Livewire readers are full of optimism and anxiety - which one will win the day?

In the recent Outlook Series survey, we asked where you are currently sitting on the cycle of investor emotions.

After two consecutive 20%+ years for the S&P 500 in the US, and two consecutive 11%+ years for the ASX All Ordinaries Index, it’s no surprise that 40.6% of you are feeling ‘Optimistic’, whilst another 10% of you are feeling ‘Excitement’. These emotions are just ahead of ‘Euphoria’ (5.3% of you) in the cycle – the point at which there is the Most Risk and Least Worry.

The question, of course, is whether the optimism and excitement is well founded, or merely a product of some historically good performance.

In reality, it’s likely to be a combination of both.

Interestingly, another 30% of you are a couple of stages further down the road in the investor emotion cycle, at ‘Anxiety’.

Perhaps this is the incarnation of people recognising that as good as the past two years were, getting a three-peat of great performance could be challenging.

Let’s dig a little deeper by comparing historically, looking at the data (where possible), and seeing what the fund managers and research houses have to say.

The data

The Yanks do this data so much better than we do – or at the very least, they make the output more accessible.

The table below is from JP Morgan, showing what has followed previous consecutive 20%+ years. 

To summarise the above table, of the nine instances where the S&P 500 has gone up 20%+ in consecutive years, in the subsequent two years, the S&P 500 has been;

• Positive in both years 5 times (including 1987, which delivered 0% return)
• Negative in both years 1 time
• Up and then down 1 time
• Down and then up 2 times
• Up in the first year, 5 times

That data shows that, overwhelmingly, markets have kept rallying. Tick for 'Optimism' and 'Excitement'.

When it comes to the Australian data, it’s much harder to pin down. I found a list of annual returns for the All Ordinaries and have performed the same analysis since 1950. In this case, I was looking for two consecutive years of 11%+ gains (which is what we've experienced over the past two years), and what happened in the subsequent two years. 

To summarise the above table, of the 19 instances where the ASX All Ordinaries Accumulation Index has gone up 11%+ in consecutive years since 1950, in the subsequent two years, the index has been;

• Positive in both years 8 times
• Negative in both years 1 time
• Up and then down 4 times
• Down and then up 6 times
• Up in the first year 12 times

The data shows that, more often than not in an Australian context since 1950, markets have also kept rallying. Another tick for 'Optimism' and 'Excitement'.

Where are we in the economic cycle?

It is often said that the equity market, being a forward-looking beast, operates anywhere between 6-12 months ahead of the economic cycle. So perhaps some clues can be gleaned from where we’re headed by looking there.

As of the most recent data I could find, Australia is in a per capita recession, with the measure falling for six consecutive quarters. Conversely, GDP has been growing for 11 consecutive quarters.

The business cycle is notoriously difficult to predict, and conflicting data makes things even murkier. Most of the commentary around the business cycle in Australia, and indeed America, is that we are late cycle – that is, much closer to a contraction/trough phase of the cycle than the expansion/peak phase. 

Remember, it wasn’t so long ago that the “R” word was being bandied about, whilst only last week, the US market had a hissy fit amid some expectations inflation would stick around longer.

So, it might be fair to say that the situation is still delicate and undecided. Throw into the mix the potential game-changer that AI could be – in terms of economic growth and increased productivity (something that has been eluding many developed economies for some time, especially Australia) – and it really is a matter of watching this space. No tick for 'Optimism' here – although none for ‘Anxiety’ either.

What do the research houses have to say?

Fortunately, my colleague Vishal Teckchandani did a power of great work last year summarising a host of outlook statements from global and local research houses with the help of AI. The full wire is available below, whilst I have also pulled out the highlights.

Macro

We fed AI 16 outlook reports. It crunched key takeaways, return expectations & contrarian calls

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The text below is a direct extract from Vish's wire. 

The 2025 outlook in a nutshell

"Moderate optimism" is how AI summarised the overall global outlook for 2025 based on the reports it analysed, with Goldman Sachs predicting another Goldilocks year across asset classes on the basis of stable growth, falling inflation and monetary easing on a global basis (see chart below).

"This backdrop would naturally create a favourable environment for risk assets, alongside US outperformance."

It's a party in the USA

The overwhelming view among the reports was that the US economy will keep leading the global recovery, bolstered by continued fiscal stimulus, AI-driven growth (which will bolster infrastructure demand), and a resilient jobs market.

The new Trump administration will play a crucial role in shaping the outlook. Reports from Goldman Sachs, Fidelity, and Barclays highlight how Trump’s policies, including tax cuts, deregulation, and America-first trade policies, are likely to have a significant impact on the economy in 2025.

HSBC and ING highlight that US equity valuations have risen significantly above the long-term average. However, these elevated valuations may be sustained by the widespread expectation across reports that the Fed Funds Rate will end the year in the 3.5% to 4% range.

Our handy robot aptly noted that this could continue to support equity markets, as lower rates make risk assets more attractive relative to fixed income!

A more subdued backdrop for Australia

The outlook for the Australian economy and equities is more modest, with some even taking a bearish view, such as Schroders.

With the Federal Election required by May, the government is likely to continue spending to drive economic growth, extending cost-of-living measures, as forecasted by Morgan Stanley and AMP. However, this spending is expected to slow down afterwards, with the potential for a minority government further restricting spending increases.

Despite this, rate cuts are on the horizon, and UBS believes that, amid rising US-China rhetoric, the Australian economy remains a bright spot, with listed companies set to benefit from US exposure and potential rotation opportunity away from banks.

AI kindly sifted through the reports to find what price & cash rate targets it could:

• UBS: 8,850
• AMP: 8,800, forecasting rate cuts from February, and a year-end cash rate of 3.6%.
• Morgan Stanley: 8,500, with three rate cuts in May, August, and November, with a year-end cash rate also of 3.6%.

Outlook from Goldman Sachs

In October last year, Goldman Sachs published an article titled Late-Cycle Opportunities, Lingering Tail Risks.

It’s US-centric, but I’ve chosen to replicate part of it here because it also makes good use of data and goes right to the heart of what this wire is trying to unpack.

We believe active investment strategies, effective diversification, and strong risk management can help investors navigate the path ahead. In the final months of 2024, investors will be questioning if the strong year-to-date performance for equities can continue and extend into 2025, or if there is more bumpiness ahead and greater risk of drawdowns. Although we believe an outright bear market is unlikely, further upside at the broad index level may be limited, making selectivity in equities even more important over the coming quarters.

As Fed easing commences, the S&P 500 is near its all-time high, with a forward price-to-earnings ratio of 21.4x, well above the 20-year average of 16.3x. However, while valuations are stretched, we do not believe they are extreme. A more nuanced picture emerges when looking at the market without the so-called Magnificent 7 names driven by artificial intelligence (AI) innovation. Beyond this mega-cap cohort, the forward price-to-earnings ratio for the S&P 493 currently stands at 17.3x which is largely in line with its long-term average (16.3x). This small premium looks justified, in our view, given we expect earnings growth for the overall market to drive equity prices in the months ahead.

The final word

My mother always taught me that things are never as bad as they seem. Equally, things are never as good as they seem either. 

So, whether you fall into the more optimistic camp or you’re riddled with anxiety over what might happen next, it’s important to remember that you won’t (and can’t) know ahead of time, and that the best thing you can do is have a plan to navigate any outcome.

If you’re a long-term investor, that might simply be to do nothing and ride the bumps. If you’re more active, it might involve anything from adjusting your asset allocation to frequently trading.

In any event, Livewire will be there with you, riding the bumps and delivering insights along the way.