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Asset AllocationJanuary 2, 2025

Equity Strength May Come From More Than Just Mag 7 in 2025

Investors expect a stock rally to continue in 2025, fueled by deregulation and tax cuts, while watching policy closely.

By Matt Toledo

Art by Andrea D’Aquino

2024 was a strong year for domestic and global equities; the second year of a bull market, the S&P 500 had returned 23%. Outsized returns in large-cap technology stocks, primarily the “magnificent seven,” are primarily responsible for lifting the S&P 500 and Nasdaq 100 indices.

Analysts expect more sectors to outperform this year, rather than mostly the handful of tech stocks that drove the market to record levels. Equity analysts and strategists also see 2025 opportunities beyond artificial intelligence and in emerging markets, but will likely tread carefully to start the year to see how tariffs and other policies play out from the incoming Donald Trump administration.

“The [U.S.] economy is broadly strong, and we expect that to continue for the near future; that bodes well for most sectors,” says Ian Toner, CIO of Verus.

That said, the Federal Reserve put somewhat of a damper on expectations after its December Federal Open Market Committee meeting, when it signaled that inflation risks are back, which may mean fewer rate drops from the central bank than forecast. Expectations for 2025’s monetary policy caused an immediate decline in stock markets, and, if persistent, could shift expectations for the longer term in 2025, according to some analysts.

Under a New Administration

Investors expect the new Trump administration to loosen regulations and lower corporate taxes; Scott Bessent, nominated to be Treasury Secretary has touted a so-called 3-3-3 plan, cutting the federal deficit to 3% of gross domestic product, achieving growth of 3% of GDP and increasing U.S. energy production by the equivalent of three million gallons a day.

“The Republican sweep of the U.S. election is likely to boost equity markets, particularly those in the U.S., if the patten of the first Trump administration is any guide,” wrote Daniel Morris, chief market strategist at BNP Paribas, in the bank’s 2025 outlook. “The risks are that either growth accelerates too much and the U.S. economy overheats, or that large tax cuts prompt a negative reaction from the bond market.”

Matthew Palazzolo, senior national director of investment strategies at Bernstein Private Wealth Management, also noted “a generally constructive view on stocks in 2025.”

That view is “underpinned by a still solid economic backdrop in the U.S. and high single digit earnings growth. We’re mindful of the bullish sentiment recently, but much of that could simply be consensus coming around to the positive fundamentals,” Palazzolo says.

A number of investors point to small-cap stocks, which could be set to perform well next year.

“I’m optimistic about small caps heading into 2025 and expect them to benefit from a favorable domestic economic environment and potential regulatory changes,” says Jeff Weniger, head of equity strategies at WisdomTree. “There’s also a lot of buzz around a revival in [mergers and acquisitions,] with large-cap banks likely to see gains from more deal activity, though that trend may already be priced into the markets.”

The current market environment also could be favorable for passive investors.

“We believe we’re in a positive environment for risk assets, at least for now,” Toner says. “The economy is running well, and while inflation hasn’t yet gone all the way to target it’s much lower than recent high levels. Passive investors are likely to benefit from this environment.”

But concentration continues to be a risk, with around “40% of the S&P 500’s weight in the top 10 stocks, those few names account for an outsized amount of risk in indexed portfolios.” Palazzolo cautions.

Sectors and stocks that are set face headwinds in 2025 include those sensitive to tariffs and green energy companies that rely on materials like lithium and graphite, the supply of which could become constrained in a trade war with China, which controls much of the supply.

What Do Investors Like in 2025?

A common investment theme found across 2025 outlooks is artificial intelligence, which drove performance in 2024, while other sectors did not see strong growth. Some strategists see this distribution to be more evenly balanced this year.

“We think there is potential for markets to broaden out further in the U.S., particularly given Trump’s focus on deregulation and corporate tax cuts,” writes Johanna Kyrklund, group CIO at Schroders in the firm’s 2025 outlook.

Weniger says he is bearish on energy stocks, such as oil and gas, saying that they are oversupplied in the market. “I also expect the stronger dollar to be a headwind for all commodities. While big returns may be hard to come by, focusing on stable, value-oriented stocks is a solid strategy, with U.S. equities likely to outperform global stocks due to this stronger dollar environment,” Weniger says.

Macquarie Asset Management, in its outlook, expects strong opportunities in value stocks, small-caps and across diverse geographies. Macquarie also suggested listed real assets, which it wrote, “continue to be an interesting asset class in an environment in which inflation becomes more of an ongoing, structural challenge.”

In Europe and Asia, Goldman Sachs Asset Management sees strength in the financial sector, as well as healthcare, clean energy, and luxury goods companies without a U.S. equivalent. “Across non-U.S. developed markets, we see opportunities in dividend-paying companies with sustainable returns on invested capital, strong cash flow generation, a track record of capital discipline, and consistent payout histories,” said Alexis Deladerrière, head of international developed-market equity at GSAM, in the firm’s 2025 outlook.

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Emerging and Global Markets

The MSCI Emerging Markets Index returned 4.35% in 2024 through late December, far below the S&P 500’s results, but investors see opportunities in these markets. Some point to outsized returns available in EM, which could provide diversification compared with the tech-heavy concentration of the S&P.

