On the other hand...

Brutal geopolitics and gentle economics passed this year like two ships in the night, with portfolios following in the wake of the latter. After healthy returns in 2024, however, we find ourselves looking to 2025 with unusually equivocal views on the big three assets.

For most of the last fifteen years a top-down perspective has favoured stocks, particularly the US market (and, more often than not, its technology sector). Now, however, valuations seem full, and plausible expectations for prospective long-term US returns are as low as we can remember seeing them in this period.

At the same time, inflation and interest rate risk may be about to revive – a possibility now flagged officially by yesterday's relatively hawkish statement from the Federal Reserve. With unemployment low, fiscal policy loose and perhaps getting looser, and core inflation still firmly above target, it is not obvious why US rates should continue to fall. Europe has more room for manoeuvre, particularly at the ECB and (of course, given its credibility) at the Swiss National Bank – but the Bank of England today seems to be smelling the coffee too.

And within the US market narrative, people are now saying and doing strange things under the heading of artificial intelligence (read: data processing). Balance sheets are rematerialising, energy usage (wastage?) is soaring, hyperbole is rampant.

Meanwhile, bond valuations look more reasonable, and many cash rates (pre tax) are ahead of current inflation at least – neither of which has often been the case in recent years. There seems little on which to choose, tactically, between the big three assets.

What could push us off this unfamiliar fence? Gloomy outcomes are easier to imagine (even if stocks seem not be to paying them much attention). To some extent they always are, though. We talk often of the ‘wall of worry’. The clever money, and the media, is usually pessimistic on the economy.

We have discussed elsewhere why this might be. Establishment groupthink, the news industry and the human condition all likely have something to do with it. Economists and ‘macro’ funds often seem instinctively happier buying bonds and currencies rather than stocks, and are easy prey to notions of ‘deflation’ and permanently-lower ‘equilibrium’ real interest rates (‘R-star’).

Yet ironically, some of the biggest losses in recent years have been in bonds, not stocks. Net of inflation, Bloomberg's Global Aggregate index is down almost one-third from its 2021 peak, while the UK's FT gilt index has roughly halved from its 2020 high.

The wall remains very visible today. Measured productivity is in the doldrums, particularly in Europe, where the EU looks over-regulated and uncompetitive (a point made most recently not by the UK's Nigel Farage, but by Mario Draghi's report for the Commission). Globally, we reportedly face a demographic timebomb, a mountain of debt, growing inequality and existential climate challenge.

Now the re-election of Donald Trump revives the spectre of big tariffs and repatriation, and adds uncertainty and bellicosity to an already tense geopolitical arena. China threatens Taiwan; the Middle East and Ukraine remain traumatised by conflict.

Europe is rudderless, with France and Germany currently without authoritative government. The new UK government has lost its place in a badly-designed PowerPoint presentation. South Korea mistakenly imposes martial law. Canada threatens to become interesting.

We can imagine developments in any of these areas turning us into outright stock market bears. And as noted, they would coincide with elevated stock valuations, a possible cyclical rethink on interest rates, and transformational expectations for what big data can do which seem overblown.

But on the other hand… positive outcomes are always possible too, something which has often stopped us being prematurely bearish this last decade and a half. The obsession with ‘crises’, their false imperatives, and the search for resolution, obscures the fact that most of the time, unnoticed, the macroeconomic caravan moves on and we somehow get by (we ‘muddle through’…).

We have argued often that the productivity shortfall, and the problems posed by debt, demography and even climate change, are much more nuanced than they seem. In the case of the latter, the energy transition may even turn out to offer opportunities as well as costs.

Global inequality of income and wealth has been much higher in the past, and is arguably less important anyway than poverty (which, while still too high for comfort, is historically low). The widely-reported (but questionably-measured) lack of real growth in US median household incomes in recent years ignores the fact that so many more people there have a job than used to be the case.

That cyclical inflation risk may also be more manageable, perhaps because of an altered ‘social contract’ trading real wage gains for employment stability: crunching recessions may not be needed to tackle it. Real interest rates are not especially high, and may not need to become so.

And so on and so forth. Our economic difficulties may be more manageable than they appear. What, though, of those wider geopolitical worries?

They often don't matter in the investment context, a point we've made here many (many) times. But they could. Can there be a positive counterbalance to the obvious risks, as in the economic arena?

Yes. An idiosyncratic US president need not lead to disaster. Back in 2016, we used the example of President Reagan as an example. Reagan too was widely derided when he took office, but his seemingly reckless geopolitical and economic initiatives eventually led to the dismantling of ‘mutual assured destruction’ and a thriving economy. Trump's first administration did less damage than feared, and the lesson may be relevant again today.

Remember, China, not the US, is the most protected big economy, and economic engagement with the West has helped keep its Communist Party in power. Trump's unpredictability, like Reagan's, might yet encourage compromise – not just in Beijing, but perhaps in Moscow/Kiev, at European defence ministries, and/or in the Middle East. This simple possibility has (again) been overlooked amidst the near hysteria which greeted his win (arguably, he lost an unpopularity context).

Underlying that response is a groupthink as entrenched as the established economic view. But Trump, Brexit and populism generally may not be products of an electorate which is suddenly less kind, but may instead be rejections of that groupthink, of the overconfident, muddled thinking of our Brahmins.

People impute all sorts of fancy ideas to a Trump presidency, when his most obvious characteristic is a lack of them. If he does well, it could be by accident, not grand design. But Napoleon wanted lucky generals, not clever ones, and there is an irony in the possibility that such a character might somehow help check the West's drift into decadence.

Let's keep an open mind, and sit on that fence for a bit. We thank you for your patience, and wish you a happy Christmas, and a peaceful and prosperous New Year.