Market Update

Key points

• The key themes for 2024 were: better than feared growth;global divergence; more disinflation; falling interest ratesbut with Australia lagging; and more geopolitical threats butnot as bad as feared. As in 2023, returns were strong.
• 2025 is likely to see positive returns, but after the surprisingcalm of 2024, it’s likely to be far more volatile (expect a 15%or so correction along the way) and more constrained.
• Expect the RBA cash rate to fall to 3.6%, the ASX 200 to riseto 8800 and balanced super funds to return around 6%.
Australian home prices will likely see further softness aheadof rate cuts providing a boost in the second half of 2025.
• Key things to keep an eye on are: interest rates; recessionrisk; a potential trade war; and the Australian consumer.

Another year of Goldilocks in 2024…

2024 was like a rerun of 2023 with lots of angst but it turned out okay. Key big picture themes of relevance for investors were:

1. Stronger than feared growth. Yet again the much feared recessionfailed to materialise. Despite the monetary tightening of 2022 and 2023 and China’s property collapse, global growth in 2024 remained just above 3%. In Australia, despite a “per capita recession”, economic growth remained positive albeit at only around 1% helped by strong population growth, stronger than expected growth in public spending and labour hoarding offsetting severe mortgage pain for some.
2. Global divergence. Within emerging countries, India grew around 6.5%, China grew around 4.8% (which is slow for China) but South America and the Middle East only grew around 2%. And within developed countries, US growth remained strong at around 2.8% but growth was just 0.8% in Europe and around 0.3% in Japan.

…resulted in strong returns for investors

There were a few bumps along the way for shares – notably with an inflation scare in April and a growth scare into August – but they were relatively minor (with brief falls in shares off less than 10%). For diversified investors 2024 was another strong year.

Investment returns for major asset classes

* Year to date to Nov. Source: Bloomberg, Morningstar, REIA, CoreLogic, AMP

 

• Global shares had a strong year as rates fell, albeit less than expected, and profits were stronger than expected.
• US shares outperformed reflecting its stronger economy, tech exposure and a boost from Trump’ s re-election promising US friendly policies. By contrast non-US shares underperformed, particularlyEurozone shares which weren’t helped by French politicaluncertainty. Chinese shares got a boost from more stimulus.
• Australian shares did well in anticipation of stronger profits and rate cuts ahead but underperformed with China worries and no rate cut.
• Government bond returns were constrained by smaller than expected rate cuts and worries about Trump’s policies driving higher inflation.
• Real estate investment trusts saw solid returns in anticipation of better commercial property returns ahead.
• Unlisted assets were constrained by the valuation effect of high bond yields with office property seeing losses from reduced space demand.
• Australian home prices rose with the housing shortfall, but “high” rates saw gains stall into year end with prices falling in several cities.
• The $A fell but mainly against the $US, with the latter rising on Trump’s tax cut, deregulation and tariff plans.
• Reflecting all this, balanced super funds had very strong returns forthe second year in a row. They were roughly double our expectations!

The key threats for 2025

Just as was the case for 2024 the worry list for 2025 is long and maybe even more threatening given the uncertainty Trump’s policies pose:

• Share valuations are less attractive, with the key US share markettrading on a 26 times forward PE and the earnings yield bond yield gap is negative. Australia is not so bad at 20 times but it’s not cheap.
• Uncertainty remains around how much the Fed, the RBA and some other central banks will cut rates as core inflation is still not at target.
• Bond yields could continue to rise on the back of Trump’s tax cut and tariff policies, placing pressure on shares.
• The risk of recession remains, particularly in the US if rising bond yields prevent a recovery in manufacturing and housing and in Australia if the RBA leaves rates too high for too long.
• A global trade war in response to Trump’s threatened tariffs could add to this risk particularly in Europe and Asia.
• Risks for the Chinese economy are high and could be amplified as Trump ramps up tariffs & if Chinese policy stimulus remains modest. There are signs of bottoming in China’s property market though.
• Geopolitical risk is high: “maximum pressure” from Trump to resolve the war in Ukraine and Iran’s nuclear aims could see the Ukraine and Middle East wars getting worse before they get better threatening higher oil prices; similarly tensions with China could escalate; politicaluncertainty will likely be high in Europe with issues around the French budget and another potential election and a German election in the first half (although the latter is likely to be benign with the centre right Christian Democrats likely to “win”); and the Australian election is due by May although it’s unlikely to lead to a radical change in economicpolicy but does run the risk of even more public spending.

These considerations point to at least a high risk of increased volatility after the relative calm of 2024.

