Humble New Year Resolutions

Equities have delivered exceptional returns year to date, with global markets (MSCI World All Countries) rising 22% and the S&P 500 surging 28%. Investors would be tempted to assume continuation of the favorable trend. While we don’t disagree, as we step into 2025, there are reasons to approach the market with caution. In this article, we’ll update you on which data we’re looking at, and what we’re making of if for our positioning.

The past two years of equity gains are historically remarkable. Consecutive S&P 500 annual returns exceeding 20%—as seen in 2023 and 2024—have occurred, on average, just once per decade since 1900, with the last instance in the 1990s. Historical data also suggests only a 7% likelihood of another positive year after such strong back-to-back performances.

As we plan for 2025, these insights encourage us to set humble resolutions, balancing optimism with prudence.

Sentiment Suggests Caution

Market sentiment reinforces a cautious outlook. The CNN "Fear & Greed Index" does not indicate extreme greed, partly because the rally has been driven by the "Magnificent Seven" stocks. However, several sub-indicators warrant prudence¹.

For instance, Put/Call Ratios show a reduced appetite for downside protection, signaling complacency among investors. Additionally, bullish sentiment among retail and institutional investors is nearing a decade high, making equities an increasingly crowded trade.

As we consider positioning for 2025, these signals remind us of the importance of balancing opportunity with risk awareness.

Macro suggests optimism…

While current market sentiment appears somewhat overly optimistic, the economic outlook has improved since early 2024. Our business cycle indicator Wave², illustrated in Figure 1, has shown signs of strengthening momentum in recent months. As depicted in Figure 1, where the Wave indicator (black line referenced on the left axis, denoting the share of macro indicators that are improving vs. a year ago) is plotted along an indicator of monetary supply (M1 growth, cyan line referenced on the y-axis), we are currently in a situation where the macro environment is improving, and the monetary supply is coming off of its 40-years low, both of which are supportive of risky assets, including equities.

Declining corporate and household leverage ratios since the Great Financial Crisis have bolstered the resilience of developed market economies³. This resilience has allowed private sector balance sheets to manage the lagged impact of the most aggressive policy tightening cycle in decades relatively well⁴.

As central banks are expected to continue easing, the economic strain from earlier tightening should gradually subside. Assuming central banks deliver what future markets currently anticipate, real money growth is projected to return to positive territory in the second half of 2025. This is our base case estimate, as depicted by the yellow line in Figure 1.

…and seasonality too

Despite the strong rally in 2024—which seems difficult to replicate—a continuation of the year-end rally into the new year is not uncommon. Over the past 50 years, U.S. equity markets have averaged a 4% gain in the last two months of the year, with these rallies often extending into the next. Historically, about 70% of U.S. equity returns occur between November and March.

Being underweight in equities at the start of the year has historically been costly for investors, a trend that has intensified since the 1990s. As shown in Figure 2, S&P 500 gains tend to be strong in the first quarter and even more pronounced toward year-end.

To avoid missing out on a continuing equity market rally, as indicated by our Wave indicator, we plan to maintain outright equity exposure. However, rising optimism and the risk of a market correction call for caution. To address this, we aim to increase hedges on market strength. Alongside existing positions, such as the yen, we are prepared to trade some equity upside for downside protection through equity index puts. Compared to outright long-duration positions, equity options appear more suitable as a hedge in a multi-asset context, as a strong bond rally would require significant macroeconomic deterioration—an outcome not currently supported by our Wave indicator.