To know your future, you must know your past

A (not so) fresh start

• Back to square one? – As we approach a new year investors may be forgiven to assume that the clock resets, and we start anew. While it is true that performance is typically measured in yearly increments, it is also important to recognize that context matters. The rise in the S&P 500 in 2024 has been one of the strongest since 1928. In fact, we´re observing one of the few periods with the S&P 500 being up >20% for two straight years in a row.
• Profit growth vs multiple expansion - The rally of the last ~ 13 months was supported by a solid growth in corporate earnings. Nevertheless, around half of global equity returns in 2024 are based on an expansion of valuation multiples. We think that this can be explained, at least in parts, by a growing optimism regarding lower inflation and a continuation of the rate cutting cycle. With valuations reaching fair to expensive levels in many markets, profit growth is likely to become the main driver of returns in 2025
• Moderating returns – A (very) strong run itself is – based on past observations – no good reason to turn bearish. Bulls may take comfort from the fact that bull markets tend to last for almost 6 years. Additionally, the year following back-to-back 20%+ gains (8 occasions since 1950) has produced an average return of 12.3%. At the same time, the third year is often the weakest of a bull market, albeit it´s still positive on average.

Main recommendations

Riding the improving small cap business cycle – As we expect business sentiment and thus capex investments of SMIDs to improve in the US, we see increasing value in companies catering SMIDs as those should benefit from rising revenue potentials

Diversify away from US Mega Caps though as valuations look stretched. This limits the potential for further multiple expansion. We continue to find value in US SMIDs, certain European equities – especially growth compounders, high US exposure and certain value sectors – as well as in some Emerging Markets

Hasta la vista – Downgrading Mexico to underweight: The Mexican economic activity is likely to face a negative shock on the back of heightened tariff uncertainty and potential trade frictions. This adds to certain headwinds from the judicial reform and an unclear financing strategy of the energy reform. We also believe the impact on inflation will be to the upside, preventing Banxico from adopting a more aggressive cutting cycle.

The key risks are that the market starts to reprice growth fears with central banks being perceived as “behind the curve”. Increasing policy uncertainty around tariffs could weight on sentiment, too.