The 5 lessons investors should learn from 2024

Stay invested if fundamentals don't change

Investors might have been forgiven for losing their nerve as equities repeatedly scaled fresh peaks during 2024, but ultimately holding that nerve paid off.

Yes, valuations appear lofty, but equities trade at all-time highs 30 per cent of the time. And there were no equity market corrections of over 10 per cent during the whole of the year. The sharpest correction – which occurred in the summer – was caused by a false alarm over a US recession that never came close to happening.

For equity investors, strong fundamentals can be summed up in above-trend economic growth, which boosts corporate earnings, and falling inflation which lifts stocks' P/E valuations via lower interest rates. And this was exactly the prevailing macroeconomic backdrop in the US in 2024. At the start of the year, US GDP growth was forecast at well below 1 per cent, with a 60 per cent probability of a recession. Instead, the world's biggest economy ended up growing three times faster. And while US core inflation fell a bit less than expected (to 2.8 per cent), the decline was enough to allow the US Federal Reserve to cut rates three times.

The year ended with the S&P 500 index up 23 per cent, with its price-to-earnings (P/E) ratio increasing by more than 10 per cent and the rest of the gains split almost evenly between sales growth and profit margin expansion. The occasional corrections triggered by growth worries and geopolitical events proved to be great buying opportunities. 

And it wasn't just a US story. The fundamentals at play in smaller markets are often more global than local in nature, potentially diverging from domestic economic conditions. Germany might be dubbed the sick man of Europe, but its equity market was one of the best performing in 2024 (up 18 per cent), thanks to its highly cyclical composition and the relatively large weighting of financial stocks in its index, which outperformed globally.

Inflation proved tough to vanquish

There is no doubt that inflation has been falling as fast as it had risen in 2021-22. US headline inflation rate peaked at 9 per cent in June 2022, euro area inflation at 10.6 per cent in October 2022; now the rates are below 3 per cent in both economies.

But recent data suggest that inflation remains irritatingly sticky around this 3 per cent (or higher if we look at the core rate of inflation, the favourite gauge of pricing pressure for most central banks). While for investors and policymakers what matters is the rate of inflation, consumers and voters care primarily about the price level.

The “cost of living crisis” made headlines for a reason. The sharp rise in inflation in 2021-22 resulted in a significant and prolonged drop in real incomes for many; median real wages have only recently started to rise in both US and Europe. This post-Covid inflation surge boosted domestic populism and isolationism. A multipolar, politically fragmented world is here to stay. 2024 showed us that the advantage incumbent governments tend to have during election campaigns turns into an insurmountable liability when the economy is turbulent and the cost of living is the dominant concern. In every election that took place in the developed world in 2024, the governing party lost vote share. That's the first time this has happened, with the ruling party (or that of the outgoing government) recording an average vote share loss of 7 percentage points - a record. 

It seems, then, that governments that are willing to boost growth by tolerating higher inflation will be voted out. After all, inflation is a (very visible) tax on the average consumer.

Don't take US exceptionalism for granted

US exceptionalism is real. But it’s not guaranteed to last forever.

Economically, the US has come out of the Covid crisis on a much firmer footing than the rest of the developed world, reinforcing pre-pandemic trends. In nine of the past 10 years, the US economy has outperformed the average of other developed countries, by an average of 1 percentage point each year.

The country's energy and technology industries have been the sources its strength. The US is now the biggest producer of oil globally by a wide margin, having achieved energy independence in 2019 thanks to a booming shale oil sector. And it also has a commanding lead in artificial intelligence (AI) – both in the development of the technology and its adoption. Interestingly, shares of the US supermarket giant Walmart now trade at a higher multiple than Amazon, partly as consequence of the firm's early adoption of AI throughout its business. 

The US's exceptionalism is even more striking when seen through equity markets. US stocks now account for 75 per cent of the MSCI world equity index, up from 57 per cent 10 years ago. US equities have outperformed the rest of the developed world by more than 8 per cent a year over the past decade. The US dollar, meanwhile, trades at its highest level, in real effective terms, since 1986.

For all this, the US’s economic and geopolitical leadership is more vulnerable than it might seem. Investors can't rule out the possibility that other countries can close the performance gap - economic and otherwise - with the US. 

Indeed, one source of US exceptionalism has been the economic and political weakness of its main competitors. Take China. Poor demographics, excess leverage and increasingly business-unfriendly policies have driven the country's trend GDP growth down towards 3 per cent. In Japan, the reformist zeal of former prime ministers Junichiro Koizumi and Shinzo Abe has faded, while policymakers' failure to  push the country’s inflation rate up to target has undermined the Bank of Japan’s (BoJ) credibility. And a fragmented, leaderless Europe never misses an opportunity to disappoint – it remains too weak – institutionally, economically and geopolitically – to create a coherent and credible growth strategy. Germany is once again the sick man of Europe as its economy struggles to climb out of a long-lasting, if mild recession.  France is mired in a political stalemate. And Ukraine and its western supporters are on the defensive in its war with Russia.

So if some of the US's advantage can be attributed in part to the failings of its rivals, there is always the possibility that 2025 will see some of its rivals begin to get to grips with the problems they face.

Moreover, even if the US looks good relative to its rivals, on an absolute basis, it disappoints on several measures. Real GDP has only just returned to its pre-Covid trend. Consumer confidence remains weak and a record 75 per cent of Americans think the US is heading in the wrong direction. Uniquely among developed countries, US life expectancy is falling. The US is also the biggest debtor in the world, having hollowed out its industrial base. Global dollar reserves as a percentage of the total have been falling for years. And for the first time in decades, the US government spends more in interest than in defense. The historian Niall Ferguson notes that any great power that spends more on servicing its national debt than on defense doesn’t stay great for very long. This was true of Habsburg Spain, of Ancien Régime France, of the Ottoman Empire, and of the British Empire. Will the US prove to be an exception?

