Stock selection key to investing in 2025

Market pundits are looking beyond the Magnificent Seven technology stocks in anticipation the valuations of other companies will encourage trading across a broader range of sectors in 2025.

Expectations for global sharemarkets over the next year are mixed, though there is general agreement that gains are likely to be more restrained than the record highs of the past 12 months. 

“Shares continue to present as an asset class with both upside and downside risks, with a balanced and neutral view still warranted. Policy support as a globally synchronised central bank easing cycle unfolds is a key tailwind for shares,” according to Dan Farmer, Chief Investment Officer at MLC Asset Management.

“Corporate earnings remain strong (particularly in US IT stocks), balance sheets remain robust, and earnings quality remains high. On the other hand, expensive valuations (particularly in the US) alongside euphoric sentiment and bullish positioning suggests medium term caution as investors increasingly price this constructive cyclical outlook,” Farmer says.

Janus Henderson Investors argues the growing likelihood of a US soft landing and shifting geopolitics will provide further impetus to an ongoing shift to non-technology stocks.

“The S&P 500 Equal Weight (EW) Index, an equal-weighted version of the large-cap benchmark, outperformed the cap-weighted S&P 500 in two of the last seven quarters – both of which occurred in the last 12 months,” according to Janus Henderson’s Marc Pinto and Lucas Klein.

“Meanwhile, since July, the S&P SmallCap 600 Index has rallied 13.5% versus 5% for the cap-weighted S&P ... Even then, the potential exists for more upside. While the cap-weighted S&P 500 has a forward price-to-earnings (P/E) ratio of 22, the P/E for the EW benchmark is a comparatively lower 17,” they say.

Active opportunities

Janus Henderson argues this is an ideal environment for active managers, stating that when the S&P 500 EW outperforms the cap-weighted S&P 500 Index over a one-year period, the top-performing quartile of actively managed, large-blend US equity funds also outperform 93% of the time. 

Warakirri Asset Management is another fund manager positioning its global portfolio to capture potential outside the technology sector. It has told its clients that it remains selective in its holding of the Magnificent Seven and believes that Alphabet, Microsoft and Nvidia have superior earnings growth prospects at more reasonable valuations than the overall group. 

But it also holds “a range of high-quality stocks” that, in its view, may perform and “tend to be lower risk, steady growers providing core products and services”. 

Examples include Visa in payments; British company Informa in journals and events; US multinational Becton Dickinson in health care equipment; Marsh McLennan in insurance broking; and Nasdaq-listed CME Group in exchanges.

Local prospects

Forecasts for the Australian sharemarket are unremarkable, with analysts suggesting it is unlikely the benchmark index will stand out among its global peers in 2025.

Equity Trustees Asset Management argues that much of the good news for the next years appears to be priced into expectations and that local investors should expect much more muted capital returns and flat, or lower income, in the year ahead.

“In Australia, although we have some wonderful global businesses, economically we are more leveraged to domestic drivers and a weakening China story than the stronger US economic thematic,” according to the fund manager’s Chief Investment Officer, Darren Thompson.

“In simple terms, more than 100% of the Australian equity market gains over the last 12 months has been due to “multiple expansion” – investors paying more for the same level of earnings,” he says.

“Moreover, future period earnings forecasts continue to be downgraded. Current expectations are that aggregate earnings in FY25 for the ASX200 basket of stocks will be flat to slightly down relative to FY24.”

Morningstar has a not dissimilar view, ranking the Australian market as the one of the least favourable for investor opportunities in 2025. An exception is small caps stocks, which it argues are a better prospect than over-extended blue chips.

“The divergence between large and small caps is stark. The 20 largest stocks on the ASX, which account for almost 60% of the benchmark ASX 200 index, trade at a premium of 12% to our fair value estimates. Very few large caps trade at a discount,” Morningstar equity market strategist Lochlan Halloway says.

“For small caps, almost a third of our coverage trades at a discount. If progress on inflation continues, and the Reserve Bank of Australia sticks a soft landing, we think this end of the market can do well,” he says.

Cautious optimism

So what is the likely overall gain from local shares in 2025? AMP, for one, forecasts the S&P/ASX 200 will sit at around 8,800 points by the end of next year. It says general investments returns will be “good” over the coming 12 months – but that people should expect a rougher ride than proved the case in 2024.

“Global and Australian shares are expected to return a far more constrained 7% in the year ahead. Stretched valuations after two strong years, the ongoing risk of recession, the likelihood of a global trade war and ongoing geopolitical issues will likely make for a volatile ride in 2025 with a 15% correction somewhere along the way highly likely,” says AMP’s Head of Investment Strategy and Chief Economist, Shane Oliver. 

“But central banks still cutting rates with the Reserve Bank of Australia joining in and prospects for stronger growth later in the year supporting profits should still see okay investment returns,” Oliver says.

Advisers and their clients may need to get used to lower returns next year after a goldilocks 2024 in which both global and Australian shares posted impressive double-digit returns.

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