In a November roundtable discussion, strategists in Vontobel Asset Management’s quality growth team note that many global and emerging market equities have outperformed U.S. equities. Their favorite global stocks: SAP, Hermes, RELX Group, and Ashtead.

Vontobel analysts noted that many companies that fall into the “global” equities category have significant exposure in the U.S., and vice versa. “You can invest in great international companies and participate in the U.S. economy,” says David Souccar, portfolio manager at Vontobel Asset Management. “Now, by the way, when you invest in the U.S., half of the earnings come from the outside. We live in a globalized economy. We need to stop the division between domestic and international… invest in great companies wherever you find them.”

Elias Erickson, portfolio manager at Ninety One adds that: “The opportunity cost of investing overseas has been much higher than most anticipated, especially when comparing index returns. However, this blunt comparison misrepresents the attractiveness of international markets, which actually house the majority of outperforming shares on a global basis.”

In a broad sense, two primary factors will likely impact emerging market performance next year; U.S. monetary policy and the approach to tariffs under the Trump administration, says Crit Thomas, global market strategist at Touchstone Investments. “Emerging markets tend to benefit from looser U.S. monetary conditions. However, long-term rates may remain elevated, and the Fed could slow its pace of rate cutting,” Thomas says.

Meanwhile, the Trump administration’s focus on tariffs and encouraging manufacturing onshoring could disadvantage emerging markets, which have been long-term beneficiaries of offshoring. “Many emerging market economies have benefited from the reshoring of Chinese manufacturing, but President-elect Trump aims to bring that production to the U.S., potentially redirecting foreign direct investment from emerging markets to the U.S.,” Thomas says.

There are two drivers behind the “U.S. vs. non-U.S. question,” says Bernstein’s Palazzolo. “Will the U.S.’s earnings growth advantage offset or be offset by other markets valuation advantage? We think it’s likely to be the former, but you can only have so much conviction in that view given the exceptional run U.S. stocks have had.”

While China is generally becoming excluded from many asset owners’ benchmarks, analysts note that government policy has an outsize effect on the performance of Chinese equites and corporate profits. “China has started implementing more stimulus, which could stabilize this important [emerging market] economy. An active manager may be in a better position to manage through the cross currents,” says Thomas.

Emerging markets are attractive, and could provide opportunities in 2025, but the strength of U.S. equities, driven by strong financials, will continue to be the staple of equity portfolios. “As always, a broadly diversified portfolio makes sense, but overweighting the U.S. continues to appear to be a reasonable approach for many investors,” Toner says.

What About the Fed?

The Federal Reserve’s December 18 decision to cut the federal funds rate by 25 basis points and lower the outlook for more rate cuts in 2025, though expected, was greeted as a surprise in the U.S. equity markets. The S&P 500 fell as high as 3% the day of the meeting.

“Overall, [the] FOMC meeting brought back some unwanted clouds of uncertainty over monetary policy .. At a minimum, market expectations have shifted toward a shallower- and slower-than-anticipated rate-cutting cycle,” said Adam Turnquist, chief technical strategist at LPL Financial in a statement after the December Fed meeting.

Turnquist noted that the near-term risk remains to the upside for 10-year Treasury yields, likely creating a headwind for stocks. “Based on this backdrop, and the deterioration in market breadth over the last few weeks, we recommend waiting for support to be established and for momentum to improve before stepping up to buy this dip,” he said.

Charlie Ripley, senior investment strategist at Allianz Investment Management, said in a statement that, despite having been able to make 100 basis points of reductions so far in this rate cutting cycle, it may be tough to continue at its current pace. “The other reality is Powell and Co. cannot afford to be wrong on inflation again as upside risks continue to persist,” Ripley continued. “Therefore, we see the bar being raised for rate cuts going forward from here and given this Fed is operating on a data-dependent level, any meaningful upticks of inflation raise the risk that additional rate cuts, if any, will be few and far between.”

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The Plethora of Unknowns Mean Questions for Bond Investors in 2025

The Plethora of Unknowns Means Questions for Bond Investors in 2025

Private and global credit offerings could provide diversification as debt markets deal with political and policy uncertainty.

By Bailey McCann

Art by Andrea D’Aquino

2025 could be an interesting year for fixed income. End-of–year performance across credit asset classes was broadly positive and many of the trends driving that performance appear likely to continue. However, 2024’s elections in the U.S. and the deterioration of governments in several EU member states could add to ongoing geopolitical uncertainty. That uncertainty could impact credit performance in a handful of major investment markets and is pushing some investors to look for diversification in global credit and private credit.

Sources say, with so many unknowns going into the beginning of 2025 it is hard to forecast how performance will ultimately shake out. Investors may choose to be a bit more tactical over the next six months in response to higher volatility and greater uncertainty.

The Good

According to a recent research note from Schroders, we’re likely to start 2025 “with 10-year U.S. Treasury nominal yields above 4%, and real yields (net of inflation) above 2%, an attractive level of income we haven’t seen since the 2008 financial crisis.” This will mitigate some of the negative carry that has made holding long-duration bonds more expensive in recent years.

