Stock markets have moved into year-end mode: position tweaking, window dressing and final assessments take centre stage as liquidity has gradually evaporated. With the release of Nvidia's results last month, the markets have successfully cleared the last endogenous hurdle of the year. November has thus resolved the last two known unknowns before the end of 2024: the new US president and the state of the artificial intelligence investment cycle.
Paradoxically, while Donald Trump's victory puts an end to the suspense of the US presidential elections, it also raises the question of the impact of the economic policies of the Trump 2.0 administration. The consensus that the incoming administration will increase deficits and reignite inflation seems overly simplistic. The appointment of Scott Bessent as US Treasury secretary provided some relief to the US bond markets, as his 3-3-3 formula -- 3% budget deficit, 3% economic growth, and 3 million more barrels of oil produced per day -- eased fears about financing the US public deficit.
At the same time, the new Department of Government Efficiency (DOGE) is vying to significantly reduce the size of the US federal government. One can imagine that federal services will be reduced to the point where some measures will have to be reversed in order to ensure the smooth running of the core functions of the federal departments concerned. That said, the US corporate sector remains the growth engine for the world, with 2025 earnings growth expected to accelerate to 14.4%.
So far this year, US and European equities have experienced different fortunes. As of Dec 23, the S&P 500 Index is up 24.3% for the year to date. The Stoxx Europe 600, on the other hand, is up just 5.1%, and even less when computed in dollar terms. Overall, 2024 is shaping up to be one of the years in which European equities will lag their US counterparts the most. The performance gap has widened dramatically in recent weeks, especially following the confirmation of a second Trump presidency.
Part of this can be explained by recent movements in the euro-dollar exchange rate, where the euro has depreciated significantly over the period and is now trading at the lower end of its two-year range against the dollar. Nonetheless, the level of relative underperformance over such a short period of time is striking and reminiscent of episodes following the outbreak of the Covid-19 pandemic and during the eurozone debt crisis.
Granted, this is not a new phenomenon. The relentless secular outperformance of US equities relative to their European counterparts began in the aftermath of the global financial crisis of 2008. Prior to that, the leading European and US equity indices had moved largely in lockstep. The secular decoupling has been driven by the emergence of the US mega-cap information technology leadership, which has occupied an increasingly dominant position in the S&P 500 Index, while demonstrating an unmatched ability to generate sustainable free cash flows.
In Europe, equity indices tend to be dominated by older sectors, such as industrials and financials, that have not kept pace. To further illustrate this point, if we look at the top 10 companies in the S&P 500 and Stoxx Europe 600 indices, the average age of the European cohort is twice that of the US cohort. By contrast, in 2000, this figure was roughly the same on both sides.
Meanwhile, we do not foresee a mean reversion or reversal of fortunes on the horizon. Valuations, more often than not, are a consequence rather than a cause. From an investor perspective, capital will ultimately flow to where it is best treated. The US markets remain unrivalled in this regard; as long as the secular US dollar bull market continues, we expect US assets to continue to outperform the rest of the world.
Aside from the misleading debate over valuation levels, there is another area where investors tend to distract their attention from what really matters -- the year-end targets for equity indices -- especially when these predictions come from sell-side research organisations. Referencing a list of initial 2024 year-end targets for the S&P 500 Index from various leading sell-side organisations will reveal that these ranged from 3,300 to 5,400.
The S&P 500 Index broke through the 6,000 mark last month and is trading near 5,900 as of Dec 23. As a result, the deviations of these forecasts currently range from 9% to an astounding 79%.
Even more disconcerting is perhaps the tendency of these forecasts to be pro-cyclical, with a high probability of the most pessimistic voices suddenly becoming the most optimistic and vice versa, leading to likely massive overshooting at both ends of the spectrum. Aptly, the final word of this column for 2024 will be: take all 2025 index target forecasts with a healthy pinch of salt.
Kean Tan is Head of Investment Solutions with SCB-Julius Baer Securities Co Ltd in Bangkok.