Our Asset Allocation team’s key beliefs

This week, we’re discussing a shock election result in Japan, the prelude to the UK Labour government’s first budget, and the travails of European car manufacturers.

As with all key beliefs emails, this represents solely the investment views of LGIM’s Asset Allocation team.

For the last email of the year, we had intended to keep it somewhat light. Then Jerome Powell came in like a wrecking ball, playing the part of the Grinch rather than driving the so-called Santa rally. So this week I’ll briefly comment on this before lightening the mood.

The Grinch that stole Christmas

Last Wednesday evening the US Federal Reserve delivered a 25 basis points (bps) cut to interest rates. Markets had been expecting this as a near certainty, but as it turned out this decision was much more finely balanced. Some of the Federal Open Market Committee appear to be taking a tentative stab at addressing what Donald Trump’s re-election might mean for underlying inflation.

The biggest surprise to markets was the upward revisions to forecasts of core inflation, with estimates for 2025 rising by 30bps and for 2026 rising by 20bps. This repricing higher of rate expectations lead to equity markets repricing lower as the discount rate applied to forecast future profits rose.

This week we conducted our monthly ‘street view’ process, where we attempt to gauge positioning of other market participants via a number of potential indicators (surveys, sell-side recommendations and options data are all examples). We’ve seen an ever-growing enthusiasm for US equities since Trump’s re-election. This could point to the reason for the outsized reaction of equities compared with interest rate markets and is increasingly looking like it could be an opportunity for an underweight relative to other markets in the coming months. However, we don’t think we’re there yet.

We close the year with our overall risk view neutral, expressing a preference for equities over credit. In this event, moves in credit derivative markets largely mirrored those in equities when adjusted for having lower risk. However, the combination of lower equities and higher interest rates makes for a difficult time for multi-asset investors.

Countdown to 2025

My colleagues Ella Hughes and Becky Burgess have penned a blog taking a look at some of the key themes in markets for last year and what we may be able to expect 2025.

They touch on important themes such as green bond issuance, which this year has seen cumulative issuance surpass $3tn, as well as on the growth in Model Portfolio Services in the UK wealth market (£8bn in sales this year) and the potential growth of private markets in 2025.

Seven swans a swimming

The term ‘grey swan’ refers to events that, while not highly probable, are foreseeable and can have significant impacts. Unlike ‘black swans’ – which are highly unpredictable and impactful – grey swans are in our peripheral vision. Our mantra, ‘prepare, don’t predict,’ emphasises the importance of being ready for various outcomes, even those that seem unlikely.

For 2025 we have a long list of potential long-necked avians. These range from industry-specific – Apple diving into the electric car market by acquiring BMW – to geopolitical risks, such as a global leader dying. Perhaps influenced by recent market events, higher gilt yields were a popular suggestion with potential triggers including an error by the ONS (Office for National Statistics) leading to downward GDP revisions and Rachel Reeves resigning.

Not all grey swans have a negative tilt. The list also included rising productivity as the next step in the AI revolution adds improved integration with hardware or AI agents. One that is centre of attention for markets but out of consensus was European equities outperforming US equities. A summary of 2025 outlooks recently showed a unanimous US equity overweight, leaving room for a positive surprise. The US political and economic outlook unsurprisingly featured in multiple ways. There were two-sided grey swans for US deficits: Republicans losing their majority in the House of Representatives and becoming unable to pass more expansive budgets versus an end to the filibuster and a blockbuster budget.

The point of this exercise is to identify risks to current positions and opportunities for new ones. The team is taking these ideas away with that in mind. But we also include some non-market grey swans to the mix. Some of these are more serious in nature, such as continuous glucose monitors becoming mainstream (this could of course be relevant for bottom-up investors). Some of these are less serious, such as that our very own Chris Jeffery releases a number one selling single which he performs at next year’s Christmas party (self-nominated, I’ll add), or that the Oasis tour is cancelled due to irreconcilable differences between the Gallagher brothers leading to hundreds of thousands of disgruntled fans rioting in Manchester next summer (that suggestion was from Willem Klijnstra, who has tickets…).

Keep your eyes peeled on the LGIM blog for the full list early in the new year.

We’ll be resuming key beliefs emails in the new year. In the meantime, for those that celebrate I wish you a Merry Christmas, and to all a happy New Year.

Unless otherwise stated, all data sourced from Bloomberg as at 23 December 2024.