Why bargain hunters will have to wait a little longer in today’s market

Roger Montgomer | Montgomery Investments

I like bargains—I think most Australians do. To be clear, I won’t ever haggle with a market stall holder about the price of their hand-crafted ceramics—I have seen that done, and it just seems distasteful. However, if those ceramics were $50 last month and the vendor has decided they’re on sale for $10 this month, well, I’ll probably buy the lot.

That’s why I pull my seat under the desk at the beginning of every year to consider the investment landscape. The result won’t impact my investment strategy, but it will help me decide whether to prepare for a few bargains and might inform me about how much to allocate to, for example, a private equity opportunity.

For those who are pressed for time and prefer to skip to the end, the likelihood of finding substantial bargains – the sort of bargains presented by a correction in the stock market - in 2025 is approximately 20 per cent. That likelihood increases slightly (beyond the rise expected for the longer time frame) as we approach the final quarter, and it rises further still in 2026. To understand the reasons behind this, read on.

At the beginning of last year, I estimated the probability of bargains in 2024 at zero.  Some followers will remember my optimism, even bullishness, even though at the commencement of 2024, the near-consensus view was that after a surprisingly strong 2023, stock market returns would be modest at best.

The pessimists at the time pointed to lofty valuations—such as Australian bank shares trading at circa 22 times forward earnings or record price-to-earnings (PE) and price-to-book ratios on major global indices—as harbingers of an imminent pullback.

Similarly, doomsday forecasts abounded from legendary investors and major institutions, including Ray Dalio’s call for a 45 per cent market drop before 2025 to Jeremy Grantham’s perennial warnings of a crash. At the same time, speculation in seemingly outrageous assets such as a banana duct-taped to a wall selling at auction for $6.2 million, meme-coin ICOs, and in Bitcoin which surged to beyond US$100,000 added to concerns that markets were perched on the edge of a cliff.

By the end of 2024, the most dire forecasts failed to materialise and the market’s resilience had defied expectations.

Including dividends, the S&P500 rallied circa 27 per cent in 2024, the Nasdaq circa 27 per cent, the ASX200 12.5 per cent and bank shares end the year on a PE ratio of about 29 times forward earnings.

If the last few years have taught us anything, it is that valuations alone—however extreme—are not sufficient catalysts for a crash. Markets can remain elevated for longer than sceptics imagine, especially when two conditions are met: abundant liquidity and the co-existence of positive economic growth with disinflation. Looking ahead to 2025, these dynamics remain relevant and could drive yet another bullish year for equities, albeit one not without risks emerging on the horizon.

High Valuations: Necessary but Not Sufficient for a Crash

A striking feature of the last two years has been the relentless march of PE ratios and other valuation measures to near-record or all-time highs. Critics often highlight the CAPE ratio (cyclically adjusted price-to-earnings), which for the S&P 500 has reached levels surpassed only during the dot-com era and immediately after the COVID earnings collapse. Similarly, the S&P 500’s price-to-book ratio now flirts with levels exceeding even the tech bubble peak.

Yet history demonstrates these measures are blunt tools for market timing.  More relevant are the following observations:

• Records are made to be broken. Valuations can keep climbing beyond levels once deemed “unthinkable,” particularly when enthusiasm runs high.
• Changing market composition. Today’s stock indices are dominated by capital-light, intangible-asset-rich companies (e.g., software and internet businesses), so comparing today’s price-to-book ratios to those from past manufacturing-heavy eras can be misleading.
• Earnings denominators matter. For example the very high CAPE Shiller ratio includes the last decade’s earnings—which still include the COVID downturn—and therefore skew the Cyclically Adjusted PE higher. Meanwhile, rapid innovation means leading companies can expand margins and grow earnings faster than older business models once did.
• These elevated valuations increase a market’s vulnerability to bad news, but overextension alone is not a crash trigger. For a full-blown reversal, you typically need a catalyst—often a shift in liquidity or a dramatic change in sentiment about growth or inflation.

The Fuel of Speculation: Liquidity

If there is a single thread uniting rising equities, meme-coin Initial Coin Offerings (ICOs), bananas taped to walls selling for millions, and soaring cryptocurrencies, it is liquidity—the engine that powers speculation. The rationale is straightforward: when abundant cash circulates, much of it will inevitably chase higher-yielding or higher-risk assets.

CrossBorder Capital’s Global Liquidity Index (GLI) suggests liquidity still has room to grow, possibly peaking around late 2025. With over $316 trillion in global debt outstanding, a significant chunk was issued near zero per cent interest rates during the pandemic. As these debts come due—beginning in late 2025 and throughout 2026—the competition for refinancing could reduce the liquidity that has inflated assets of all kinds.

This “liquidity wave” may thus remain supportive for markets through at least the first three quarters of 2025. However, as the refinancing of trillions in low-rate pandemic debt collides with higher prevailing rates, liquidity could become constrained. That potential “liquidity cliff,” if accompanied by frothier valuations and a shift in sentiment, might trigger a more pronounced downturn.

But I note this is a process rather than a single event—markets may handle it with ease, or it could prompt a pullback.

Growth and Disinflation: A Bullish Duo

Since the 1970s, equities—particularly shares of innovative companies with pricing power—have thrived when positive economic growth converges with disinflation. This dynamic persisted through 2022, 2023, and 2024, even as many pundits forecasted a recession that never arrived. The result? Investors poured into companies at the forefront of innovation—think artificial intelligence (AI), cloud computing, and electric vehicles (EVs)—leading to eye-popping gains, especially among the so-called “Magnificent Seven” in the U.S.

