Blog post by Empower Wealth

Priced to perfection: VanEck’s 2025 Q1 Summary

Please Note: This report was created and provided by VanEck.

“Although expectations of the future are supposed to be the driving force in the capital markets, those expectations are almost totally dominated by memories of the past. Ideas, once accepted, die hard.” – Peter Bernstein

If the market does represent the future, US markets have priced in a lot of good news. Undoubtedly, the uncertain outcome of the US Presidential election impacted markets throughout 2024. But, after Trump swept to power, equity markets rallied as he was seen as the more pro-business candidate.

Overall, in 2024, international equity markets, driven by the US have had a strong year. Reflecting the new cycle, US large caps followed by smaller caps both had a strong December quarter, the latter have historically done well following rate cuts made in response to economic weakness. The consumer discretionary, communication services and IT sectors were among the best returning international sectors during the quarter. These sectors were seen as beneficiaries of Trump’s election victory with the rally petering out post the Federal Reserve meeting. Healthcare, on the other hand, seen as a policy target, was the worst-performing sector globally for the quarter.

Cryptocurrencies defied naysayers and affirmed the resilience of risk-on sentiment in an evolving global economic landscape.

Bitcoin broke through the US$100,000 mark during the quarter, buoyed by Trump’s pro-digital-currency campaign pledges.

But it has not just been risk-on assets that have done well. Gold, typically associated as a safe haven asset, has also had a stellar year. The gold price had been around US$2,070 per ounce at the start of the year. Now it sits above US$2,600, breaking price records throughout the year.

Closer to home, our banks have driven share market returns with financials being the better returning sector last quarter with Australian equities posting a negative result. While there was initial euphoria for China’s policy changes, it petered out, but Australia’s resources sector could potentially benefit from any kick-start for Chinese growth in the new year.

Chinese authorities, rightly, might be waiting for the impact, the depth and the size of Trump’s expected tariffs before deciding how they will approach 2025.

The reality is no one knows what 2025 has in store.

While the US appears fully priced, we think there are opportunities in equities at the sector, market capitalisation and stock levels. Being selective will be important. In terms of bonds, duration may be a way for investors to add value. 10-year yields have been volatile this year, but with the Fed well into its easing cycle and the market expecting the RBA to start easing in 2025, longer-duration assets may be the place to be, they also tend to be a buffer against shocks. Emerging markets, both debt and equity complexes, offer a greater risk premia and past structural reforms have resulted in strong relative fundamentals coming to the fore now.

Gold still has many tailwinds, and we continue to think its miners are undervalued and could outperform the yellow metal through 2025. Famed investor Warren Buffett turns 95 in 2025 and throughout those many years he has “never met a man who could forecast the market.”

Neither have we. All we know is that 2025 will be unpredictable.

This time last year, we wrote about the coming year saying, “A new wave of opportunities will present themselves and smart money anticipates this.” We enter 2025 with the same carriage.

The US is the best

US markets are bubbling over with exuberance. Equities are flying, bonds are complacent and credit spreads exhibit zero concern. Even the crypto market has been running.

November’s Presidential election has led to a merry festive season for investors – one and all!

There are valid factors that kicked off the latest US rally. A non-exhaustive list includes:

Artificial intelligence exuberance;
Avoiding the hard landing;
The Fed loosening, to support the economy; and
A new President with a pro-investor agenda.

By contrast, there’s plenty not to like about investing in other parts of the world such as Europe. Investors seeking global exposure, therefore, do not have a lot of alternative investing destinations.

And, while the US looks priced to perfection, it would take a brave soul to stand in front of the trend. At least until Inauguration Day, it’s hard to see much to derail the train. Beyond that, perhaps the only clear ‘end-of-the-party’ signal is a bond market riot. But the appointment of one hedge fund bro to the Treasury portfolio seems to have been enough to quell that issue, for now.

Benjamin Graham aficionados may recall his observation, “Please do not forget that as the common stock level advances, the advantages of common stocks appear to be more attractive and the basic need for owning them becomes more persuasive in everybody’s reasoning. Yet in fact, common stocks undoubtedly become riskier as the price advances, and thus the risk increases as the widespread acceptance of common stock develops.”

It’s not hard to argue that, right now, US markets are pricing all the good bits and none of the bad bits.

They’re not even asking for a premium for uncertainty – in any asset class. We think it would have caused an investor like Graham to pause. Berkshire Hathaway’s cash holding has doubled to over A$500 billion.

