Jan 22, 2025
• U.S. growth, fuelled by productivity gains, is expected to exceed long-term trend with inflation likely to remain above the Fed’s 2% target.
• Europe continues to grapple with political and tariff uncertainties, while potential stimulus measures in China could largely mitigate tariff impacts.
• Aggressive tariffs and stricter immigration controls pose significant risks to both U.S. and global economic outlooks.
• India’s growth is expected to rebound in 2025, accompanied by a moderation in inflation.
• Expensive Indian equities face downside risks in case of earnings disappointments.
• Shallower RBI rate cut cycle may cap duration gains, but FII flows limit downside risk.
Trumponomics
The global economic and market outlook has never hinged more heavily on the actions of a single individual than it does in 2025. Mr. Trump’s potential policies are set to shape the global economy, not only for 2025 but for years to come.
Before exploring what 2025 may bring, let’s take a moment to reflect on the year gone by. Global growth and inflation were expected to slow down amid tighter financial conditions, and while they did, the pace of this slowdown varied significantly across regions. The U.S. stood out as an exception, with restrictive monetary policy failing to dampen economic growth despite a moderation in inflation. This “no landing” scenario appears to have been less a result of the Fed’s policy timing and more influenced by supply-side factors, including enhanced productivity from greater AI adoption and record immigration levels.
Source: IMF, World Economic Outlook Projections- October 2024
Other economies faced more challenges. In Europe, inflation slowed, and economic growth remain muted. In China, despite policymakers introducing substantial measures towards the end of 2024, these efforts fell short of market expectations. Among emerging markets, India, Indonesia, and Vietnam stood out as growth leaders, while many other EM nations grappled with the pressures of a strong U.S. Dollar.
Looking ahead to 2025, most economists anticipate the US productivity gains to persist. They also view Mr. Trump’s tough rhetoric on tariffs as a negotiation strategy, with actual tariffs likely being less severe. The negative effect of tariffs is expected to be partly offset by deregulation and corporate tax cuts, leading to US growth slowing modestly but still exceeding the long-term trend. Goldman Sachs Research forecasts that these trade policies will negatively impact US GDP by approximately 0.2% only in 2025.
Under moderate tariff scenarios, inflation is expected to rise by less than 0.2-0.4% above the baseline but remaining above the Fed’s target. However, income growth is expected to outstrip inflation, leading to real wage growth. In this context, the Fed has limited room for rate cuts as reflected in the dot plot and money market pricing.
Source: RBC GAM, Oxford Economics.
Deviation (in percentage) in level of GDP and CPI from normal trend after two years
One consistent aspect of Mr. Trump’s approach is his unpredictability. Should broader-than-expected across-the-board tariffs be implemented, U.S. growth in 2025 could decline by up to 1%, while inflation may exceed 3%. Such a scenario could compel the Fed to rethink its stance on rate cuts or even consider rate hikes.
Europe might experience a more significant impact from trade policy uncertainty which could hinder the region’s economic recovery. Yet, inflation is expected to approach the ECB’s 2% target, allowing for more aggressive rate cuts compared to the Fed. Major European economies like France and Germany are also navigating through political uncertainty but seem more open to fiscal loosening than in the past. Any shift to growth-oriented policies could lead to growth surprises.
Although China is more directly affected by US tariffs, it is expected that Chinese policymakers will implement additional stimulus measures to mitigate these impacts. A depreciation of the renminbi might also soften the blow on growth. Given China’s ongoing disinflationary trends, both monetary and fiscal policies are expected to remain accommodative, though past stimulus measures have not met market expectations.
Other emerging market economies have room for monetary easing, but they’ll need to navigate the strength of the US dollar, which has weighed on EM currencies. Countries such as India, Indonesia, Vietnam, and the Philippines are expected to emerge as growth leaders within this group.
Japan stands out as one of the few major economies where the central bank is actively considering interest rate hikes. Following the conclusion of its 17-year negative interest rate policy in 2024, the Bank of Japan (BoJ) is focused on further normalizing monetary policy. Inflation is projected to stabilize around the BoJ’s 2% target, marking a significant shift after years of persistent deflation.
Global Market Update
US exceptionalism was also visible in its stock market performance in 2024, with both the S&P 500 and Nasdaq 100 rallying over 20%. The rally was driven by robust earnings growth, especially among technology companies capitalizing on the AI boom. Investor sentiment was further bolstered by expectations of America-first policy measures following the post-election results.
Source: Bloomberg, Sanctum Wealth
Looking ahead to 2025, markets are anticipating mid-teens earnings growth for US corporations, leaving room for potential disappointment. Moreover, starting valuations remain elevated, particularly for mega-cap companies. Mega- cap companies have driven much of the market’s recent gains, largely due to their ability to grow earnings at a much faster rate than the broader market. Earnings for mega-cap companies are projected to moderate from approximately 34% in CY 2024 to about 20% in CY 2025, while the earnings of the broader market are expected to improve in 2025, thereby narrowing the gap. Consequently, most analysts predict a broadening of the rally this year.
