Outlook 2025: Where and what to invest in?

The solidifying of a major secular trend — deglobalisation

A good place to start would be to look at the major secular trend that began in the 2010s on the back of populist backlash across Europe and the US, and which has since gained traction after the pandemic exposed supply chain vulnerabilities and with rising geopolitical tensions around the world. That secular trend is deglobalisation.

Political rhetoric, spurred by growing nationalism-populism, has translated into a rise in trade barriers (tariff and non-tariff) and more restrictive immigration policies across the Western world. Rising geopolitical tensions and the tech war between the US and China, as well as the severe supply chain disruptions during the pandemic, have also led to the return of industrial policies in the West, reshoring, near-shoring and critically, technology decoupling.

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The unfettered free movement of goods and services, and people that has prevailed for the past four decades — driving economies of scale and lower and lower prices for goods and services — has come to an end, at least for the foreseeable future. Even the free flow of capital is starting to see the beginnings of restrictions, notably into China, the world’s second largest economy. In other words, global economic fragmentation.

Because of the US-led wide-ranging export controls over critical advanced chips, intellectual properties and technologies and restrictions on US investments in high-tech sectors, China is forced to invest heavily in the homegrown tech industry for self-sufficiency. This will result in two primary tech and digital ecosystems in the world, as well as duplication of production and supply chains — all translating into reduced scale, higher production costs and higher prices for goods and services, at least in the short to medium term.

Higher inflation + rising global debts = higher interest rates compared to last 10 years

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What this means is that inflation will be higher than it was in the preceding 10 years (when persistent goods disinflation offset stronger services inflation). So will interest rates, which reflect inflation expectations, on top of compensation for time and risks.

Western governments including the US have socialised debts through massive stimulus packages during the pandemic. Mounting debt servicing costs due to higher interest rates will necessarily mean even more debts, in the absence of sufficient offset from reduction in spending and/or tax increases.

Reducing spending and higher tax rates are highly unlikely at the moment in the US. China too is stepping up fiscal and monetary stimulus to try to put a floor on its property sector and revive flagging consumer confidence and domestic consumption. In short, debts for the world’s two largest economies as well as across much of the developed world, will continue to grow in the short and medium term. That means greater borrowing demand. And when demand is high, interest rates (the price of money) tend to rise. Higher borrowing costs, compared with the last decade, have broad implications for the global economy.

Hence, even though the US Federal Reserve will cut the short-term federal funds rate over the coming months, yields for the longer-dated treasury notes will probably see far lesser reductions. Case in point, the difference in yields between the 10-year and 2-year treasuries have reversed from negative at the start of 2024 (an inverted yield curve) to positive currently. That is, the yield curve has steepened (see Chart 1). The yield for the all-important 10year treasury (which is the global benchmark for lending rates, including for mortgages) has risen to 4.25% (at the point of writing), higher than the 3.95% on Jan 2, 2024 — after the Fed’s rate cut of 50 basis points in September.

Of course, the steepening of the yield curve is also due in part to receding investor expectations of an imminent recession. Historically, a yield curve inversion typically precedes a recession. US economic growth has remained remarkably resilient, contrary to earlier expectations and despite the sharp hikes in interest rates (since March 2022). Case in point, the preliminary estimate for real GDP growth in 3Q2024 came in at an annualised rate of 2.8%, supported by consumption, only marginally weaker than the 3% expansion in 2Q2024 and an acceleration from the growth of 1.6% in 1Q2024. That has led to a wholesale shift in investor outlook. The prevailing consensus is that the US economy will avoid recession and make a soft landing in this current business cycle. A recession will happen at some point but probably not in the near term.

The job market has been resilient with unemployment continuing to hover near historically low levels, at only 4.1% currently. While businesses are no longer hiring as rapidly as they did post-pandemic (lower job openings), layoffs have stayed low. This suggests businesses remain fairly confident in the economy. The still-strong employment and real wage gains (as inflation cools) are supporting domestic consumption, even if consumers are more cautious of their spending as excess savings from the pandemic dwindle (see Charts 2 and 3).

