by Patrick Fearon-Hernandez, CFA, Bill O’Grady, Thomas Wash, Daniel Ortwerth, and Mark Keller, CFA
Summary of Expectations | PDF
The Economy
Economic Growth
- We expect the US economy to keep growing throughout 2025, with no recession. However, current growth is only moderate, and because of elevated real interest rates and cooling labor demand, growth could slow in the coming year.
Recession Risk
- As the economy loses momentum, it will become more susceptible to recession from an outside shock, such as a major geopolitical crisis or disruptive policy changes. Therefore, a recession cannot be ruled out entirely.
Inflation & Monetary Policy
- As the economy moderated in 2024, price pressures fell. Nevertheless, recent data suggests inflation may not slow much further. While moderating economic growth will encourage the Federal Reserve to keep cutting interest rates in the near term, sticky inflation may keep policymakers from cutting rates as much as some investors expect.
Continued-but-moderating economic growth, sticky inflation, and limited interest rate cuts lay the groundwork for the asset class returns we expect in 2025.
Election Implications
Balancing Coalitions
- Even though the Republican Party won control of the White House and Congress in the 2024 election, President-elect Trump’s coalition will be hard to manage. Different constituencies in the coalition have dissimilar, and sometimes contradictory, goals. The actual policies put into place will be determined by Trump’s bargaining skills and how he balances their varied interests.
Foreign & Domestic Policy
- Despite this complex and fluid situation, we believe we can make some basic predictions about Trump’s policies. In foreign affairs, we think he will adopt protectionism writ large, i.e., forcing increased defense burden sharing on US allies, while imposing import tariffs to protect US manufacturers and workers. In domestic policy, we expect he will emphasize extending his first-term tax cuts and cracking down, to some extent, on legal and illegal immigration.
Monetary Policy
- While Trump’s actual policies are still in question, the major initiatives that we foresee could conceivably buoy price inflation. If so, they could further discourage the Fed from aggressive rate cuts.
Market Outlook
Our asset class return expectations depend, in part, on our expectations for monetary policy and bond yields. After discussing those factors below, we address US and non-US equities and commodities.
Fixed Income
- TREASURY YIELDS
As of this writing, the US yield curve is either slightly inverted or modestly upward sloping, depending on the calculation methods used. Our modeling suggests the yield on the benchmark 10-year Treasury note will end 2025 little changed from current levels. If the Fed cuts short-term rates very little, as we expect, the yield curve should remain fairly flat in 2025. Government bond returns are therefore likely to be similar to today’s yields. - CORPORATE BONDS
Our modeling suggests US investment-grade corporate bonds are currently a bit overvalued, leaving their yields somewhat low compared with government bonds. Even if government bond yields only modestly change in 2025, as we anticipate, corporates are susceptible to repricing that would weigh on their returns. - HIGH YIELD
Our analysis suggests below-investment-grade corporates are more dramatically overpriced, leaving their yield spread over Treasurys much too low to compensate for their greater risk. These below-investment grade bonds will therefore be even more susceptible to negative repricing in 2025, especially as the Fed moves slowly to cut rates and economic growth slows.
US Equities
- BASE CASE FORECAST
We see a much more positive outlook for US equities. Based on our expectation for continued economic growth, profit margins remaining close to where they are now, and P/E ratios staying at today’s level of about 25.0x, our base case calls for the S&P 500 price index for large capitalization stocks to rise by 10.5% in 2025. We expect the index to end the year at 6,735, with a likely range between 6,500 and 6,800. However, our modeling suggests there is significant upside to the P/E ratio. In a best-case scenario, it could
go as high as 30.0x, boosting the percentage price gain commensurately. - CAPITALIZATION
If US equity prices rise as strongly as our analysis suggests, continuing their current momentum, then sectors and styles that have been outperforming recently may continue to do so. Nevertheless, because of the outperformance of large cap stocks in 2024, we think the better buys will be found among mid-cap and small cap equities. - GROWTH/VALUE
Similarly, the 2024 out-performance of growth stocks has left them relatively expensive versus value stocks, in our opinion.
Foreign Equities
- We continue to believe that the relative performance of non-US equities depends largely on the strength of the dollar. Given the US’s relatively better economic growth, elevated real interest rates, and financial market momentum, we think it will continue to see strong inflows of capital from abroad, boosting the value of the greenback. That, coupled with the incoming administration’s expected protectionist policies, will likely constitute headwinds for foreign stocks.
Commodities
- Finally, we continue to see evidence that global central banks are buying up gold, boosting the yellow metal’s price despite our own modeling that suggests it is already richly priced. Because of central bank buying and increased geopolitical tensions around the world, we think gold and other precious metal prices may rise further in 2025.
- In contrast, other commodities are likely to face a challenging price environment because of slowing economic growth in China, weak demand in other major economies, and ample supplies of some key products (such as crude oil).
