Monthly update: Markets steady in december after stellar year

After a remarkable year, markets were steady throughout December, with stocks dipping towards the end of the month after the US Federal Reserve (Fed) suggested it would make fewer interest rate cuts in 2025.

The Fed concluded 2024 with a 0.25% cut to its key interest rate, reducing the target rate to between 4.25% and 4.5%. It also forecasts two fewer rate reductions in 2025 than had previously been expected, in response to sticky inflation and the continued strength of the US economy which is likely to keep prices rising above its 2% target.

Fed Chair Jay Powell said that future rate cuts will now hinge on further progress in lowering stubbornly high inflation. Powell's cautionary remarks jolted investors, sending stocks sharply lower, boosting bond yields and prompting expectations to be scaled back for interest rate cuts this year.

While major central banks have been making progress in their battle against inflation, it remains persistently high in many economies, posing ongoing challenges to further interest rate reductions. The Bank of England kept interest rates steady in December after inflation rose for the second month in a row.

Lilian Chovin, Head of Asset Allocation, Coutts, says: “The Fed is possibly moving into a new phase of the cutting cycle, signalling less aggressive cuts going forward.

“Any further reductions will likely depend on inflation progress or signs of weakening growth, with the data in the early months of the year being crucial in determining their next steps.”

Despite some volatility and stocks being relatively flat during the month, it has been a strong year overall for markets. US stocks rallied to new highs, driven by excitement over artificial intelligence, enthusiasm for rate cuts and the strength of the economy.

The S&P 500 had its second consecutive annual gain exceeding 20%. Meanwhile, the FTSE 100 recorded its best performance since 2021, buoyed by resilient corporate earnings. European shares also notched a modest gain for the year, despite weaker economic growth across key sectors such as manufacturing and services.

Despite December finishing on an underwhelming note, it still completes a positive year for markets. US stocks have performed spectacularly well again, while UK and European markets ended the year with more modest gains. This contributed to our own strong performance given our overweight position in global equities throughout 2024.

Our anchor and cycle investment process has worked well. We leaned into risk – staying overweight equities throughout the year – and our investments in assets such as high-yield bonds and gold did well while we held them.

Over the summer, we capitalised on these gains by taking profits from our overweight positions in high-yield bonds and gold. Our strategic shift to global equities in the summer also contributed positively.

While we favour equities, we also hold US government bonds, which can help stabilise returns during periods of market stress. Additionally, our liquid alternatives fund is designed to provide a further layer of diversification, offering resilience in the unlikely event of simultaneous declines in both stocks and bonds. Although we do not foresee such a scenario in the near term, our approach ensures we are prepared for a range of market conditions.

Elsewhere, Japanese corporates have been witnessing an improving outlook. In response, we have adjusted our strategy accordingly. As part of our cycle process – our near-term outlook on where the business cycle is today – we are increasing our allocation to Japanese equities.

While the benchmark exposure to Japan will remain unhedged, the additional overweight position will be hedged. This approach ensures that portfolios maintain a broadly neutral stance on the Japanese yen, despite the overweight allocation to Japanese equities.

Our expectation is that the Bank of Japan will steadily increase interest rates, which should benefit the trade. A stronger yen against the dollar could temper earnings growth in Japan's equity market next year, given the economy's reliance on exporters. However, with fewer US rate cuts anticipated than currently priced in, significant dollar weakness appears unlikely.

Investing in Japan is particularly compelling right now, thanks to a combination of strong earnings growth, domestic and global economic trends, and ongoing corporate reforms.

Japanese companies have a long track record of delivering robust earnings. Over the past 15 years, Japanese equities have delivered superior earnings growth compared to global equities, yet they have underperformed in market terms due to persistent valuation de-rating. Today, that narrative is shifting. Japan’s earnings remain robust, supported by strong global nominal growth and domestic economic activity that has outpaced the previous decade.

Japan’s position as a leading export nation adds to its appeal. The country’s high-quality equity index, with significant exposure to global economic trends, benefits from strong US growth and a strengthening dollar, which supports export-driven earnings.

Corporate reforms represent another major driver for Japanese equities. Efforts to improve corporate governance and shareholder returns are yielding tangible benefits, including rising dividends and a significant increase in share buybacks.

Going forward, we believe our base case of strong global economic activity, combined with an improved domestic backdrop in Japan, will support superior earnings growth for Japanese equities. This should translate into continued outperformance compared to global equities.

If you are a Coutts client and would like to discuss any of this in more detail, please contact your private banker.