Our call to arms at the outset of 2024 was to ‘lean into risk’. Many of the positive market drivers that encouraged that perspective will, fortuitously, continue as 2025 gets under way—growth is slowing but not collapsing, inflation continues to moderate toward targets, and most central banks are now lowering interest rates. Such a benevolent ‘macro’ backdrop delivers a strong foundation for what could be another year of robust returns.
Yet, 2025 will see investors confronted by a new set of forces to navigate. As this year of elections draws to a close, the ‘red wave’ across the US has undoubtedly proved the most impactful. Uncertainties surrounding US trade policy, immigration, fiscal spending, tax cuts, and deregulation are set to challenge this otherwise benign macro outlook.
Thus, we enter 2025 still tactically leaning into equities, a posture that has heartily protected returns as we have traversed 2024. But we also recognise that the sequence and substance of new US policies (and the world’s response to them) has the potential to deliver a year of more meaningful market volatility and less buoyant returns. Indeed, 2025 may be less about leaning into risk (to harvest upward market trends) and more about a willingness to actively discover opportunity during dislocation across a (likely needed) diversified portfolio.
“The fundamentals of the global economy are improving. The inflation and interest rate shocks of the last two years are subsiding, real incomes are growing at the fastest pace in 20 years, and there are signs that housing markets are starting to turn”.
As UBS notes in its 2025 outlook, “the fundamentals of the global economy are improving”. That said, the outlook remains for slower world growth, even as the moderation proves more tepid than earlier forecast by many (as policy eases gradually and the threat of a trade war looms). To this end, 2025 has the potential to deliver modest sub-trend growth, moderately lower interest rates, and more modest investment returns than 2024.
Consensus has coalesced around a 3.1% world growth forecast for 2024, 2025 and 2026, a little below the long-term average near 3.5%. This view is also reflected in the ‘steady growth’ outlook of Société Générale (SG). In contrast, UBS targets a more definitive call for weakness later in 2026 (at just 2.6%), as the impacts of a trade war weigh on activity.
There is also greater regional dispersion than we have become accustomed to. The US economy is on a slowly slowing path, while Europe and the UK face patchy recoveries post their late 2023 recessions. Optimism regarding Japan’s ability to sustainably exit from decades of deflation is mirrored by concerns surrounding China’s persistent property headwinds (and the prospects for sharply higher US tariffs). For Australia, a stalled (private) economy may deliver improving sub-trend growth through 2025, as lagged rate cuts arrive. For emerging markets, their vulnerability to a trade war during 2025 is hard to ignore.
While inflation remains a little above most central bank targets, slower growth should foster further rate cuts in H1 2025, albeit markets have begun to fret that the extent of any easing may disappoint. Uncertainties surrounding a Trump presidency (a mix of positive and negative forces) must also be viewed in tandem with the positive secular themes in artificial intelligence (AI) and the energy transition, along with the potential for more China stimulus.
“The new incoming [Trump} Administration is business friendly and will implement deregulation, fiscal stimulus and deliver smaller government, while the US private sector is primed to grow.”
While expectations through 2024 largely centred on the November US election delivering a Republican Trump presidency, the extent to which this could shift the narrative was widely anticipated to be constrained by a close contest and a split Congress. However, former President Trump’s strong showing across both the popular vote and Congress has laid the foundation for a more significant policy upheaval post Trump’s January 2025 inauguration.
There is a range of policies that have the potential to disrupt, including heightened tariffs that could spark a global trade war, initially reversing disinflation trends and challenging the outlook for lower rates. There are other policies that promote tax cuts, which will likely drive consumer and business activity stronger than originally anticipated, but may also add to the angst about fiscal ill-discipline, ultimately threatening the ire of the bond market.
Whether ‘talk’ of government efficiency actually eventuates, or the reality that tariffs ultimately do destroy consumer demand, will also impact market outcomes (as could a slower pace of immigration, over time). Policies targeting climate transition will likely remain largely unscathed, but particular measures for selected sectors may be under threat.
