HWP Insight, February 2025

Last month we published our view for the year ahead and consequently, how we are positioning asset allocation and portfolios as we enter 2025.

We published a piece in The Weekend Australian on the 18th of January where we discussed the Australian Dollar (AUD) and interest rates here in Australia.

The emphasis from us on the AUD was the volatility we have experienced in the first few weeks of 2025.

As we enter the second month of 2025, President Trump is back, and the speculation over what he will or will not do will shortly end and the way markets will interpret his actions will become more obvious.

Going into his inauguration the markets interpreted Trump’s policies as marginally inflationary and therefore resulting in less rate cuts than expected before the election result. This means interest rate differentials will be less supportive of the AUD over 2025.

Up until the last week the market had been interpreting a similar delay in rate cuts in Australia and only two for the calendar year, while now the market has the chances of a rate cut for February priced at 80 per cent and three rate cuts overall in Australia for the calendar year.

The Fed Funds rate in the US is presently 4.25 – 4.5 per cent, which is a full 1.0 per cent below where it was a year ago.

The RBA official cash rate is 4.35 per cent and unchanged since November 2023, meaning what was looking like an interest rate differential in Australia’s favour is no longer in place, as markets are forecasting three interest rate decreases domestically for 2025, as against two in US markets, meaning we are looking at either no interest rate differential or a rate in Australia slightly below that of the US – with this adding to recent AUD weakness.

As important as the US is for currency direction, so is China.

Tariffs on an already weak Chinese economy as mentioned are not only inflationary but will force the Chinese to look at further stimulus measures, which are hard to predict, but play a key role in determining where the AUD will head.

For instance, a step up in Chinese stimulus that targets their consumer will lift sentiment and provide a boost to the AUD in the short term.

It is these counteracting forces that will lift currency volatility in 2025.

Whilst there is a lot of speculation as to the direction of the AUD and USD, we would see any level below 60 cents against the USD as the AUD representing good value and this would have implications for our portfolio construction as we see the AUD closing above current levels at the end of 2025.

In looking back at where US equities have come from since they bottomed in October 2022, the S&P 500 is up approximately 70 per cent whilst earnings have been running at half this rate. This is clearly multiple expansion.

We have seen the bears appear on the front pages of the financial press this year arguing the US equity market is overvalued. Their argument also looks at the concentration risk around the mega caps that have fueled this rally.

We have entered 2025 overweight Developed Market equities with a bias to the US. We believe the US should continue to outperform based on earnings and economic growth, but for this to be sustained market performance needs to broaden, which is why we included mid-caps with a US bias in our portfolios in mid-2024.

US exceptionalism has occurred both economically and through growth, however we have entered a period of uncertainty, and that uncertainty is around the US President and what is he going to do or not do and the consequences of these actions?

One thing we will experience is deregulation in the US economy as well as an emphasis on lower taxes but the negative and uncertainty around this is Tariffs.

The US economy is performing very strongly, and we cannot see any reason this will not be the case moving forward.

The case for the upside on consensus is strong and we cannot see a recession in the US in the next year, as financial conditions have been easing, and earnings growth remains robust.

Late last year US Financial Publication Barrons said to “embrace the bubble.” We believe markets will continue to move higher however, expect volatility during 2025. In 2024 the US equity market did not experience a downside correction exceeding 10 per cent. Historically, since 1980, a 10% or greater decline in the S&P500 has occurred just over once a year.

Our main concern is complacency has returned.

Calling the top on these rallies is extremely difficult as is any form of timing markets. As we have argued, US economic performance relative to other developed world economies is strong, but we have a US administration that will not only be polarizing in its decision making but uncertain. Expect therefore the unexpected.

We will remain well diversified and evenly balanced amongst and within asset classes.