Mohammed Zaidi (MZ): Hi, my name is Mohammed Zaidi and I am the Director of research for Asian and Emerging Markets Equities here at Nikko AM (Asset Management). 2024 has been quite the unexpected and eventful year. We've witnessed the birth of AI (artificial intelligence) for all of us to use. The global economy continues to hum along and the Goldilocks scenario. Multiple elections with sharp political moves to the left and to the right, culminating with the Republican clean sweep in the US. We have war, the rise of nuclear risks, catastrophic weather events. And yet the markets have given investors one of the best performances in many years. Going into 2025, we're going to explore some of the macroeconomic themes and political and regulatory issues that can affect the markets.
To give us an overview and share his thoughts, I'm talking to Chris Rands, Joint Head of Global Multi-Asset here at Nikko AM. Chris has been with Nikko for 12 years and is one of our in-house experts on interest rates, central bank policy and monetary policy.
Welcome Chris, so starting the discussion, what are some of the key areas of policy that could surprise you and how are you guys thinking about them and positioning for them?
Chris Rands (CR): Yes. So when I think of surprise, it's always an interesting question because you're trying to think of things that are unexpected. So when I look at this at the moment, the things that I'm really thinking about are focused on fiscal and monetary policy. If we start with fiscal policy, it's really about the US and what they're going to do with taxes. At the moment, the Republicans have been campaigning; before they won the election, on cutting taxes on the corporate side from 21 down to 15, and the market has pushed US equities higher on the expectation that this would occur. And when we look at where we are now, I think there's two directions this could go, either there's more than the market expects, perhaps there's some income tax cuts to come with the corporate tax cuts or alternatively we could see less corporate tax cuts.
Now, when we look at positioning, at the moment, we are overweight equities and underweight treasuries, and that's really as the fiscal deficit gets worse and the tax cuts come through, we should see more growth. Now, when you think about some of those other policies that we looked at, we might need to change our positioning if the tax policy changes. If there's more policy coming with more tax cuts, we'd probably want to go more overweight equities and less on the Treasury side because the fiscal deficit will get worse. And alternatively, if there's less, then we'll need to probably dial those equity positions back.
MZ: Okay. So right now you're talking a lot about the US, and I guess the markets are fixated on the US for leadership and direction. So why do you think that's true today, more so than before?
CR: Yeah, there's like a couple of ways I think that you can look at leadership. You know, if we think of it from a policy perspective, leadership, I think is declining from the US. You know, they've got protectionary policies coming through under Trump. Tariffs, US tax cuts, policies which put America first and usually are at the detriment to the rest of the world.
If we think about markets, though, the leadership is quite strong. If you look at US equities, for example, they make up about 65% of the global equity index (Source: MSCI World Index, December 2024). And the earnings growth in the MAG Seven1 earnings power over the past few years have been quite substantial. So when you think about the kind of themes coming through the equity market at the moment, you know, AI, tech spending in those areas, it's the US that's really leading it. And I think going into this year with Trump putting America first, it's still going to be the US that drives that forward.
MZ: So it sounds like 2024 was all about the US and the US leading global markets forward and 2025 will be something similar?
CR: We think it's going to be similar for the US, but potentially more difficult for everyone else. So if we look at the US, one of the other policies there that should be good for the US is Federal Reserve rate cuts.
So that's coming at a time when the Republicans are putting America first. But if we look outside of the US, you know, the tariffs, the trade restrictions, penalising his neighbours, there's questions being raised over kind of how performance will be certainly across Asia. But even for countries like Mexico and Canada, where there's a lot of trade done between US and those countries and tariffs could slow them down. So I think that America first policy, you know, it's really good for the US, but it's a big question mark everywhere else.
MZ: So it's 2025 then going to be a buy and hold in the US and then every place else to sort of play it tactically?
CR: Yeah, you know, I think at the moment when we think about kind of buy and hold and tactical, when we build our strategic asset allocation, we're always trying to build portfolio which are looking kind of 3 to 5 years forward.
So the correlation structure and the expected returns will really drive what we're doing on the portfolio construction side. From a perspective of core allocations, those will kind of remain the same regardless. But when we look at tactical position taking, I think the US equities and US treasuries are something that we probably have a pretty good confidence in what we're doing. And then when we look beyond that, it becomes a little bit more questionable. Some of the other areas where it becomes a bit tougher, central bank policy outside of the US is pricing quite aggressively. If we look at the European Central Bank (ECB), for example, the market is pricing a sub 2% cash rate, which for our positioning we've been overweight European bonds.
Now if these policies from the US do hurt trade and slow Europe and China and, you know, Canada and Mexico down, we probably should see that amount of rate cuts. But in the instance where we're wrong and you know you think of these buy and hold US strategies in the instance where we're wrong on that the pain that could come outside of the US, you know, perhaps the ECB doesn't need to cut as hard as that, and in which case those bonds probably should sell off. The currencies will be a little bit stronger and there'll be some opportunities which come across those countries tactically.
MZ: Okay. So going a bit deeper into the non-US part of the portfolio, I mean, the US doesn't have a monopoly on political drama, right? We've got Japan, France, Germany, UK, you name it. They're all in the running for either going left, going right. So if you had to pick one of those countries for where you think tactical alpha2 could be had, where would you go?
CR: So that the political kind of mess that has been occurring globally opens up quite a few of those. But I think Japan is probably the most interesting at the moment, and that really comes on two fronts that the main one that is causing some difference in Japan is the monetary policy where all other central banks are getting ready to cut. The Bank of Japan (BOJ) is actually entering its hiking cycle. Now it probably will not hike aggressively, but we do think that they will be able to continue to push the cash rate higher.
So for alpha opportunities, where you look at a central bank who's moving higher against central banks that are moving lower, that opens up opportunities in the bond market, it opens up opportunities in the currency markets, especially for yen, where there's been a lot of people using carry trades3. And then the other place that's really interesting is coming from the volatility. So if you're going to be generating alpha, as long as you have the stomach for it, volatility kind of helps you quite a lot. Since the BOJ did its first hike, we've seen that volatility across the Japanese market has been quite high. Yen volatility high, Japan equity market volatility is high and that creates opportunities. Now we're certainly not stock pickers, so that's not something that we'll be doing. But if we look at the Japan equity market, the reforms that are coming through for those companies to use their cash better, that has our internal teams relatively bullish on the Japanese theme of reflation and the ability to deploy capital better.
So, you know, the other area where alpha could come at the moment is from the Japan market, where there's a low Price Earnings (P/E)4 on the equity side and the ability for companies to start using their cash balances more effectively.
MZ: So there you have it. We've got a positive outlook for the US. A bit of volatility maybe in Europe, depending on what happens with interest rates. And Japan is an area of alpha. That about summing it up?
CR: I think it sums it up. But there's always the caveat with these outlooks that forecasting is hard. And usually when you feel relatively comfortable about a position, it's probably a good time to start thinking twice.
MZ: Okay, Thank you very much. I think that's a wrap.