For investors, sequencing the impact (and announcement) of these policies will be key to market outcomes. We expect the first half of 2025 to be focused on tariff announcements and measures to target (and slow) immigration, with the impact on growth and inflation likely to be evident only from mid-year. In contrast, legislation around lower taxes is unlikely to be formalised until the northern Autumn (Q3 2025), and the impacts (apart from confidence) more likely evident from to appear from 2026.
Notwithstanding Trump’s strong electoral mandate, we still expect constraints to influence outcomes. The incoming president remains sensitive to equity market movements (which are, in turn, vulnerable to decisions that create inflation risk), while the bond market will play a key role in constraining poor fiscal decisions. There are procedural matters associated with introducing tariffs, which take time and allow for negotiations. And as the chart below reveals, Trump has shown his willingness to shift the narrative—in this case toward focusing on fiscal efficiency—as the consumer mood toward ballooning deficits sours.
As discussed below, there remains some chance the market may only experience political ‘flesh wounds’ as 2025 progresses, ducking and weaving through the various policy ups and downs, announcements and likely un-announcements, tweets and such.
For now (as shown above left), we stay tactically constructive, remaining overweight US, Japan and domestic equities as central banks remain proactive in trimming interest rates and economic growth remains resilient (albeit slowing). While we are slightly underweight government bonds, we are conscious the peak in yields has likely been set. However, given a near-term concern about US fiscal largesse, we are choosing to seek return in investment grade credit, supported by a soft-ish economic landing. Alternatives remain a favoured destination for limiting volatility in the year ahead, as well as mitigating the impacts of inflation, which we continue to expect to settle at a pace higher than past decades.
Former President Trump’s strong showing, across both the popular vote and Congress, has laid the foundation for a more significant policy upheaval post Trump’s January 2025 inauguration.
As noted, there is a range of disruptions investors will need to navigate through 2025 and 2026. In each case, we suggest the opening salvo will typically be at the extreme end of outcomes, and the constraints and the ‘learnings’ by the administration will likely result in outcomes that, at the margin, may have less material ongoing market impacts.
For investors, sequencing the impact (and announcement) of these policies will be key to market outcomes. We expect H1 2025 to be focused on tariff announcements and measures to target (and slow) immigration, while legislation around deregulation and lower taxes is unlikely to be formalised until H2 2025.
Geo-political disruption—The opening salvo from the Trump presidency is undoubtedly ‘isolationism’. Make America Great Again—MAGA. This aligns with the US playing a reduced role in regional ‘police-keeping’, perceptions of dysfunction in the Middle East, and aggressive mercantilistic trade tactics toward China (and just about everyone else).
However, the underlying geo-political environment may be less disruptive than consensus assumes, providing buying opportunities at moments in time. Trump has a penchant to focus on ‘deals’ and while disruption will likely be the initial event, more market-friendly solutions (trade deals, military truces, and energy agreements) may also be forthcoming.
Trade disruption—The opening salvo is tariffs for everyone, reversing globalisation to the 1920s. This will likely involve retaliatory tariffs from key trading partners that escalate to a tit-for-tat global trade war. An initial inflation spike that limits further rate cuts (or even drives US rate hikes) sends bond yields soaring and leads the world into recession.
Clearly possible. Yet, the reality is more likely to reflect that Trump was elected largely in response to cost-of-living pressures. Tariffs are paid by US consumers and inflation will emerge relatively quickly if they are put on. This suggests a more measured approach may arise. Tariffs at 60% for China may be introduced in stages to dilute the inflationary impact, while also making room for an early deal to be done. Similarly, the proposed 10% tariff on other nations is already being re-shaped to target selected industries instead. Trump’s use of tariffs as a negotiating tool also favours our equity bets of Australia and Japan.
Trump’s late November nomination of Scott Bessent for Treasury Secretary, who’s previously flagged ‘layering’ tariffs to reduce their inflationary impact, is an example of the evolution of Trump’s policies. Bessent’s hedge fund background and revealed bias toward deregulation to help business and mitigate inflation have been well received by markets, with bonds yields falling sharply on his nomination. This volatility may well continue.
