Why these are the investment areas to watch in 2025

Ceri Jones drills into areas of the market piquing the interest of fund managers and analysts for the year ahead.

15th January 2025 10:22

by Ceri Jones from interactive investor

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2025 finance concept with arrow and graph rising

Traditionally, investment gospel has it that, at the start of any new year, the best investments to choose are rarely those that have recently enjoyed a storming run. Generally speaking, sectors and even geographies that have done well in one year, tend to flounder in the subsequent year, while sectors that are out of favour often bounce back.

In the last few years, however, the proverb has been debunked by tech stocks which have made indefatigable multi-year gains, outstripping the broader market.

The year ahead could be different, however, with potentially good recovery among the broader market. There is the prospect of investors recognising that – transformative as tech undoubtedly is – artificial intelligence (AI) benefits will take longer than expected to percolate through and weakness in any one of the Magnificent Seven will damage the others, as their earnings are interconnected.

Moreover, in terms of the wider macro backdrop, we are entering the point in the interest-rate cycle when falling interest rates do not favour companies with extensive cash balances and the fortunes of small-caps typically improve.

An easy way to play the broadening of market performance is by tracking the S&P 500 Equal Weight index, using an ETF such as those from iShares or Invesco, in contrast to the market-cap weighted S&P 500 index, in which the Magnificent Seven account for around a third of its exposure.   

“There are already signs that S&P 500 performance is broadening out from the small sub-set of mega-cap stocks that have driven it in recent years,” says David Aujla, multi-asset fund manager at Invesco.

He adds: “Valuations and earnings expectations for those larger stocks are high and any earnings disappointment could be painful. In addition, a Trump administration is expected to bring policies – such as deregulation and lower corporate taxes – that should be supportive for US company earnings in other sectors, which could help this broadening out of market performance.”

US smaller companies

US smaller companies, due to making most of their money domestically, are poised to be beneficiaries if corporate tax rates fall when Donald Trump returns to the White House.

“Small-caps currently benefit from lower valuations than their large peers, and the prospect of deregulation and lower corporate tax rates in the US could support smaller company earnings,” says Aujla.

However, over-exposure to a single country makes for a volatile ride in the short term.

While US small-caps have already started to re-rate post elections, there are a number of high-quality stocks, from around the world, that have the potential to outperform in 2025, notes Kirsty Desson, manager of abrdn Global Smaller Companies I Acc fund, oneof interactive investor’s Super 60 investment ideas.

Desson notes: “From a sector perspective, the automotive industry has faced severe challenges [in 2024]. One company that stands out is CIE Automotive SA (XMAD:CIE), a Spanish-listed, globally diversified manufacturer of automotive components. The stock is trading on single-digit multiples, yet CIE has expanded its sales and delivers best-in-class EBITDA margins. Over the medium to long term, our need for cars is likely to sustain. When sentiment towards the industry turns, CIE’s share price could bounce.”

Japan

Smaller value companies in Japan could pleasantly surprise this year, as they are well insulated from global macro uncertainties, and there is scope for further corporate reform and improving consumption.

“For many years, Japan has been seen as a graveyard for equity investment, with anaemic economic growth, poor demographics, deflation and poor corporate governance,” says David Lewis, investment manager in the Jupiter Merlin team. “This has resulted in many companies trading at extreme valuations versus their developed world counterparts. We believe change is afoot.”

Lewis also points out: “Inflation has returned, interest rates are rising and a corporate governance revolution has been taking place with Japan instigating a stewardship code based on the UK’s.  

“In addition to pressure from the Tokyo Stock Exchange, this has catalysed companies to address balance-sheet efficiency, cut down cross shareholdings and focus on return generation, leading to more mergers and acquisitions and far more capital returned to shareholders as dividends and buybacks. This is from a market that has actually seen strong earnings growth, creating a potent mix for potential returns.”

Lewis says the Jupiter Merlin team often finds the best opportunities lower down the market-cap scale where companies are trading significantly below book value, with material net cash on their balance sheets. The team own WS Morant Wright Japan B Acc fund, which has 58% of its assets in mid-cap stocks.