Successive US administrations’ efforts to weaponise the dollar and the country’s economic and financial clout via sanctions have proved a failure so far. Sanctions against Russia haven’t caused its economy to collapse. Technology restrictions imposed on China have merely resulted in Beijing’s push to achieve technological independence, with considerable success to judge by Huawei’s new, entirely Chinese-made smartphone and operating system.

Valuation matters at the extremes

Stocks considered value traps can and do outperform – in the short term. The lesson here, though, is not that investors should try to catch falling knives. Rather, it’s that they should avoid being extremely short assets that are both significantly undervalued and under-owned, which is to say suffering from bearish sentiment. These stocks can sometimes rally powerfully and unexpectedly. Take the performance of Chinese stocks and the Japanese yen this year.

Chinese equities appear to be the very definition of a value trap. After peaking in 2007, they have lost 70 per cent of their value in relative terms, dropping to a point at which they trade at a record discount to global equity of some 50 per cent (on a 12-month forward price-to-earnings ratio). To a large degree, that’s justified. Earnings per share in the MSCI China index are lower than a decade ago – by contrast, they doubled for the S&P index over the same time.  The economy is stagnating and suffers from deflation.

For most investors China had become uninvestable. And yet, in a matter of just three weeks beginning late September, Chinese equities staged a massive rally, catapulting the MSCI China index from the worst to best performing region year to date. The trigger was Beijing’s announcement of a new, long overdue, policy stimulus, and although the measures were largely underwhelming, the initial conditions – extreme undervaluation and bearish sentiment – were enough to trigger the rally.

The debasement trade has legs

Gold was the best performing traditional asset class in 2024, rising 27 per cent on the year, a performance that beat global equities by a wide margin. 

Perhaps more remarkable is that the gain came in somewhat unusual circumstances. Historically gold benefits from a weaker dollar and a decline in real bond yields, which represent the opportunity cost of holding gold. But in 2024, the dollar surged while the yield on 10-year Treasury inflation-protected bonds also rose – a consequence of both the very strong dollar and a shift in expectations of how far the Fed will cut rates (see Fig. 6).  

What is more, the rally in gold cannot be explained by either a generalised flight to defensive assets or an uptick in inflation expectations. 

Although geopolitical risks remained elevated, they didn’t have a meaningful impact on markets: the VIX index, the so-called fear gauge, spent the year below historic norms. Nor did inflation expectations move much, fluctuating in a narrow 2.2 to 2.4 per cent range on a 5-year 5-year forward basis.

According to our fair value model, gold looks significantly overvalued.

So what explains gold’s performance? Two factors: relentless buying by emerging market central banks, and the emergence of a secular ‘debasement trade’.

In the former, the buying of gold stems from the emerging world's desire to diversify away from US assets and the dollar.

In the latter, the rise in demand for gold is inextricably linked to the fear that as government debt and deficits reach unprecedented levels, particularly in the developed world, the endgame could be a widespread debasement of currencies rather than outright default.

The risk of debasement is rising in the US too.

The US Congressional Budget Office estimates that under Trump’s policies, the debt to GDP ratio will rise from 100 per cent today to 143 per cent in 2035 (125 per cent on current law), the budget deficit will rise from 6.5 per cent to 9.7 per cent (7 per cent on current law) – this is equivalent to c 5 per cent primary deficit. According to our estimates, assuming a 5 per cent bond yield and a 5 per cent primary budget deficit, the general government net interest payments to GDP will rise to the critical threshold of 10 per cent (equivalent to what Italy was paying in the early 1990s) by 2040. At that point, the choice will be between cutting vital social spending, raising taxes on almost everything – including wealth – or debasement of the dollar. It is easy to see why some investors think the latter option may be the most (politically) feasible.

Against this backdrop, gold is an obvious hedge against the risk of currency debasement. Bitcoin has been a beneficiary of this trend too, doubling in price in 2024, with a final massive boost from Trump’s re-election in November. Bitcoin has proved to be the ultimate Trump trade. But in our view Bitcoin is in effect a type of lottery ticket and is unsuitable for a cautious multi-asset portfolio.

For those seeking an alternative to gold as a hedge against the risk of debasement, owning currencies of countries with a proven record of fiscal discipline and moderate inflation is a possible solution. The Swiss franc comes to mind here. Switzerland has a primary budget surplus, a massive current account surplus, trend growth rates close to the US thanks to productivity growth, immigration and political stability. Post-Covid, its inflation rate peaked at a modest 3.5 per cent - a third of the levels reached in US and Europe.

The debasement trade is alive and it’s best achieved by holding gold and the Swiss franc.

Even the yen can surprise

The yen also sprang a surprise in 2024. The currency has been in secular downtrend since the early 1990s amid economic weakness, policy confusion and capital outflows. At one point in the summer, the yen was trading at 160 against the dollar, an all-time low in real terms.

The yen was the cheapest among the 50 asset classes the Pictet Strategy Unit monitors, trading 45 per cent below its purchasing power parity exchange rate. The yield differential relative to the US at that point was more than 5 percentage points, making the yen an extremely unattractive currency to hold.

But in July, an alleged intervention in the foreign exchange market by the BOJ, coupled with a general sell-off of risk assets globally, triggered a 15 per cent rally in the Japanese currency.