Interest rates interruption—Here, the opening salvo is fiscal largesse and rising deficits, led by unfunded tax cuts, that drive inflation and bond yields higher, short-circuiting US rate cuts. Clearly, term premium has already risen as Trump was elected, and there is a risk of further increases. A steeper yield curve remains likely as fiscal pressure persists for years.
Still, notwithstanding the market has already removed arguably ‘too much’ easing from the US Federal Reserve (Fed, a positive for equities, should they be reinstated), we do anticipate the risk that around mid-2025, Fed Chair Powell will get ‘stopped out’ on the full extent of his planned rate cuts. However, we expect that to be largely driven by better-than-expected growth not reaccelerating inflation, a support for ongoing corporate earnings growth.
Moreover, Trump may be less fiscally profligate than first believed, especially with such a narrow Republican House majority and given the nature of his popular (cost-of-living and inflation) mandate. As a result, term premia may not rise as much as feared, moderating a potential headwind for financial markets.
“I would recommend that tariffs be layered in gradually. If you take that price adjustment coupled with all the other disinflationary things that president Trump is talking about, we’re going to be at or below the 2% inflation target again”
In 2024, we focused on leaning into risk. Despite the benign macro backdrop, 2025 might be more attuned to ‘average’ returns – those aligned with our ‘capital market assumptions’ (CMAs), which for equities is around 7% (compared with 20% to date in 2024) and 4% for fixed income (only 2% year-to-date). 2024 was a year to harvest the beta in markets, given the persistent positive backdrop (that delivered short and limited market drawdowns). In 2025, volatility could lead to more meaningful market movements, while also presenting opportunities to be active and nimble through that volatility, rather than chasing rallies (as in 2024). Truly diversified portfolios are likely to re-establish their importance during 2025.
Notwithstanding the market has already removed arguably ‘too much’ Fed easing, we do anticipate the risk that around mid- 2025, US Fed Chair Powell will get ‘stopped out’ on the full extent of his planned rate cuts. But we expect that to be largely driven by better-than- expected growth not reaccelerating inflation.
For 2025, the set-up for global equities remains constructive, albeit complicated by the lack of a valuation cushion. This time last year, the MSCI World ex-Australia Index was trading at less than 17.0x 12-month forward earnings, broadly in line with its 10-year average. It's now at ~19.5x, and ranks in the top 15% of observations over the past decade. US equities have a price/earnings (P/E) ratio of 22x, ranking in the top 5% of readings over the past decade.
Despite this, we retain our overweight to equites, punctuated by an ongoing positive stance towards US equities. The benefits to the stock market under a Trump/Republican Congress are a lighter regulatory burden for many areas (real estate, energy, and financials), a reduction in the corporate tax rate, potentially to 15% from 21%, and a relatively closed economy that will prove more defensive in a world of escalating trade tensions (i.e. elevated tariffs). The extent to which the fiscal deficit can be contained, if at all, could go a long way to determining how much pressure the bond market puts on equity valuations.
For now, investors are right to focus on a resilient equity earnings backdrop, expanding use cases for Generative AI, tailwinds from lower front-end rates and a banking sector that may find itself with more excess capital under a Republican Administration than a Democratic one (and thus a greater willingness to extend credit at a time ‘animal spirits’ are resurfacing).
We continue to view Japan as a key overweight, driven most importantly by ongoing corporate governance reforms and an improving domestic macro environment and relative insulation from trade wars. Japan’s valuations also sit around average levels. In contrast, while we are overweight Australia, the position is more challenged, reflecting a stretched banking sector, while the other ‘barbell’ of resources is confronted by fading hopes of a ‘big-bang’ China stimulus. Investors have recalibrated local rate cut expectations as well, with only two rate cuts priced for all of 2025. With a federal election looming in May, it’s likely that the strongest gains for domestic equities may be behind us for the time being.
