Defensive income: A steady beacon amid potential disorder

Q What trends and developments shaped market performance in 2024?

The year was marked by significant economic and market volatility. As inflation gradually returned to target levels, most major central banks grew more comfortable and began initiating rate-cutting cycles. However, much of this had already been priced in during the previous year. Consequently, bond yields ended 2024 slightly higher on average than at the start of the year, though they did manage to rally from their springtime peaks.

Economically, the US stood out, with growth comfortably outperforming the rest of the world. This strength drove strong performance in US cyclical equities and led to a narrowing of credit spreads, particularly in the US. In contrast, growth and policy actions in Europe and China fell short of expectations.

Late in the year, the US elections took centre stage as a major market event, introducing significant uncertainty. Nevertheless, Donald Trump’s victory in the US presidential race further bolstered sentiment toward US equities and the dollar.

Q What are your views on the coming year, particularly in light of Donald Trump's election victory?

In recent years, bond and equity markets have experienced larger and more frequent setbacks than usual. Today, equity and corporate bond valuations appear expensive relative to history. However, investors continue to favour areas that have already performed well, such as US growth stocks and high-yield corporate bonds. In contrast, we believe government bonds offer better value as they appear reasonably priced relative to growth and inflation outcomes.

The Trump policy agenda is likely to introduce a significant element of disruption, though its precise impact remains uncertain. We anticipate it will weigh on growth outside the US, where policy choices are already failing to improve their growth outlook for many economies.

Finally, fiscal policy in many nations appears increasingly unsustainable over the medium term, adding another layer of complexity to the global economic landscape.

Q What question marks remain over the outlook for 2025?

We are less certain of exactly what a Trump presidency will bring across a range of variables. For instance, we don't know how quickly or fully he will follow through on his various policy proposals. As a result, it remains uncertain whether the impact on US growth, inflation, the deficit, interest rates and the dollar will be positive or negative.

We also don’t know how other countries will respond to trade tariffs or whether they might impose tariffs in response to the US.

Q Given the above, what are the key risks and the opportunities across income generating assets as we head into 2025?

We think that traditionally defensive areas, such as select government bonds, could provide interesting opportunities for investors who seek income, given that they look reasonably well-priced. This applies to markets outside the US, which are subject to less uncertainty. Specifically, we like short-to-medium-dated government bonds in markets where inflation, growth and interest rate risks look skewed to the downside. This includes New Zealand, the UK and certain emerging markets.

There appear to be fewer opportunities in equity and corporate bond markets, particularly in the US, as highlighted in earlier comments regarding valuations. While we see potential in some resilient, high-yielding equities and selective opportunities within the credit space – such as in collateralised loan obligations and agency mortgage securities – these remain relatively limited. Overall, these are areas where we continue to struggle to find assets we are eager to own.

Option pricing looks undemanding, particularly in the equity market, which could provide a way to hedge against some of the alternative outcomes given the uncertainty surrounding the incoming US president. For instance, if the momentum-driven rally in the US stock market continues, options may offer a safer way to take exposure.

We do not see a strong case for running significant active currency exposure, given the elevated levels of uncertainty going into 2025.

Overall, we believe investors should prepare for the unexpected. Avoid chasing overvalued assets, of which there are many, and instead focus on building a portfolio of attractively priced, resilient, income-generating securities while carefully managing risk.

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