Reasons for optimism in 2025

However, despite these worries there are several grounds for optimism. First, inflation is likely to continue to trend down as labour markets are continuing to ease, demand growth is still slowing and commodity prices are in a mild downtrend from their 2022 high.

Second, central banks are likely to continue cutting interest rates. This is likely to range from the Fed which will become more gradual and cut to around 3.75% to the ECB which is likely to cut to 1.5% (partly to offset the negative impact of a possible trade war and political uncertainty in France). This is expected to include the RBA where quarterly trimmed mean inflation is likely to soon drop to around 0.6-0.7%qoq (or 2.4-2.8% annualised), enabling it to possibly start cutting in February but by May at the latest taking the cash rate down to 3.6% by year end.

Third, global growth is likely to slow in 2025 but only to just below 3% with US growth around 2.5% helped by optimism on Trump’s policies, Chinese growth around 5% with more stimulus offsetting a potential trade war with the US and Japanese and European growth around 1%. Global growth is likely to strengthen in the second half helped by rate cuts. Australian growth is likely to edge up to 1.8% helped by rising real wages, tax cuts & rate cuts and this should see profit growth return.

 Fourthly, if recession does occur it’s likely to be mild as most countries including Australia have not seen a spending boom that needs to be unwound and traditionally makes recessions deep. And the Chinese government is likely to continue to do just enough to keep growth around the 5% level. Currently global business conditions surveys are still around levels consistent with okay global growth.

Implications for investors

In the absence of a tried and tested process, trying to time the market, ie, selling before falls and buying ahead of gains is very difficult. Many of the mistakes referred to above kick in and it can be a sure way to destroy wealth. Perhaps the best example of this is a comparison of returns if the investor is fully invested in shares versus missing out on the best days. Of course, if you can avoid the worst days during a given period you will boost your returns. But this is very hard and many investors only get out after the bad returns occur, just in time to miss out on some of the best days and so hurt their returns. If you were fully invested in Australian shares from January 1995, you would have returned 9.5% pa (including dividends but not allowing for franking credits). But if by trying to time the market you miss the 10 best days the return falls to 7.5% pa. If you miss the 40 best days, it drops to just 3.5% pa. Hence, it’s time in the market that’s the key, not timing the market. The last two years provide a classic example of how hard it is to time markets – there has been a long worry list, so it’s been easy to be gloomy but timing markets on the back of this has been a loser as shares put in strong gains.

Just as trees don’t grow to the sky, 20% plus returns from global shares are not sustainable. So, we expect good investment returns over 2025, but it will likely be a rougher and more constrained ride than in 2024.

• Global and Australian shares are expected to return a far more constrained 7% in the year ahead. Stretched valuations after twostrong years, the ongoing risk of recession, the likelihood of a globaltrade war and ongoing geopolitical issues will likely make for a volatile ride in 2025 with a 15% correction somewhere along the way highlylikely. But central banks still cutting rates with the RBA joining in andprospects for stronger growth later in the year supporting profits should still see okay investment returns.
• Expect the ASX 200 to end 2025 at around 8,800 points.
• Bonds are likely to provide returns around running yield or a bit more, as inflation slows to target, and central banks cut rates.
• Unlisted commercial property returns are likely to start to improve next year as office prices have already had sharp falls in response to the lagged impact of high bond yields and working from home.
• Australian home prices are likely to see further weakness over the next six months as high interest rates constrain demand and unemployment rises. Lower interest rates should help from mid-yearthough and we see average home prices rising by around 3% in 2025.

The main things to keep an eye on are: interest rates; recession risk; a likely trade war; China’s property market; and the Australian consumer.

Conclusion

We wish all our clients a Merry Christmas and hope you take time to rest from our busy lives. Last Christmas, I warned of extra volatility, but great news—I was wrong! This year, we still expect some volatility. However, as interest rates decrease to stimulate a slowing economy, financial markets usually rise. As always, stick to the strategy we've built for you and ride the ups and downs, as over time, the ups outweigh the downs.

We look forward to guiding you through 2025 and beyond!

Bill Bracey
CEO & Founder of Sydney Financial Planning

 

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This article was prepared by Dr Shane Oliver with opening and closing summary by William Bracey - CEO & Senior Financial Planner from Sydney Financial Planning. Dr Shane Oliver who provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Sydney Financial Planning Pty Ltd (ABN 29 606 413 254), trading as Sydney Financial Planning & Illawarra Financial Planning is an Authorised Representative & Credit Representative of Charter Financial Planning Limited, Australian Financial Services Licensee and Australian Credit Licensee.

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