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But real interest rates will fall

That said, because of the ballooning government debt servicing costs, central banks must lower interest rates if the growing public debt is to be sustainable. Higher interest expenses are also hurting borrowers and especially low-moderate income households, making it harder to get out of a vicious debt cycle. It is putting homeownership out of the range for many, including younger and first-time buyers, making it harder to build wealth. Ultimately, high interest rates would cause economic damage and worsen inequality. This is why we suspect the Fed will come to accept a higher structural inflation (if and when the current disinflation stalls). What this will then mean is that as nominal interest rate falls and inflation remains elevated, real interest rate (the gap) will narrow and may even drop into negative territory.

So, what does all this mean for investing in 2025?

Lower and falling real interest rates would be bad for bonds and fixed-income investments including savings, particularly if short-term rates drop rapidly. 

Select commodities could do well in this landscape. Precious metals including gold and silver have rallied this year, as a hedge against inflation and geopolitics. That includes the weaponisation of the US dollar. Central banks, for instance, have been big buyers of gold as part of their reserves. On the other hand, crude oil prices have been relatively muted even as tensions ratcheted up in the Middle East. This signals weak global demand expectations, particularly with slower economic growth in China. Latest signs of potential de-escalation of tensions between Israel and Iran has further pushed oil prices lower. Over time, the anticipated growth in renewable energy such as solar and wind and increasingly, nuclear, will progressively diminish the demand for oil. Elsewhere, properties would be another good alternative hedge against inflation, for investors with much longer investment horizons.

China is grappling with flagging consumer confidence and subdued domestic consumption, at a time when pushback against its export-driven economic model from the rest of the world is growing. We think China will need a period to stabilise and revive the property sector and restore confidence — and address its underlying structural issues. The country needs to shift away from its heavy reliance on residential real estate investments to drive growth. Consumption as a percentage of the economy notably remains low relative to other countries at a similar stage of development and per capita income. Its national savings rate — about 43% of GDP — is well above those in other major economies. The brief rally in Chinese stocks appears to be losing steam, pending more stimulus measures — beyond the monetary policy loosening announced in September — and concrete signs of recovery. One way for China to address this is to allow negative real interest rates, which will surely stimulate domestic consumption. We think China will do it.

US equity, we think, will continue to outperform since we believe the economy will gain on other developed countries over the coming years, bolstered by artificial intelligence (AI). The biggest concerns in the short term are valuations and concentration risks. That said, past experience has taught us that attempting to time the market is usually a fool’s errand. It is time in the market that is all-important for long-term investors. That is why the Absolute Returns Portfolio is intended to be fully invested at all times.

The megacap tech stocks, the Magnificent 7, have been the key drivers in this rally, perpetuated by the AI boom (and hype) that is exacerbated by the strong growth in indexing and exchange-traded funds (ETFs). As a result, they now collectively account for a hefty 32% of the S&P 500 total market cap. Current price earnings (PE) valuations for this handful of stocks are well above the historical market averages (see Chart 5), as well as that of the other 493 companies in the S&P 500 index. This premium is justified by their higher-than-market average earnings growth thus far. The risk is that reality may fall short of the very high expectations for future growth that is currently built into their stock prices. For instance, both Microsoft and Meta reported earnings beats for the latest quarter, but share prices fell as guidance couldn’t quite meet elevated market expectations. We think this risk is even higher for Nvidia, given the cyclical nature of the semiconductor industry. Plus, we have no doubt that competition will grow and eat into the chipmaker’s current huge margins. A correction from its current lofty valuations could trigger a cascading selloff in index funds and drag down the S&P 500 — even if most of the other stocks continue to perform. And we think they will, in terms of underlying margins and earnings growth.

Companies that improve productivity and profitability with AI-driven tools

We believe that the AI revolution is real. The massive spending on AI will continue but the beneficiaries will gradually broaden out beyond the current handful of megacap tech darlings — and ultimately, to the users of AI-driven technologies.

