December Newsletter

Despite a strong start to December, most indices gave up these gains towards the back end of the month as profit taking came to the fore. However, the resultant sea of red ink to mark the close of the month only marginally detracted from what has been decent performance across all major markets and most sub-indices for calendar 2024.

Lead by the United States, where the Dow Jones gained a solid 12.9% and the NASDAQ a whopping 28.6% for calendar 2024, our own indices performed well with both the All Ordinaries and ASX 200 gaining 7.5% over the year.

The rally in early December was the tail end of the Trump rally following his election win. Trump’s stated vision of revitalising the US economy through America first and tax cuts propelled the US indices higher during November and this carried over during the first weeks of December. 

However, following the 0.25% rate cut on the 18th of December to reduce the target rate to 4.25
4.50%, the US Federal Reserve predicted that in 2025 there would likely be only two further interest rate cuts amounting to 0.50%. Given more substantial interest rate cuts had  been expected, share market enthusiasm for the US election result was tempered accordingly. 

The Australian share market continues to be largely directed by the US share market, but also
remains fixated on when Australia’s initial rate cut will be. The RBA seemed to turn slightly dovish in statements made during December, encouraging some pundits to suggest an initial February rate cut of 0.25% was possible. We view this outcome as unlikely, with an April/May interest rate cut more realistic. 

Across commodity markets, the weakness experienced for much of 2024 largely continued. On the positive side, iron ore showed a gain of 1.4% over December during what is often its best  month for iron ore price gains. Oil also picked up 3.2% because of increased fears of supply  disruption for the Northern Hemisphere winter caused by the fall of the Syrian dictatorship and  possible military action by Israel on Iran. 

Most pleasing was that spodumene (lithium concentrate) gained 4.3%, marking a second consecutive month of price gains, albeit coming from a very low base relative to  previous price highs and against a backdrop of fundamental concerns over long-term  oversupply. 

Looking ahead into 2025 

Arguably, the main influence for our share market in the year ahead will be the US economy as that in turn will strongly influence the direction of the US share market, which now represents over 50% of global share market value. 

Love or hate Trump, there is no argument he is a whirlwind and his coming four years as  President will be a wild ride both geopolitically and economically. 

Trump’s avowed policies of America industry first, corporate and personal tax cuts and reduced energy prices are multiple catalysts which, if delivered, will spur US economic activity.  This in turn should drive US equities. However, we would not be surprised if gains are tempered compared to 2024. Markets often pre-empt expected outcomes and US markets are already trading on stretched earnings multiples in anticipation of favourable Trump policies. There is  also the risk the expected upcoming economic growth spurt will reignite inflation, meaning US  interest rates will need to remain restrictive. There is no certainty the two projected cuts for 2025 by the US Fed will eventuate. 

An unknown is what effect proposed Trump tariffs will have on both the US economy and trading partners, particularly China. Given Trump’s negotiation style, and that tariffs are one of his preferred negotiating tools, we suspect headline tariff rates quoted in the news may not  necessarily become reality should other concessions or favourable outcomes be granted to the  US. 

While a resurgent US economy and stronger US equity market will be positive for Australian equities, closer to home, our major trading partner in China has an economy in the  doldrums. 

In his recent annual address, Chinese President Xi Jinping put on a brave face but acknowledged that the Chinese economy needed further stimulus to combat forces coming from outside China (by implication, Trump’s tariff threats) and the transformation from old  economic growth drivers such as infrastructure and housing into new ones such as consumer  consumption. 

Recent industrial output data from China suggests some stabilisation of its economy. It is critical for Australia that Chinese industrial output grows to ensure that demand for our commodities  remains reasonable. 

As the US economy grows and US interest rates remain relatively high, demand for the US currency will remain strong. Coupled with weak Chinese demand for our bulk commodities, this will likely maintain downward pressure on the Australian dollar. Higher import prices are  inflationary in nature and will restrict the ability of our Reserve Bank to lower interest rates. 

Overarching all of this is the Federal election that is due around May. Whichever party wins government, fiscal control will need to be a priority as Australia’s growing debt, both federally and at a state level, needs to be brought under control. 

There is no doubt that Australian equities exceeded expectations during 2024 given the slowing economy, persistent inflation, high interest rates, a reduction in per capita income and  relatively flat corporate profit growth. 

Given the influencing factors discussed, we nevertheless remain mildly positive for the broader 
Australian market in 2025, but we are more bullish on a range of sectorial and stock opportunities emerging from cyclical underperformance in 2024. We also favour Australian  companies that have a high sensitivity to a stronger US economy and have direct US dollar  earnings. 

A big unknown will be how the materials (resources) sector performs. Resource companies in 
general experienced their worst performance in 2024 relative to the market since 2015 and underperformed the All-Ordinaries Index by around 18%. 

At some stage there will be a significant recovery in this sector. However, a recovery in the  Chinese economy appears essential to facilitate. 

Australian Banks 

Unlike the materials sector, the Australian Banks have enjoyed a stellar run over the past 14-15 months, outperforming the All-Ordinaries Index by more than 25%. With the bank sector comprising of a third of the market capitalisation of our share market, the outperformance of major bank shares has had a significant positive impact on overall share  market returns. 

This outperformance has been on the back of the prolonged period of higher interest rates as well as the housing boom making for very healthy bank margins, with very low provisioning for  bad and doubtful debts being presently required. 

The magnitude of the outperformance has surprised as it has propelled bank multiples  skywards and well above their historic averages. It has also reduced the yield differential (the  difference between a bank’s grossed up dividend and the RBA official rate) to less than 1%, a  level not seen over the last decade. 

To analyse if the banks are expensive relative to historic trends, we have completed a study of  the historic Price to Earnings Ratio (PER) for the Big Four.

This analysis shows that the median CBA PER is around 18 times. At current prices, CBA is  trading at a premium of around 35% to this historic measure. At the same time if we just look at   previous PER highs, CBA is trading at a PER multiple approximately 10% higher than previous  highs. 

NAB and WBC are trading at premiums of around 15% to their PER median and NAB is trading at a premium of around 5% to previous highs, whereas WBC is only trading around previous PER  highs. 

On the other hand, ANZ is trading around its long-term median but at a discount of around 20%  to its previous PER highs.  

CBA is being rewarded by the market for its consistency and quality of earnings. However,  based on historical earnings multiples, one could argue that the current market premium  appears excessive at this time. 

Banks will always form a core part of every portfolio but based on this analysis it may be best to delay any new investment in the banks until an inevitable pull back. Of the Big Four, we  consider ANZ to be the most prudent exposure at the current time. 

Conclusion 

We trust you had a merry Christmas and have been reenergised ready for the New Year. 

As in the past, please do not hesitate to contact your financial advisor to discuss any of the  themes or stocks mentioned in this monthly letter. And we also always appreciate feedback so  please let us know if you are finding the monthly letters of interest or would like to see changes  made on how it is presented or topics discussed.

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Horizon Investement Solutions

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