Everybody loves a happy ending but when it comes to a thing as big and as complex as the world economy things are never quite that simple.
After the high inflation of 2022 and 2023 and the high interest rates that followed in 2024, the misty-eyed amongst us may have been waiting for a 2025 in which interest rates fell rapidly; crushing our mortgage interest payments with just as much force as they pushed up our share prices.
In reality, though, this cold January is a little more complicated. Yes, the final quarter of 2024 did see interest rates start to fall - with a full 1% removed from the most important US interest rate bringing it to 4.5%. Yet at the same time hopes of rates falling much further from here have faded somewhat.
Indeed, borrowing costs for the US and UK government have risen in the early days of 2025 with the cost of borrowing for the UK rising to a high last seen in 2008. Unfortunately, this only exacerbates the problems for the UK, and complicates Labour’s plans to re-build Britain, which we scrutinised in our annual report.
It now looks that inflation, whilst still falling, may only fall slowly. The derivatives market estimates that in five years it could still be slightly above the 2% target – both in the US and UK. Higher inflation pushes up interest rates and is arguably the reason why despite posting a 21% gain last year global shares fell 1.8% in December.
These weaker markets of course also reflect a more uncertain world as the new US President Donald Trump promises rapid economic reform, big spending and a much less active involvement in keeping global order.
It can seem like when these seismic political changes happen the market does not react very much. This is because observers often expect immediate dramatic moves. In reality though whilst these changes can be hard to relate to the movement of shares in real-time, the market always keeps the score. Each piece of information is absorbed into the price and when there is simply quite a lot of unpredictable change – as has been the case in recent months – there is often a bumpier ride for investors. This is what we saw in December.
Year in Review: Policy shifts mark turning point
The start of the Federal Reserve's rate cutting cycle and the re-election of Donald Trump dominated market sentiment in the final quarter of 2024. The US Federal Reserve cut interest rates by 1% in three months to 4.50%. However, the Fed's rhetoric suggests a more measured path in 2025.
In 2024, US equities led developed markets, with the technology-heavy S&P 500 climbing 26.9% despite late-year profit-taking in the sector.
European indices delivered more modest gains of just 1.9% as the region's economies showed signs of strain. UK large caps proved relatively resilient, returning 9.8%, while Japanese equities advanced 11.5% amid continued support from the Bank of Japan's accommodative stance.
Asian markets excluding Japan posted gains of 14.1%, benefiting from China's monetary stimulus, including substantial cuts to banks' reserve requirements. The region's performance highlighted the value of geographical diversification in portfolios, particularly as developed market returns diverged.
Fixed income markets reflected the changing monetary landscape, with global government bonds returning 3.6% as yields moderated from their peaks. Corporate debt generated 3.8%, while high-yield securities proved more rewarding with a 9.8% advance, suggesting investors' continued appetite for risk despite tighter financial conditions.
Global infrastructure investments emerged as a notable bright spot, delivering 16.1% as the sector benefited from sustained government spending and its traditional role as an inflation hedge. The performance underscored the merits of maintaining exposure to real assets alongside traditional equity and fixed income allocations.
Market Outlook
Whilst markets enter 2025 facing a more complex policy environment than initially anticipated we should not assume this means we are destined for market falls.
Rather we see a world where progress is simply more muted than it was in 2024. Companies must deliver on their profit promises to rise in price, rather than relying on generally improving sentiment in the wider world.
We have responded to this more nuanced outlook by adjusting down some of the exposure to Asian and European markets and have introduced a quality flavour to the sorts of companies we own across our portfolios. This helps us position into more resilient companies during this phase where markets must fight their way upwards whilst also coping with only gradually falling interest rates.
Ultimately, our investment process is at its heart designed to understand and respond to changes in inflation and interest rate expectations as it is this basic cost of money that drives the relative performance of most assets. So, whilst the world isn’t perfect heading into 2025, our process means we are prepared with a plan and can remain optimistic about the progress portfolios can make over the year ahead.