While valuations are not always reliable indicators of short-term returns, they tend to serve as stronger predictors of long-term performance. Historical trends suggest that valuations can remain elevated in the absence of major economic or earnings growth shocks. However, any adverse economic developments could disproportionately affect market performance.
S&P 500 forward P/E ratios and subsequent 10-year returns
Source: Oaktree Capital, From Howard Marks Memo – On Bubble Watch
Japanese equities also had a good 2024. They stand to benefit from corporate reforms, return of mild inflation which is driving corporate pricing power and earnings growth. Improving real wage growth, accelerated buybacks and expectations of more stable currency could further support Japanese equities.
Valuations in Europe are fair. However, political and trade uncertainty could impact investor confidence, unless there is a shift toward growth-oriented policies in France and Germany.
While Chinese equity valuations appear attractive, sustained gains may necessitate substantial policy stimulus.
A key risk to global equity markets is the potential for larger-than-expected across-the-board tariffs by the new US government. In a worst-case scenario, these tariffs could significantly dampen investor sentiment.
Global bond markets, particularly U.S. government bonds, experienced significant volatility in 2024 as central banks navigated uneven disinflation. With inflation expected to remain persistent and fewer Fed rate cuts anticipated, U.S. government bonds may continue to face challenges in 2025. The credit environment is relatively stable, but low spreads have led investors to seek higher yields in private credit. Additionally, investments in digital infrastructure, such as data centres, are likely to remain a key focus in 2025.
Crude oil prices largely traded within a narrow range of around USD 80/bbl in 2024. With subdued demand, particularly from China, and ample spare supply from OECD countries, prices are expected to remain stable and range-bound through 2025.
India Macro Update
Government spending has been a key driver of GDP growth in recent years. As the 2024 general election neared, spending slowed. It has picked up again in the last quarter, boosting economic activity, as seen in high-frequency indicators such as GST collection, services PMI, and industrial production. However, due to the higher-base effect, it may take one or two quarters for this rebound to show in GDP growth numbers.
Another factor contributing to the moderation in economic activity in 2024 was the slowdown in credit growth. However, this was a deliberate move by the RBI to curb the rapid growth of higher-risk unsecured personal loans. Despite this, credit growth remains in the double digits.
Consumption demand has been weak overall. While urban demand held up initially, rural demand remained muted. However, in recent quarters, rural demand has started to recover, while urban demand shows signs of moderation. With expectations of a good crop-sowing season, above-average water reservoir levels, and the prospect of a normal monsoon this year, rural demand is likely to continue improving.
Rural demand continues to outpace urban demand
Source: Morgan Stanley, Kotak AMC
While there may be some short-term slowdown, India’s long-term fundamentals remain strong. The fiscal deficit is under control, the current account deficit is low, and the INR has remained relatively stable compared to other emerging market currencies. After several years of deleveraging, both corporate and bank balance sheets are in a healthy position. With capacity utilization above average, the stage is set for a pickup in private capex in India.
Although the direct impact of US policies, such as tariffs, on India is limited, any second-order effects could still affect the Indian economy. As a result, global uncertainty presents a risk to India’s growth as well.
The monsoon in 2024 was better than usual but the distribution was uneven. Prolonged rains into late September affected crops nearing harvest, contributing to higher food inflation and subsequently driving up CPI inflation. The crop harvest has been good so far, expectations of another normal monsoon in 2025 suggest that food inflation is likely to remain contained this year. Consensus estimates indicate that CPI inflation is expected to approach the RBI’s target of 4% in 2025.
The RBI needs to strike a balance between supporting growth and controlling inflation in India, while also maintaining the stability of the INR amid a strong dollar. Therefore, we expect the current rate cut cycle to be modest, with cuts of only 0.5-0.75% expected this year.
India Equity Outlook
Indian equities had a strong performance in 2024, despite a correction in the last quarter. Mid- and small-cap stocks continued to outperform large caps, driven by robust earnings and optimism surrounding a potential majority for the incumbent government ahead of the elections. Although the BJP fell short of securing a majority and the July budget included a capital gains tax hike, the market quickly rebounded and rallied through September. However, subsequent earnings disappointments triggered a sell-off in the final months of the year.
Source: Bloomberg, Sanctum Wealth
Over the past few years, India has seen robust earnings growth, with the profit-to-GDP ratio in FY24 reaching a 15- year high. While some moderation in earnings was expected for H1FY25, the downturn was more pronounced than anticipated, prompting analysts to revise EPS estimates for FY25 and FY26 down by over 5% each. This adjustment reflects a sharper-than-expected slowdown in economic activity and a peak in EBITDA margins. As economic activity picks up, earnings growth is expected to recover in FY26, likely mirroring nominal GDP growth in the mid-teens over the next 2-3 years.