From a factor perspective, we continue to advocate for an approach that invests ‘beneath the index’. In H2 2024, the equal-weighted S&P beat the market-cap weighted S&P500, value outperformed growth, and small and mid-cap equities outperformed their large cap counterparts. We believe this outperformance can continue during 2025, as lower rates, and more attractive valuations support continued rotation away from index-level investing.
We continue to advocate for an approach that invests ‘beneath the index’. In H2 2024, the equal-weighted S&P outperformed the market-cap weighted S&P 500, value outperformed growth, and small and mid- cap equities outperformed their large-cap counterparts. We believe this outperformance can continue.
Bond markets in 2024 found it difficult to predict the path of easing, hindered by a strong US economy and sticky inflation locally. It was thus a year of peaks and troughs without an aggressive easing cycle. For 2025, Trump’s re-election could create uncertainty and further near-term volatility as markets await action around trade, tax cuts, and immigration. But we believe these risks will not be as extreme as some predict. We expect markets will re- focus on macro data and monetary policies, with bonds likely to be less volatile in 2025, suggesting yields are close to their peak, a supportive environment for fixed income.
After a strong sell-off during Q4 2024, the 10-year US Treasury at 4.30% provided a good entry point for investors, as global growth should slow, and inflation improve further.
While potential fiscal changes and tax cuts may re-ignite inflation fears down the track, the risk-reward of adding duration over the next six to 12 months is favourable. We have a bias towards domestic government bonds over global to take on duration, as the curve is positive and yields remain at or above the cash rate, the highest in the G10 countries.
Investment grade credit spreads are close to their tightest levels in the past decade, but should still return positive attribution to portfolios, particularly through any periods of potential market volatility. The emphasis will remain on the single A-rated subordinated tier II major banks as they continue to issue (replacing additional tier I hybrids). While we expect another year of robust issuance, attractive outright yields above 6% will be met with equal or greater demand. Any widening of spreads due to growth concerns should be more than offset by falling interest rates, as the focus will remain on rate cuts over H1 2025.
After a strong sell-off during Q4 2024, the 10- year US Treasury at 4.50% provided a good entry point for investors as global growth should slow below trend and inflation improve further…
A key conversation for 2025 will be the extent to which private equity activity improves. According to Bain & Company, global deal count and exit count look set to equal the strong experience of 2023, while deal and exit values have seen marked increases of 18% and 17%, respectively. With interest rates falling, activity appears to be picking up, and should continue to do so through 2025. For investors, crucial will be whether increased activity translates to increased valuations. Data suggests holding values are relatively conservative immediately prior to exit, while look-through portfolio analysis of our core open-end positions implies meaningful (multiple) discounts to public comparables. While a single data point doesn’t set a trend, we continue to advocate for maintaining and building private equity exposures.
Beyond private equity, private debt continues to offer attractive risk-adjusted returns, despite the falling interest rate trajectory. The excess returns of 2023 have passed, but prudently allocating to diversified exposures across both corporate and broader asset-based sectors is sensible. Private infrastructure also remains a key preference across risk spectrums, providing exposure to major structural themes, including decarbonisation and digitisation. We are also more constructive on real estate looking forward with data across both the US and Australia turning positive. Whilst sentiment is still mixed, particularly within office, 2025 presents an attractive deployment opportunity for long-term real estate positioning.
Moving to broader diversifiers, hedge funds have fared better in 2024 and have benefited from pockets of dislocation and dispersion in addition to higher interest rates. We believe it is important to maintain exposure to true diversifiers than can generate long-run equity-like returns (i.e., 6-10%), with lower correlation to traditional risk factors (equity and credit beta, and duration). So called, ‘alternative alternatives’, such as royalty and litigation finance, are also gaining traction given their return profile and lack of correlation to traditional and mainstream alternative assets.
…investment grade credit spreads are at decade tights, but should still return positive attribution to portfolios. Any widening of spreads should be more than offset by falling interest rates during H1 2025.
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