2025 Outlook – Still a Supportive Backdrop, but New Challenges and New Opportunities
A look back at 2024
2024 proved to be a stellar year for investors. The S&P 500 set 57 record highs and achieved its second consecutive year of 20%-plus performance for the first time since 1998. While European markets faced more difficulties, the German Index reached record highs. US Mega-cap tech led the way, but solid gains were recorded across sectors, styles, and market caps. With 2024’s strong performance now in the rearview mirror, it is natural to wonder if the equity markets can maintain this momentum.
2025 will bring a mix of headwinds and tailwinds, along with some policy uncertainties
The new US presidency, the tariffs, and the taxes, the China slowdown and its stimulus efforts, the European leadership crisis, and most importantly the direction of inflation and interest rates are all critical issues that will unnerve investors. Ultimately, stocks and bonds may build on 2024’s gains, as the main drivers that propelled the stock market higher over the past 12 months seem poised to continue. We expect another year of economic growth, rising corporate profits, and a continued normalization of Federal Reserve policy, all of which can support the ongoing bull market. However, the new Trump policies, inflation and interest rates and the usual geopolitical issues will be the key catalysts adding volatility to the markets.
For Europe, despite facing headwinds from political and trade uncertainties, as well as slow economic growth, European stocks are anticipated to benefit from cooling inflation and supportive central bank policies. In addition, these markets are very cheap. This could help to fin a bottom and potentially a rebound.
Looking ahead, here are some opportunities and challenges to consider:
U.S. Economic Growth Cools: With a potential soft landing in the second part of the year, the U.S. has defied expectations in 2024 for a sharper slowdown, growing at a 2.7% pace. Positive but more moderate economic momentum is expected in 2025, supported by a healthy labor market, wages rising faster than inflation, and appreciating real estate and portfolio values. A damaging return of inflation, however, could hurt equity markets.
In Europe, Germany seems to remain in a shallow recession, a broader Europe-wide recession has been avoided. Modest GDP growth is forecasted across the Eurozone. Asian countries will depend more on their domestic markets to boost growth. This is the strategy initiated a decade ago by the Chinese authorities.
Central Banks Slow the Pace of Interest Rate Cuts: The U.S. economy continues to perform well, and uncertainty persists around the speed at which inflation will return to target, so the Fed could stop cutting rates or even increase rates. Conversely, the ECB might be forced to cut rates to support the European economy, creating opportunities in more indebted sectors like telecoms and real estate. Overall, inflation will continue only a very slow cooling trend as the substantial cuts in inflation are already behind us.
Equity Bull Market Continues for a Third Year: As with economic growth, stock market gains are likely to cool and take a breather. Fundamentals remain broadly positive, but high expectations due to rising valuations leave less of a cushion for any stronger slowdown, rise in inflation or simply a buyer’s fatigue. Earnings growth will need to drive market returns rather than further valuation expansion.
Broadening Leadership in the Stock Market: Market leadership began to broaden in 2024, as the divergence in performance started to shrink between the Tech and the Value sectors. New opportunities could arise in 2025. Valuations for lagging segments (values and cyclicals) are favorable, but a catalyst is needed to unlock these discounted valuations, especially as enthusiasm around mega-cap tech stocks may abate. We could see some accelerating earnings growth in other parts of the market versus strong but slowing earnings growth for mega-cap tech could occur. Deregulation and pro-growth policies might benefit cyclical sectors such as industrials and financials.
Yields Remain High: Despite the Fed cutting its policy rate by 1%, the 10-year Treasury yield might spend most of 2025 in the 5% range. Hopefully additional Fed rate cuts and bond purchases should help keep yields from rising too significantly. However, resilient growth, widening deficits, and uncertainty around inflation could prevent yields from falling sustainably.
Conclusion: We need to keep expectations realistic. A linear run is never guaranteed. The year 2025 will bring its own twists and turns in the market narrative, but there are reasons for cautious optimism. The Fed appears to favor stability in its monetary policies, while the labor market remains strong, and economic growth is robust. Despite rising valuations and high policy uncertainty, corporate profits are likely to rise, providing fuel for further gains.
The United States will continue to be the premier investment destination globally, offering the best growth profile and a wide array of opportunities for investors. However, diversification remains a crucial strategy for any robust investment portfolio. In this context, Europe presents a plethora of affordable and attractive companies that offer excellent opportunities for diversification and growth.
Meanwhile, Asia is expected to see a resurgence, particularly as China navigates its path back to growth. This recovery in Asia could unlock new investment prospects across the region, further enhancing the global investment landscape.
In summary, while it’s essential to keep expectations grounded, the combination of strong economic fundamentals and strategic diversification can help navigate the complexities of the market in 2025 and beyond.