JANUARY 2025
US equities produced strong double-digit gains in 2024, for the second year running, but a host of sentiment and valuation metrics are starting to look stretched.
Take the chart below as an example.
It shows the S&P 500’s cyclically-adjusted (CAPE) ratio since the early 1900s. It has risen from 31x to 38x in the last 12 months alone.
Over the past century it has only been higher on three occasions; 1929, 1999 and 2021. Each episode marked a major bull market peak, followed by pronounced share price declines.
At face value the current level of overvaluation warrants extreme caution and suggests, at a minimum, the prolonged period of US equities outperformance is nearing an end.
However, all three of those bear markets were triggered by Central Banks hiking interest rates aggressively.
The opposite is happening this time around with rate cuts and other liquidity support measures set to endure throughout 2025.
We are thus in unchartered territory, which means this CAPE ratio (and share prices) could yet rise a lot further.
Historically, when the US stockmarket has been valued at such high levels it has tended to de-rate via abrupt and substantial price declines.
Valuations can, however, compress to healthier levels in a more gradual, positive manner via stronger corporate earnings.
We could be on the verge of this more constructive scenario playing out.
Whilst early days, it seems “animal spirits” in corporate America have been sparked into life since the election.
The NFIB Small Business Optimism index has spiked at an unprecedented rate. So too have indicators measuring firms’ plans to raise worker pay.
The start of Trump’s first term, back in 2017, catalysed a similar trend, especially in the manufacturing sector with new orders surging during his first year in office.
The chart below shows how manufacturing new orders (red line) typically lead S&P 500 earnings growth (blue line) by around 12 months.
So any positive new orders trend would likely boost profit levels which, in turn, would help to justify at least some of the valuation premium that’s currently priced into markets.
Heading into 2025, a further deterioration in US/China trade relations seems to be a strong consensus call.
This would be an extension, and possible amplification, of a decade long trend.
As the chart below shows, the share of US goods imports from China (blue line) has dropped significantly since 2015; from 22% of the total value to just 13%.
Note how Mexico’s share (red line) has risen steadily over the same period.
This partly reflects a strategic pivot by US businesses to rely on supply chains closer to home, but it stems mainly from the tense political environment.
However, it often pays to go against the trend.
Whilst unlikely, there is a chance that US/China trade relations actually improve this year. There would be obvious benefits to both sides.
For the US, it would lower costs for US firms and consumers, offsetting some of the mounting domestic inflationary pressures and boosting the growth outlook.
For China, improved trade terms would help to stabilise its export-dependent sectors, which are becoming increasingly vital to the broader economy given the ongoing challenges in the real estate and financial sectors.
This is a long way from being the most likely scenario, but any talk of conciliation or some form of “Mar-a-Lago Accord” would be well received by markets.
It’s been a year since we first showed this chart and the initial publication proved well timed.
As predicted, last year’s Central Bank U-turn, which saw rate cuts begin despite steady economic growth and above-target inflation, triggered a boom in the precious metals complex.
Gold had a banner year, rising by approximately 30% in US dollar terms to a comfortable record high.
Despite pervasive investor scepticism towards the asset class, it has been performing well for several years now, particularly in risk-adjusted terms, but will the good times continue?
On the one hand the rally looks a little stretched and a high degree of retail investor participation (at least from Asian investors) suggests the bull market is entering a more mature phase.
However, we are in a highly unusual environment in which policymakers are easing liquidity conditions just as inflation rates are perking up.
This reinforces our long held view that we are in an era of “financial repression” whereby the Central Banks are devaluing fiat currencies to help manage the colossal debt burdens.
Should this trend continue (as we expect it to) a U$3,000/oz gold price is on the cards in 2025, but expect there to be plenty of volatility and the occasional large price drawdown too.
The content of this communication is for information purposes only. Bentley Reid believes that, at the time of publication, the views expressed are a matter of and opinions given are correct but cannot guarantee replication of depicted performance. Viewers intending to take action based upon the content of this communication should first consult with the professional who advises them on their financial affairs. Capital invested will be at risk, and you may get back less than you invest. The past is not a reliable indicator of future performance. Neither the publisher nor any of its subsidiaries or connected parties accepts responsibility for any direct or indirect loss suffered by a recipient as a result of any action or inaction, in reliance upon the content of this communication.
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