Earnings growth likely to moderate after strong growth
Source: MOSL, ABSLAMC Research
FPI outflows contributed to the sell-off beginning in September, with FPIs selling nearly USD 11.8 billion worth of Indian equities during the fourth quarter of 2024. This was driven by a shift in funds to Chinese equities following stimulus measures and by a strong U.S. dollar after the elections, which triggered outflows from emerging markets. Currently, FPI exposure to India in EM funds is below the historical average, indicating room for a potential reversal in 2025
Despite foreign outflows, domestic investors more than compensated with strong SIP and lumpsum mutual fund inflows, especially in mid and small caps funds. Indian investors also heavily participated in IPOs, helping companies raise a record amount in 2024. However, many of these investors haven’t faced a prolonged correction, and how they would react in such a scenario remains uncertain. Flows are sentiment-driven and can shift quickly.
Despite a 10% correction, valuations remain above historical averages. Large-caps are trading at a 20% premium to their historical average on a one-year forward PE basis, while mid-caps and small-caps are at premiums of 70% and 50%, respectively. Furthermore, the relative market capitalization of large-caps is at a two-decade low, with mid-caps, small-caps, and micro-caps surpassing their December 2017 highs.
Mid and Smallcap trading at significant premium to historical averages
Source: Bloomberg, Sanctum Wealth
Overall, we remain underweight equities due to elevated valuations, global uncertainty, and near-term weaker earnings growth. Within equities, we prefer large caps given relatively better valuations.
Indian equities have shown strong recent performance, but such periods are often followed by moderated returns. The table below illustrates historical 1-year, 3-year, and 5-year returns following 2-year trailing returns of 20-30%. For instance, after a 2-year CAGR of 20-30%, subsequent 1-year returns typically range from 1-9%, with 2-year and 3- year returns at 10-12% and 7-8%, respectively. As of December 31, 2024, Nifty 2025 has achieved a ~20% 2-year CAGR. The 2003-2007 period, which concluded with a significant correction during the global financial crisis, stands as an outlier distorting the >30% return range. Notably, the current rally, starting in March 2020, has surpassed the April 2003 to January 2008 bull run, becoming the longest on record. Therefore, investors should moderate short-term expectations. Nonetheless, with strong long-term fundamentals, Indian equities are poised to deliver solid returns over longer time horizon.
Source: Bloomberg, Sanctum Wealth
Data since 1st Jan 1999 till 31st Dec 2024 for Nifty 500 Index.
Return ranges are 40th to 60th percentile range.
India Fixed Income Outlook
Indian bonds also performed well in 2024. The India 10-year bond yield declined from around 7.2% at the start of the year to about 6.75% by year-end. Investors saw high single-digit to low double-digit returns, depending on duration, as shown below.
Source: ACEMF
Above returns are total returns
Looking ahead, with a likely shallower rate cut cycle, we do not anticipate significant outperformance from adding duration at this time. However, downside risks appear limited due to strong FPI inflows into Indian bonds. The yield curve remains flat, which means it may be prudent for investors to align their investment horizon with the duration of their investments to minimize reinvestment risks.
Investors can also explore alternatives to fixed income, such as higher-yield private credit. With strong corporate balance sheets, the credit environment is favourable. However, given the high competition for limited deployment options, it’s important to be selective when investing in private credit funds.
REITs, INVITs, and pre-REIT/INVIT investments present opportunities to generate regular income alongside potential backend gains. The commercial real estate sector is witnessing strong demand, with vacancies decreasing from their 2021 peak as companies reinforce work-from-office policies and leasing activity hits record levels. Moreover, India is experiencing robust demand from global capability centres (GCCs), driven by the availability of English-speaking talent, cost advantages, and a well-established business ecosystem, solidifying its position as a key hub for GCC operations.
Gold Outlook
Gold was one of the top-performing asset classes in 2024, driven by demand from global central banks among other factors. While central bank purchases may not match the record levels of the past two years, demand has remained strong. Central banks are continuing to build their reserves amid a strong dollar, and with concerns over the U.S. fiscal deficit and potential asset freezes, they are increasing gold as a percentage of their reserves. As a result, central bank gold demand is expected to remain robust in 2025.
Global central bank demand has been key driver of gold prices
Source: World Gold Council
Gold’s strong performance has also been driven by its role as a hedge against rising market volatility and geopolitical risks. In 2025, key concerns include potential volatility from U.S. policy changes and inflation from higher tariffs and stricter immigration policies, making gold an effective hedge against these uncertainties.
Gold has traditionally moved inversely to the U.S. dollar, and this has been seen recently as gold prices fell with the strengthening dollar post US election. Hence, a sharp rise in the dollar could put downward pressure on gold prices.
Gold remains a good hedge against global risks and remains a valuable component of investment portfolios. However, the exceptional returns witnessed over the past two years are unlikely to recur, and investors should anticipate more moderate returns from gold in 2025.