The labour market has softened slightly, unemployment is up from its lows, and all the while wage growth has not slowed. Hourly earnings continue to grow at around 4%. This growth rate is not consistent with a 2% inflation target. And US GDP growth is again firming to a rate above potential growth.

What could go wrong?

The US is essentially experiencing a ‘no landing’ scenario, albeit with inflation bottoming out near to, but still above, target.

And yet, markets continue to price around another 50 basis points (bps) of Fed easing over the next year. The market has pulled this back from where it was a couple of months ago. It’s hard to see the reason for any such urgency. Given the behaviour of the economy, it’s hard to be certain the neutral rate is even that low. The optimism on the cash rate propagates out along the curve too. There’s little or no risk priced into 10-year yields, especially since the risks are stacked towards both higher inflation and higher real yields.

In turn, credit spreads are at record lows. Though to be fair, it’s hard to see a near-term economic slowdown or rate hikes to shake defaults. Heading further out the risk spectrum, as mentioned above equities are also priced to perfection: the yield spread between risk-free Treasuries and equities is basically zero. This, however, is a US peculiarity, both Europe and Japan feature healthy yield divergences.

So, the question then is, what would Graham be asking himself? Perhaps he’d start by considering, “What could go wrong?”

The short answer is plenty. It starts with geopolitics and cascades down to macro imbalances. But let’s focus on the predictable and quantifiable. President-elect Trump pulled off a stunning victory. He won the popular vote and the Republicans control both houses of Congress, the Senate and the House of Representatives. He will enter the highest office in the US with a mandate to implement many of the plans he campaigned on.

And yet, plenty of pundits continue to believe he’ll step back from some or most of his declared policies. Trump, we think will not be stepping back – and some of these could present some risks to the US economy. While many fanboys are hailing a new era of American success based on a shrunken government. It is worth analysing some of the proposed policies and observable economic relationships.

Debt trap

The first policy issue is fiscal: while markets are applauding the expected renewal and extension of expiring corporate tax breaks, there is no significant offset for the lost revenue. Wharton Business School estimates that Trump’s fiscal proposals will blow out the budget deficit by a further US$600 billion a year over the next decade, or around 2% of US GDP per year.

With a budget deficit already running near 7% of GDP, in an economy not far from full employment, this is unsustainable.

First, it will result in an overheating economy, forcing the Fed to hike rates; in turn, this will force the US dollar higher, reducing competitiveness.

This could lead to making it hard to “bring manufacturing and jobs” home to the US.

Of course, the President-elect might decide to lean into the Fed, an institution he’s already expressed ambivalence towards, including his appointee Chairman Jerome Powell – even while he’s cutting rates. But this is not without risks either, undermining Fed independence could push bond yields higher, making the funding of the US budget deficit even more unsustainable.

The US debt to GDP ratio already exceeds 100% (currently 123%). Even without adding to the pile, with deficits as far as the eye can see, this means the ratio will grow whenever nominal interest rates exceed nominal growth. The FOMC’s long-range projections are for real GDP growth of a little less than 2% and inflation of around 2%. That is, whenever the interest rate on government debt is above 4% the ratio will increase.

Add a whopping deficit every year and the debt to GDP ratio goes parabolic.

Even without the extra policy impost, the Congressional Budget Office was projecting debt to GDP of
166% within 30 years.

This is not just a US problem, of course. It’s going to lead to global instability.

On the other hand, optimists point to the newly created Department of Government Efficiency (DOGE), led by billionaires Elon Musk and Vivek Ramaswamy, as holding the key to reining in the deficit by cutting US$2 trillion from government spending. Apart from collecting government subsidies for their various businesses, Musk and Ramaswamy do not have any experience in government and the magnitude of their task looks arithmetically impossible. But these are two determined individuals.

Looking at DOGE’s task, last year the US Government spent US$6.75 trillion. Chart 8 shows the break-up of that spending. The vast bulk of the spending is mandatory or politically untouchable – defence and veterans at 23%; already-underfunded social security at 21%; net interest 14% (and this is rising sharply); health and medicare 28% (a potential target, but some cuts here could be politically difficult).

All in all, something like 94% of spending is in too-hard categories. Even the good old “sack all the public servants” wouldn’t work: if they sacked every single Federal public servant, it would save around US$300 billion – or roughly 15% of the budget deficit.