Businesses applying AI tools will see significant improvements in efficiency and productivity, which will enhance their competitive advantage, and drive global market share gains and earnings growth. And we have no doubt these will be predominantly US companies. Corporate America is far ahead of the rest of the world (save for China and South Korea) in adopting AI tech. That includes Europe, where there are few large tech companies and businesses are hampered, in part, by extensive AI regulations.

As we have explained in previous articles, the US attracts a disproportionately large share 4.5% this year, more than triple the rate for all advanced economies. From 2016-2025, the IMF estimates US investments will have grown by an average 3.3% per year, compared with 2.3% for all advanced economies. It upgraded projected growth for the US to 2.2% for 2025, versus 1.8% for all advanced economies and 3.2% for the global economy. Conclusion US FRED BLOOMBERG IMF of global capital flows. This strong inflow of capital gives it an “unfair” advantage over the rest of the world. Huge capital inflows translate into lower cost of capital, support investments that lead to more and rapid innovations and even higher productivity and stronger corporate earnings. That, in turn, translates into higher wages and purchasing power, and ultimately stronger economic and corporate earnings growth. It also highlights the risks for the rest of the world whose capital markets are being increasingly marginalised. Additionally, the need to fund the US’ growing debts will sap capital that would otherwise flow to other developed and developing countries. This will hurt their future potential growth.

This fact was underscored in the International Monetary Fund’s latest World Economic Outlook update — where it notes that the US is increasingly pulling ahead of the world’s advanced economies. US gross fixed capital formation (a broad gauge for investment) will rise 4.5% this year, more than triple the rate for all advanced economies. From 2016-2025, the IMF estimates US investments will have grown by an average 3.3% per year, compared with 2.3% for all advanced economies. It upgraded projected growth for the US to 2.2% for 2025, versus 1.8% for all advanced economies and 3.2% for the global economy.

Conclusion

US equity will continue to dominate global portfolio funds, attracting investors with its capitalist system that promotes economic dynamism and earnings growth, which in the long run is the primary driver for stock prices. AI-led productivity gains will put Corporate America in the driver’s seat, particularly as global economic growth slows and cost savings becomes key in expanding — or at the very least defending — margins and market share. Robust foreign capital flow is also a source of strength for the US dollar, despite the country’s trade deficit and growing public debt.

Given our above market outlook, we made two changes to the Absolute Returns Portfolio. We disposed of our entire stakes in Airbus and DR Horton and used the proceeds to buy Uber Technologies and Talen Energy Corp, two companies that we think will benefit from AI spending and AI-driven tools.

Talen Energy is an independent power producer (IPP) with 10.7GW of nuclear, coal and natural gas-fired power-generating plants in the US. The company primarily sells electricity into the PJM Interconnection transmission grid, which covers all or part of Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, and West Virginia as well as the District of Columbia, where many data centres are located. Strong demand growth — outpacing new power-generating capacity — is driving up capacity prices in the wholesale market, benefiting the IPPs. The capacity auction clearing price for 2025/2026 delivery settled at a record high of US$269.92/MW-day, compared to US$28.92/ MW-day for the 2024/2025 auction. We foresee rising power demand as a long-term story in the AI revolution.

Uber, as we well know, is the leading global platform for ride-hailing with an extensive network in both urban and suburban areas across the US, as well as a significant presence in many other countries. The company has over the years expanded its software network to other businesses including food delivery and freight services. Though its shares came under some selling pressure following softer gross bookings in its latest 3Q2024 earnings results and a more tempered 4Q2024 outlook guidance, we think Uber will continue to see new growth opportunities leveraging AI advances, improve productivity and raise return on equity (ROI) going forward. The company provided a three-year outlook that included mid-to-high teens compound annual growth rate (CAGR) for gross bookings, adjusted earnings before interest, taxes, depreciation, and amortisation (Ebitda) CAGR of between the high-30s% and 40% and significant improvements in free cash flow conversion exceeding 90% of adjusted Ebitda.

