The economic backdrop is still conducive for returns, but diversification will be essential for building resilient portfolios.
By Johanna Kyrklund, Group Chief Investment Officer
News of Donald Trump's conclusive US election win has led to endless speculation about what his policies might be. In this environment, it is always useful to step back and focus on the bigger picture trends.
We have written before about the changing investment regime: a shift to a multipolar world, more proactive fiscal policies, and higher interest rates compared to the last decade. The post-Global Financial Crisis environment of tight fiscal policy, zero interest rates and liberalised global trade was not working for the average person in the West, leading to support for more populist policies.
In this context, Trump is more of a symptom than a cause of the political environment. His second term will represent an intensification of trends that were already in place: loose fiscal policy and an ongoing reaction against globalisation in the form of higher tariffs (note that Biden did not reverse the tariffs imposed by Trump in his previous term).
What does this mean for markets in 2025? Leaving aside political risks, the economic backdrop remains benign. Inflation has moved in the right direction and interest rates are falling in the US and Europe. We expect a soft landing, and our expectation is that growth will reaccelerate as we move through 2025.
Our expectation is for a soft landing for the economy in 2025
Look beyond recent winners for return opportunities
Turning to equities in more detail, the S&P 500 is looking expensive but valuations away from the mega-caps and outside of the US appear more reasonable. Equity investors have grown used to a small number of large companies powering the stock market's gains; however, this pattern is already changing.
We think there is potential for markets to broaden out further in the US, particularly given Trump's focus on deregulation and corporate tax cuts.
Consensus expectations are for improving earnings growth in most regions in 2025
Beyond the US, trade will be an important area of focus if Trump implements in full the tariffs he announced during the campaign. In practice, such widespread tariffs might be hard to implement into law, but the uncertainty will encourage US companies to reshore in any case. This could boost US growth at the expense of its neighbours, but we would also expect more monetary stimulus outside of the US to offset this.
So, all in all, we see scope for positive returns from equities in 2025, but investors may need to look beyond the recent winners.
We also need to recognise that the risks are increasing as positive expectations get baked into market valuations. In particular, around a 4.5% to 5% yield on the US 10-year Treasuries, we would judge that comparisons with bond valuations would pose a speed limit to equity returns. This arises because higher bond yields can draw money away from the stock market, as well as increasing borrowing costs for corporates.
As mentioned above, we remain positioned for a soft landing which is a benign outcome, but when thinking about the risks around that scenario, our bias is still to worry that the US growth environment might be 'too hot' rather than 'too cold'. Curbs on immigration and policies to boost the corporate sector could increase the risk of domestic inflation, curbing the Federal Reserve's abilities to deliver rate cuts.
Bonds offer attractive income
Which brings me onto bonds. As I have outlined previously, we believe that we are in an environment that is very different to the deflationary, zero-rate regime of the 2010s. As a consequence, bonds do not offer the same negative correlation benefits that they did in the last decade.
However, the old-fashioned reason for owning bonds to generate income is back and we continue to argue for their inclusion in portfolios. Divergent fiscal and monetary policies around the world will also provide cross-market opportunities in fixed income and currency. Strong corporate balance sheets support the yield offered by credit markets.
To the extent that investors are seeking diversifiers, we continue to like gold as it provides a hedge against recession risks like bonds. It is also a good store of value in the event of more stagflationary outcomes and geopolitical events.
Diversification holds key to portfolio resilience
And that brings me onto the importance of portfolio resilience. While the economic backdrop generally looks favourable for returns, we cannot gloss over the fact that there are many risks to markets. We are facing disruption on unprecedented scale and it is taking various forms.
We have already mentioned the potential disruption from tariffs and trade wars. There are also the ongoing conflicts in the Middle East and Ukraine where the risks of political miscalculations cannot be ignored.
The transmission mechanism of geopolitical events to markets is typically through commodities. As an asset class, commodities have been out of favour due to global growth worries, but they have an important role to play in offering diversification and creating resilient portfolios. Energy is one way to play this, while gold is still the ultimate safe haven asset.
Private markets can also help provide resilience via exposure to different types of assets that are typically more insulated from geopolitical events than listed equities or bonds. Examples include real estate and infrastructure assets that offer resilient long-term cash flows, as well as assets like insurance-linked securities (ILS), where weather is the key risk factor.
Overall, we think conditions are favourable for good returns to be made in 2025, but there will be challenges to navigate. A diversified approach, looking across regions and asset classes, can contribute to making portfolios more resilient, no matter what the year ahead brings.
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