Map of China against a market background

China

China, of course, has been touted as a recovery play for some time. Nevertheless, the government’s recent fiscal stimulus has a better chance of revitalising the economy than for some time, despite the country’s ageing population, government intervention in certain sectors, and the prospect of Trump forcing through more tariffs.

“Given all the headlines of market-unfriendly initiatives, overbearing regulatory interventions in certain industries, a state machine that has failed to revive a flagging economy beset with low inflation, low growth and poor demographics, it has been easy to ignore China, even to consider it un-investable,” says Ian Rees, head of multi-manager funds at Premier Miton.

There is political will to address these issues, he says, such as the reforms to support buyers in the property sector, the central bank’s rate cut in July, and the September statement announcing a slew of measures to boost 5% growth, including further rate cuts, easing of lending and house-buying restrictions, and a state fund to help companies buy back shares.

“In his speech, the president referred to forceful intervention that resulted in a RMB 10 trillion (£1.1 trillion) fiscal boost to the economy,” says Rees. “We think this is a bigger deal than the market perceives.”

In response to these initiatives, China’s stock market soared by 36% from 9 September to 7 October. That market move demonstrates that if investors reappraise their views on China, any recovery could be rapid.

Regarding tariffs, Trump might not follow through on his rhetoric, if his economic team manages to persuade him that this would be bad for the US economy. China controls a significant supply of rare earth minerals, an essential element to semiconductors, so its bargaining power is real.

A more benign outcome on tariffs could lift luxury goods, and high-end automakers, if the US economy continues to perform well and China’s economic momentum improves, says Zehrid Osmani, manager of the Martin Currie Global Portfolio Ord (LSE:MNP) trust.

Osmani also believes the healthcare sector could recover in 2025. Healthcare tends to be weak around US presidential elections, but could bounce back, particularly in the area of medical technology and life science tools, where returns on investment capital are likely to improve.

High-yield bonds

In the fixed-interest arena, high yield offers a great option as starting yield is a good indicator of future annualised returns. High-yield bonds yield about 8% at the moment, which compensates investors for the risk of an economic downturn.

Such bonds have higher yields than higher-quality bonds, but the trade-off is that the risk of defaulting on their debt obligations is greater. 

In terms of portfolio construction, high-yield bonds are closely correlated to stocks. This is because high-yield bonds are linked to the business results and fundamentals of the company that issues the bond, as well as the general health of the economy. 

Sandy Jones, investment specialist at Baillie Gifford, points out: “Credit spreads (the risk premium relative to government bonds) are low relative to history. However, valuations reflect a positive outlook. Economic growth remains healthy, and falling interest rates help highly leveraged companies. Second, comparing current valuations to the past is not necessarily helpful because the high-yield market has risen in quality over time, with higher-rated bonds representing a greater proportion of indices.”

While high valuations leave little room for error in more challenged sectors, Jones seeks out bonds with attractive yields that do not have the risks associated with distressed names. 

Commodities

Finally, we know that commodities can be an effective hedge against geopolitical risk.

“The threat of intra-country tensions can see commodity prices rise as disruption to supply chains is anticipated – as was the case following Russia’s invasion of Ukraine during 2022,” says Alex Watts, fund analyst at interactive investor. 

The WisdomTree Enhanced Commodity ETF - USD Acc GBP (LSE:WCOB), one of interactive investor’s Super 60 investments, offers diversified commodity exposure, including nearly one-fifth to gold.  

Elsewhere, Copper is highlighted as being of particular interest as a key ingredient in energy-transition technologies.

Zhoufei Shi, tactical asset allocation analyst at Fidelity International, notes: “A lack of mining investment could result in undersupply - the International Energy Agency (IEA) expects mines only to be able to supply 80% of demand by 2030. Supply is relatively inelastic given the time and cost involved in starting new mines, and we are in a situation where demand is rising while supply is falling.”

“Demand has held up surprisingly well year-to-date, especially in China, despite the drag of a weak property sector. 

“While the recent China stimulus has fallen short of expectations, we do believe more is on the way. These factors suggest that copper-miner equities could be ones to watch in 2025. A bonus is that owning copper miners should provide portfolios with an additional layer of protection if inflation re-accelerates.”

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Related Categories

    ETFsFundsSuper 60Investment TrustsAIM & small cap sharesNorth AmericaEuropeJapan

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