Another stock that we are currently looking at is Palantir Technologies, a data analytics and software company that provides platforms for integrating, managing and analysing large data sets for government agencies (notably, defence and intelligence) and enterprises. The company is a beneficiary of advancements in generative AI, where machine learning enhances its platform’s ability to make better and faster predictions for  real-time decision-making. Palantir turned profitable for the first time in 2023 on the back of robust demand growth since integrating genAI into its platforms. The scalability of its software is expected to translate to further margin expansions. Not surprisingly, valuations are higher than they were this time last year, after its share price surged nearly 200% so far this year. We are still trying to figure out the right valuations, which is handicapped by our limited knowledge of the US market (a harsh reality that likely means we would never get a first-mover advantage).

We think DR Horton and homebuilder stocks are still good investments over the longer term as US demand for housing is expected to remain strong for years to come. However, higher mortgage rates have negatively affected affordability, made worse by chronic shortage of homes and rise in home prices, which has outpaced wage increases, in the past five years. This is a particularly tough environment for first-time buyers, without any existing home equity to at least pay for the down payment. Short-term sales are thus expected to be sluggish, and homebuilders expect to retain discounts to support demand, which hurts margins. Homeownership affordability should gradually improve over time, with wages growth and lower interest rates.

Given the likely rebound at some stage, plus negative real interest rates, we are bullish on building materials distributors. Demand will come from both home building and renovations for existing homes, as well as other non-residential projects such as manufacturing and data centres. Another alternative for staying invested in the property-related sector while also mitigating downside risks are home improvement retailers — companies that will benefit from lower real interest rates but also have a more stable source of demand from renovation activities.

The landscape of higher inflation and lower real interest rates is also favourable to land and property values and therefore, landowners and property holding companies, though the investment horizon may be longer. It is not so much about earnings right now but appreciation in underlying asset values. This was our rationale for buying Swire Properties, which is currently trading at a steep discount to book value, at only 0.34 times, even though we are fully aware that earnings may well remain depressed for some time.

On the other hand, we think Malaysian property stocks will continue to outperform in 2025. We have explained our rationale in our previous article entitled “Robust increase in sales and prices for residential properties with improvement in affordability” in the Oct 14, 2024 issue (scan the QR code for the full article).

We are more cautious on the outlook for the broader Bursa Malaysia market. The rally has stalled in recent weeks, which coincided with net outflows in foreign funds in September-October. The ringgit too has given back some of its gains against the greenback. It appears likely that Bank Negara Malaysia will keep interest rates unchanged for the foreseeable future. That means one less possible catalyst for domestic consumption. We think consumer spending will remain relatively muted — despite the civil service pay hike (effective December 2024) and higher minimum wage (from February 2025) — weighed down by still rising cost of living. The higher minimum wage will negatively affect corporate earnings, at least part of which will likely be passed through to consumers. Inflation would worsen further when subsidies for RON95 petrol are removed, which is reported to happen sometime in mid-2025. Save for the property sector, we do not see any outstanding theme for Bursa next year. Our strategy is selective stock picking. Asia Analytica will reveal its Top 10 stocks for 2025 in due course.

The Malaysian Portfolio ended marginally higher, up 0.1% for the week ended Nov 5. The top gainers were Kim Loong Resources (+4.6%), Gamuda (+1.8%) and United Plantations (+1.7%); while Kumpulan Kitacon (-2.7%), UOA Development (-2.1%) and Harbour-Link (-1.3%) were the biggest losers. We made no change to the portfolio. Total portfolio returns now stand at 200.6% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 11.4% over the same period, by a long, long way.

The Absolute Returns Portfolio finished higher last week, gaining 1.3% and lifting total returns since inception to 13.7%. As mentioned above, we disposed of our entire stakes in DR Horton and Airbus, and reinvested the proceeds into Talen Energy and Uber. The top three gainers were Talen Energy (+4.3%), Tencent Holdings (+4.1%) and Swire Properties (+2.6%). Berkshire Hathaway (-2.2%) was the only losing stock. Shares for Talen saw some volatility last week after US energy regulators, the Federal Energy Regulatory Commission, rejected its request to increase direct power sales from 300MW to 480MW to an Amazon data centre from its adjacent nuclear power plant. Nevertheless, its shares have since more than recouped lost ground. Despite this setback, the company intends to continue seeking alternative commercial solutions to supply large-load demand going forward.

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.