Although some tried to argue that all these tech giants shared a deeper fundamental connection, the real glue binding them was simply rising share prices and a powerful narrative about AI. To critics, the label “Magnificent Seven” seemed an echo of past groupings like FANG, FAANG, or the Nifty Fifty of the 1970s—proof that markets love to form star lineups, but the real driver is positive economic growth and disinflation coinciding.

For 2025, let’s keep in mind inflation is expected to remain contained relative to recent higher levels. Meanwhile, global growth, while moderate, still appears positive, and resilient enough to support corporate earnings growth.

That combination should continue to buoy equities. Indeed, smaller innovative firms, which underperformed in 2023 and 2024 while investors chased the perceived safety of large-cap tech winners, might see a catch-up phase.

And what about the oft-cited speculative frenzy?  Is it a sign of a bubble?

Late-stage booms often feature tales of extravagant purchases that signal frothy sentiment. The banana taped to a wall that sold at auction for US$6.2 million, the proliferation of meme-coin ICOs, including the Trump coin, which rose to a market capitalisation of US$79 billion, and the rally in Bitcoin to above US$100,000, are individually and collectively reviving fears of a speculative bubble.

Some argue these are clear signs of an “everything bubble,” pointing to historical parallels, from the tulip mania of the 17th century to the NFT craze in 2021. Yet, as with valuations, extreme headlines alone do not guarantee imminent doom. Markets can continue as long as liquidity remains ample and investors retain confidence in economic growth. 

If those preconditions persist in 2025, further gains are more likely than losses.

And then there are the countless indicators used to attempt to predict a market top. When viewing these, it is worth remembering that one unifying theme is that major peaks often occur at times of euphoria and overconfidence. John Maynard Keynes famously warned that “markets can remain irrational longer than you can remain solvent,” reminding sceptics that standing against a bull run can be costly.

The Debt Refinancing “Cliff” in 2025–2026

While the stage appears set for another bullish year in 2025, cracks may emerge as we get closer to a potential refinancing crunch. Estimates suggest that by late 2025 or early 2026, circa US$70 trillion in debt—issued when interest rates were near zero—will start coming due. Refinancing this debt at higher rates will require significant liquidity. If that liquidity is redirected from speculative or high-valuation assets toward refinancing obligations, it could stall the rally or even trigger a correction.

This redirection of liquidity is not an overnight event, but a drawn-out process likely spanning several quarters. If broader sentiment turns cautious around the same time and fewer new buyers step in, even a modest wave of selling could cascade into something larger.

Conversely, if global central banks or governments intervene with measures to ensure enough liquidity, the market could avoid severe disruptions.

The wildcards

While positive growth and disinflation, as well as solid liquidity, form the backbone of 2025’s bullish base case, various wildcards could change the outlook abruptly:

Geopolitical Tensions: An escalation involving major powers—such as a confrontation over Taiwan—could derail sentiment instantly.

Political Cycles: Historically, almost every U.S. presidential term has seen a double-digit pullback in equities and the worst have been when a Republican is in the Whitehouse. With another Republican as president, the probability of volatility is non-trivial.

Central Bank Policy: If inflation unexpectedly re-accelerates, central banks may raise rates aggressively, choking off liquidity faster.

As 2025 unfolds, the bull market’s core drivers—ample liquidity, moderating inflation, and steady if unspectacular economic growth—remain intact. Indeed, these factors have propelled equities higher than most forecasters anticipated, repeatedly defying high-profile bearish calls.

For now, the “band” is still playing, and most investors are still dancing. I currently expect the first half of 2025, at least, to reflect a continuation of the current environment. Watch the direction of global liquidity flows—particularly in the lead-up to the massive refinancing cycle in late 2025 and 2026. If these liquidity conditions remain supportive, so too may stock prices.

However, if sentiment toward inflation or growth sours or if global liquidity starts drying up sooner than expected, the market could become more vulnerable to correction. Whether that pivot happens in mid-2025, late-2025, or later is uncertain. But so long as disinflation and positive economic growth coexist and liquidity remains abundant, the bull run has a good chance of persisting—right until the day it doesn’t.

In investing, as in life, prudence lies in being prepared for all possibilities: enjoying the ride while it lasts and having a plan for when the music finally stops. For now, though, the party shows few signs of wrapping up, suggesting bargain hunters might have to wait a while longer.

All prices and analysis at 31 January, 2025.  This information has been prepared by Montgomery Investment Management Pty Ltd ABN 73 139 161 701 AFSL 354 564. The content is distributed by WealthHub Securities Limited (WSL) (ABN 83 089 718 249)(AFSL No. 230704). WSL is a Market Participant under the ASIC Market Integrity Rules and a wholly owned subsidiary of National Australia Bank Limited (ABN 12 004 044 937)(AFSL No. 230686) (NAB). NAB doesn’t guarantee its subsidiaries’ obligations or performance, or the products or services its subsidiaries offer.  This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice.  Past performance is not a reliable indicator of future performance.  Any comments, suggestions or views presented do not reflect the views of WSL and/or NAB.  Subject to any terms implied by law and which cannot be excluded, neither WSL nor NAB shall be liable for any errors, omissions, defects or misrepresentations in the information or general advice including any third party sourced data (including by reasons of negligence, negligent misstatement or otherwise) or for any loss or damage (whether direct or indirect) suffered by persons who use or rely on the general advice or information. If any law prohibits the exclusion of such liability, WSL and NAB limit its liability to the re-supply of the information, provided that such limitation is permitted by law and is fair and reasonable. For more information, please click here.