil’s advocate, I suppose. Have you heard bears on TV, recently? I haven’t heard any. Let me try to squeeze a bearish narrative from the data. Unemployment is rising. Historically, that is a bearish signal for the economy.

Second, manufacturing is slowing. The Purchasing Managers’ Index is at 47. That indicates contraction in manufacturing in the U.S. data. And third, the yield curve is disinverting, which is historically a recession signal.

So if you take those three—and you can even run models and show that the probabilities of recession are high, but…to your question, what are they missing? Let me play devil’s advocate on that, devil’s advocate position. I think the bullish narrative is much more compelling.

The Citi Economic Surprise Index is going up and up for the last three months in the U.S. Atlanta Fed GDPNow, which is a nowcast of the economy, it’s about 50 basis points higher than it was at the beginning of the year. The Purchasing Managers’ Index for services is at 56, which is massively expansionary. The Fed is easing into easy conditions.

Fiscal spending is pedal to the metal, 6%, 7% of GDP. We’re talking about lower taxes. We’re talking about deregulation. Corporate earnings are going up, and on and on and on. So I think the bullish narrative overwhelms the bearish narrative.

Why am I only moderately bullish? It comes down to valuations. Valuations are elevated, and I know we’re going to talk about that today.

Ritu Vohora

So coming to Arif, now, Seb’s talked around kind of the bullish and the bearish narratives, and we were at the UK conference here in September when the Fed had just cut by 50 basis points. It was the big news, and you said the Fed is eye-catching, but it can be deceiving. What really matters for markets is going to be the U.S. election. Now that we have a result, what’s your outlook on markets?

Arif Husain

I think I’ll stand by that statement. So we’ll talk a lot about the Fed today, but they are largely on autopilot. They’re kind of boxed in. They did their eye-catching 50 basis points and then were shocked as data started to accelerate. So they’re on autopilot, let’s say, for the Fed for a little while.

And in terms of the U.S. election, and go back to my previous answer, why I’m neither bullish or bearish at the moment, I think you’re going to see extreme outcomes, essentially. And the reason I believe that is because we now have, we know the result of the election. You’ve got this clean sweep.

You’ve also got China stimulating. You’ve got Japan doing quantitative tightening. There’s a lot going on in the world as well as some of the geopolitical events happening. So I think that area of volatility, uncertainty, even though we’ve got the result of the election, is still very, very high.

Now, in terms of that election, you have a clean sweep, right? So there is no real control, there’s no opposition. What is the limiting factor? And I think the market’s going to play that role. So the Trump trade is alive and well, until it isn’t and the market rebels back against it. So for me, I think it’s really important to focus on the signal rather than the noise, and unfortunately we’re going to see a lot of noise, very little signal, certainly over the next two to three months. So very, very important it fades any extreme in the markets and really, just look at what really is going on underneath all the noise.

Ritu Vohora

That’s a really good point. I think if investors take away, it’s so easy to caught up in the headlines, but focusing on the fundamentals is really going to matter.

So coming to you now, Justin, Arif talked there about China sort of easing policy, and we’ve seen more recently they have shifted to provide some stimulus to help support the economy, but we haven’t seen the fiscal bazooka, particularly given a Trump win, and that’s kind of dampened the mood in China. How do you see the role of China playing out in the global economy?

Justin Thomson

Well, let’s be clear about what they have done and what they haven’t done.

So what they have done is backstop the equity market in China with a very large fund that enables corporates to buy back their stock. They’ve recently backstopped local government finances with a big local government debt for central government swap. In terms of fiscal, what we haven’t heard yet, we haven’t heard anything about consumption, and we haven’t heard really about material measures to deal with the underlying problem of the economy, which is unsold housing stock.

To your point about Trump and the impending threat of tariffs, I think they’re keeping some powder dry. They’re keeping some powder dry and may respond with fiscal response once they’ve seen what’s in front of them. They set several measures, direct fiscal to consumer, they may devalue the currency, which won’t be good on a headline level for markets.

But to come back to your question, what part does the Chinese economy say, I would say China is too big, both from the demand side and the supply side, not to be intertwined with the global economy.

Those supply chains are so sophisticated, so cost-effective, so important for the rest of the world, that China will remain a huge part of the global economy.

That said, going forward, we’re going to have to get used to a China that doesn’t grow at 5%, 6%, 7%.China grows at 2%, 3%, 4%, and that’s a function of demographics. It’s a function of household formation. And most importantly, it’s a function of what they need to do, which is a change in business model from a fixed capital-led to a much more and export-led economy to stimulating their own consumer demand.

Ritu Vohora

OK. And that’s something to watch in in 2025. And I think, Arif, in the past you’ve mentioned China’s actually exported deflation to the rest of the world, and that could potentially persist, which has ramifications for Europe and of course, here in the UK as well.

Now let’s take a closer look at the U.S. …with Steph.

We’ve seen the postelection surge with the U.S. equity market, the S&P 500 broke 6,000 for the first time. We’ve also seen small-caps rally very significantly on the hopes there of tax cuts and deregulation. And of course all of this comes with the background of the Fed easing policy.

So standing here today, what’s your outlook for corporate earnings and how are the companies going to navigate these changes? And given the animal spirits we’re seeing in the markets, do you see any risks that maybe the market is not reflecting that could potentially generate volatility in 2025?