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The Federal Reserve also made good on its December quarter point cut, a move which markets wanted and had already priced in. The European Central Bank cut rates by 25 bps, also as expected. Alongside that cut, President Lagarde’s forward guidance was more hawkish than expected, driving an increase in medium-term yields.

These trends will likely be supportive for treasury portfolios going into the first quarter while markets figure out whether more rate cuts are on deck. Markets have signaled that they want more cuts but during his most recent remarks, Fed Chair Powell indicated he was fairly comfortable with where rates are now relative to economic and inflation data – a position which many interpreted as dovish on future cuts.

Even without additional cuts, bonds could be boosted by lower overall inflation. Schroders notes that “at lower inflation levels, the diversification benefit of bonds increases, providing a more efficient hedge against weakness in cyclical assets. Bonds also look cheap versus alternative assets, with current yields higher than that of the expected earnings yield on the S&P 500.”

Simon Dangoor, head of fixed income macro strategies at Goldman Sachs Asset Management, adds that 2025 is likely to be a good year for getting income from credit investments. “A big feature of 2024 is that spreads compressed to very tight levels which makes things look expensive at face value. That might lead some investors to say they want to take money off the table and head for the hills, but I think, in the U.S. in particular given the fundamental and technical aspects of the market right now, 2025 could still be a very good year for income.”

These trends extend into corporate credit and high-yield as well. Demand for income is high and issuers have remained very disciplined about supply, Dangoor, says. “We haven’t seen anything in the way of corporates trying to deteriorate their balance sheets and we expect the default rate to remain low throughout the next year. Both of these factors are positives for investors,” he says.

David Fann, senior managing director at VSS Capital Partners, agrees. He says that while some expected a wave of bankruptcies and restructurings to hit companies – especially those reliant on private credit financing – that wave has not materialized.

“We continue to see that banks and financial sponsors are comfortable with where the market is at and are willing to amend or extend maturities in many cases for companies that have strong balance sheets,” Fann says. “That’s been the story for a few years now and we don’t yet see data that might indicate distress or a willingness on the part of liquidity providers to start getting more restrictive.”

The Potentially Less Good

It can be tempting to look at these topline trends and think 2025 will be smooth sailing for credit investing, but heightened volatility is also likely to be a feature of the new year.

In the U.S., the incoming Trump administration has signaled its willingness to consider widespread tariffs as well as strict limitations on immigration – policy positions that are by their nature inflationary. How these policies eventually shake out is a source of great debate. Many sources CIO spoke to for this story argue that President Trump’s tariff positions are mostly noise designed to bring industries to the table and force negotiations. From a practical standpoint, if the administration does end up using tariffs, it will likely take several months to a year to implement.

Karin Anderson, director of credit manager research at WTW, says that with that kind of phased-in implementation, the Fed may opt to look past any initial market or supply reaction before changing course and potentially raising rates to head off inflation.

“It’s probably going to be better for everyone – investors included – that it will take some time to implement these policies, because I think it lessens the risk that the Fed would be pushed into raising rates again. That said, it really depends on how the policies are crafted if they move forward. There is inflationary risk and that could have an impact on rates,” she says.

Dangoor adds that Trump’s pick of Scott Bessent as his nominee for Treasury Secretary indicates sensitivity to bond market reaction, which could mean that the administration may be willing to back off the most destructive of its policy proposals if those policies risk the ire of bond markets. “This looks to be a relatively business friendly administration, so there could be a lot of nuance in how these policies unfold,” he says.

Outside the U.S., the deterioration of governmental coalitions in France and Germany could put pressure on European credit if uncertainty over those governments lingers. Still inflation is beginning to normalize throughout the continent which is positive for investors overall. Dangoor says that investors may find diversification in global credit opportunities if they are concerned about volatility in the U.S. market.

“You have to pick your spots,” he says. “But there are interesting themes in rates in countries where inflation is cooling and economic activity is still positive. Sweden is one, Canada is another. Inflation is starting to come down in Australia so that could be positive as well.”

When it comes to private credit, sources say investors are still upbeat. Private credit funds had another solid fundraising year and there is significant demand from businesses to put money to work. Lower interest rates raise questions about potential returns for these funds. Private credit loans are typically floating-rate and get a bit of a boost from higher interest rates. However, the slowdown in mergers and acquisitions, driven by higher capital costs, has meant ultimately that there are fewer deals to finance.

Fann says investors could start to see these dynamics shift if rates go lower. Private credit funds may have more deals to do if M&A returns, but itis likely they will get done at a lower return multiple.

Private credit funds have also been supported by the growth of net-asset-value-lending and continuation funds, as private equity managers look for ways to return capital back to investors in lieu of traditional exits. Those business lines are likely to continue to expand at least in the short-term until M&A activity resumes.

Investors are often wary of these tools, but Fann says, “We’re in a new normal. Capital costs are higher, M&A timelines are longer. I think you’re going to see these synthetic liquidity options continue to be used because they can solve some of the challenges brought on by the current market environment. I think you’re going to see the issues on investor alignment and valuations resolve themselves over time but it will take time to play out.”