Steph Jackson

Thanks for the question. From an investment perspective, we really feel as though corporate earnings are going to be much stronger and are in a position to accelerate going forward, particularly in small-caps. It’s not well known or well studied, but small-caps tend to be a fairly good inflation hedge in market environments characterized by lots of inflation, so we expect higher corporate earnings, although at this particular point in time, we feel as though earnings estimates may be a bit high and are likely to come in lower. You’re exactly right, animal spirits have clearly been released, and in those environments, stronger economic activity usually leads to better corporate earnings.

From a risk perspective, we would just say that investors need to ponder how much of the good news has been pulled forward in current valuations, and valuations are very high. We got there very quickly leading into the election and then post the election, excluding the largest and riskiest names, we still think smid-cap represents sort of the best place to invest in in terms of opportunities. When you think about where they are from a valuation perspective, their valuations are very reasonable relative to history, relative to large-cap, and so we still think that smid-cap stocks have more upside potential than large.

Ritu Vohora

Steph, you talked around sort of where valuations now are in equity markets, particularly in the U.S., and I think the story in 2024 was very much dominated by AI and just a handful of stocks. But when I look across valuations across all sectors, they still look elevated. Is there still a case for U.S. equities to move higher from here, and you highlighted some opportunities, but where are probably the most attractive opportunities, be it by sector or by market cap?

Steph Jackson

Yeah, we believe that the bull case for stocks is much broader going forward, and small-caps and mid-caps look more attractive and generally do better in inflationary environments, as you point out. This is largely because of better pricing flexibility for smaller-cap companies. The average stock really, excluding the Mag Seven or the Magnificent Seven is really only up about 10% to 11%. So you really have had a very concentrated market in terms of what is driving stock performance. AI names have really been on a tear, and the capex spending has not slowed down there.

But we have much more attractive valuations when we look more deeply at down cap and elsewhere in different indices. Where the average stock looks more like 17 to 18 times forward earnings versus 25 to 26 times for the overall index.

More broadly, we do see a potential risk of some reversion to the mean for some stretched valuation areas in the market, particularly AI. It indicates more broadly that perhaps value can outperform growth. And then we’ve been saying that for quite some time, but we think that this might be we might be approaching a tipping point.

Ritu Vohora

And Seb, coming to you, given what Arif’s talked about, as an asset allocator, how should investors think about positioning for 2025? Are stocks still going up in the U.S.? How do they think about hedges in their portfolios? How are you thinking about your positioning?

Sébastien Page

Yeah, you asked me to play devil’s advocate earlier and give the bearish narrative. Now, want to play devil’s advocate on the bearish narrative to explain how we’re positioned. There is an argument to be made that valuations are rich. The forward price/earnings ratio looking out 12 months on the S&P 500 is 22. By historical standards, that is really high. However, if you look behind those valuations, you have very high return on equity for large-cap tech companies. And if you adjust for return on equity, the valuations don’t look nearly as expensive. Also, most investors don’t realize that there are other stocks in the world. Investors know that, but if you look at the average stock in the world and calculate its price/earnings ratio, it’s between 13 and 14, which is actually the 30-year average. So you can do that with the MSCI All Country World Index equal weighted. So there are caveats on the bearish narrative where we all panic about valuations.

Ritu Vohora

Bringing you into conversation, Justin, given what Seb’s talked about, you’re head of International Equities.

We’ve seen the dominance of AI and a handful of stocks in the U.S., and it seems like U.S. exceptionalism is going to carry on. How do you see the setup for stocks?

Justin Thomson

Well, style-wise, I would go for value. Just on a relative value stance, valuation is your friend.

You heard Steph talk about U.S. small- and mid-caps, I think that’s the case internationally as well. Having underperformed for three years now, they’re at a discount to where they’ve been historically. And internationally there aren’t the some of the structural headwinds that U.S. small-cap faces.

I would say for inflation upside, a basket of commodities, and that’s, you know, the fundamentals look good there as well. As we transition to our energy needs and our energy supply, the demand for certain commodities is going to be strong after a sustained period of under investment. So commodity prices could be strong.

I would say for the really contrarian, China—much unloved, much maligned, cyclically adjusted P/E of 10 times with potential stimulus coming, that’s one for the contrarians.

Ritu Vohora

The year 2025 is shaping up to be one of transition marked by a clear broadening of investment opportunities. In this evolving world, curiosity is vital. Asking smart questions about new opportunities—within asset classes or major themes such as health care innovation, energy transition, or artificial intelligence—is the best way to source the insights on which smart investment decisions can be made.

We look forward to your company on future episodes. You can find more information about our 2025 Global Market Outlook and other topics on our website. Please rate and subscribe wherever you get your podcasts.

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Disclaimer

This podcast episode was recorded in November 2024 and is for general information and educational purposes only. Outside the United States, it is for investment professional use only. It is not intended for use by persons in jurisdictions which prohibit or restrict distribution of the material herein.The podcast does not give advice or recommendations of any nature; or constitute an offer or solicitation to sell or buy any security in any jurisdiction. Prospective investors should seek independent legal, financial, and tax advice before making any investment decision. Past performance is not a reliable indicator of future performance. All investments are subject to risk, including the possible loss of principal.

Discussions relating to specific securities are informational only, are not recommendations, and may or may not have been held in any T. Rowe Price portfolio. There should be no assumption that the securities were or will be profitable. T. Rowe Price is not affiliated with any company discussed.

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Please visit https://www.troweprice.com/en/us/insights/factors-impacting-financial-markets.html for full global issuer disclosures. This podcast is copyright by T. Rowe Price, 2024.

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