Outlook 2025: New ways to diversify

Consider a fresh approach in a more volatile world

“We expect the dominant global megatrends to continue into 2025 and beyond. Energy transition and sustainability factors are embedded in many market participants’ approaches, and any rolling back of “green” policies in the US may not have as much negative impact as some fear.“

Virginie Maisonneuve

Global CIO Equity

Global equity markets are taking stock of the new political landscape following the US election. While there is some concern that potential changes in policy direction from Washington could be inflationary, given the trajectories taken by growth and inflation in 2024, we are still confident that the major developed economies are facing a soft landing and that significant recession will be avoided. In fact, economic resilience can be observed in many parts of the world and especially in the US.

The Fed’s September rate cut was expected yet its magnitude – 50 basis points, rather than the 25 expected by some – still took some by surprise. Looking forward, economic resilience and the potential for the disinflation trend to be perturbed by the inflationary impact of tariffs will lead markets to reassess, once more, the trajectory for interest rates normalisation, especially in the US.

Look beyond the mega caps

While equity markets globally – and in the US, in particular – appear sanguine about the prospects of a second Trump administration, investors should remain vigilant and keep in mind additional uncertainty around the possible impact of radical changes in policy towards trade, immigration and other areas. Supporting some of the market optimism is the deregulation expected across various sectors – in particular, the tech sector – under the new administration. Market concentration in the US has not been as high since the 1930s (see Exhibit 2) and we expect that deregulation could help trigger a welcome broadening of the market, benefiting companies beyond the mega caps, particularly in the technology sector.

Exhibit 2:  Concentration in US equity markets has touched historic levels 

Market cap of the largest stock relative to the 75th percentile*

*Universe consists of US stocks with price, shares, and revenue data listed on the NYSE, AMEX or NASDAQ exchanges. Series prior to 1985 estimated based on data from the Kenneth French data library, sourced from CRSP, reflecting the market cap distribution of NYSE stocks.
Source: Compustat, CRSP, Kenneth R. French, Goldman Sachs Research, 2024

Outside the US, China recently announced a new USD 1.4 trillion stimulus package designed to help restructure local government debt and support the economy’s move away from reliance on the property sector. The size of the stimulus disappointed some observers. However, the move is certainly a step in the right direction and more action from the central government is anticipated as the direction of the new administration in Washington becomes clearer. Recent data in China points to a stabilisation of the macroeconomic environment, and even a rebound in the case of the financial sector. And while a good deal of investor scepticism about China remains, recent initiatives show regulators are actively easing fiscal and monetary policy and seeking to boost asset prices – a very different stance to just a few months ago.

In India, the situation is starkly different as the economy begins to capitalise on its demographic dividend – a young and increasingly skilled population – just as China starts to find its demographics a burden. India currently boasts several advantages which will enhance productivity across sectors in the coming years.

Government plans on spending, tariffs and defence will shape markets

Despite the positive response of equity markets to the US election result, challenges remain. At the forefront of concerns is the sustainability of US debt, with the independent Congressional Budget Office (CBO) forecasting that the US debt-to-GDP ratio will exceed its post-Second World War high of 105% to reach 107% in 2029. This level of public indebtedness cannot be ignored and investors will need to keep an eye on the potential impact on inflation and rates.

Yet, it is the prospect of significant increases in tariffs and other barriers to trade that has made the post-election headlines. It is unclear to what extent Mr Trump’s promises of blanket 10% or 20% tariffs on all imports – and 60% on those from China – will become a reality. However, such measures could be inflationary in the US and impact growth in Europe and China.

We expect the dominant global megatrends to continue into 2025 and beyond. Energy transition and sustainability factors are now embedded in many market participants’ approaches, and any potential rolling back of “green” policies in the US may not have as much negative impact as some fear, given the momentum of mitigation and adaptation underway. 

Global supply chain redesign is another important theme given the prospects of punitive tariffs, as well as how new technologies and geopolitical issues are driving some companies to on- or re-shore production. The return of the “America First” agenda to Washington may accelerate ongoing changes to the existing world order, especially in terms of the emergence of rival “tech hemispheres” on each side of the Pacific and the Digital Darwinism driving the rapid uptake of leading-edge technology across sectors. 

Yet even if the global political situation avoids any unexpected shocks, growing tensions between the major powers will likely lead to increased military spending. The war in Ukraine has demonstrated how warfare in the 21st century has fundamentally changed, and countries will not want to be left behind if a new type of arms race emerges. Increased military spending will boost certain sectors and companies, yet the danger is that global debt levels may rise even higher.

Rethink equity portfolio construction

Our current view on portfolio construction reflects our expectation that elevated volatility will continue into 2025. While many investors currently favour a “barbell” approach – with portfolios heavily weighted towards low risk at one end, and high risk at the other – we are encouraging a breaking of the barbell by rethinking equity portfolio construction as a pyramid. The base of the pyramid – ie, the largest segment of any portfolio – should take a multi-factor approach to absorb volatility. Building on this, a second level should look for real quality across styles: growth, value, and dividend. Finally, at the top of our pyramid, we find stocks reflecting our high conviction ideas such as those tracking megatrends – artificial intelligence and energy transition, for instance – and regional plays such as investments in China and India.

Actively manage divergence

“The shift to pre-emptive, front-loaded rate cuts suggests the US Federal Reserve has learned lessons from previous economic cycles, where policy restraint typically stayed in place for too long, unnecessarily raising recession risks.“

Michael Krautzberger

Global CIO Fixed Income

The year 2024 has been another rollercoaster ride for sovereign fixed income investors. It has been a story of diverging global growth, with the relative outperformance of the US economy versus the rest of the world remaining the key driver of global bond and currency markets. Over the near term, the election of Mr Trump as the next US president has reinforced this narrative given expectations about future US fiscal and trade policy. Nonetheless, inflation prospects have improved globally, with core inflation rates inching back towards central banks’ targets in the major markets. This has reinforced expectations of an interest rate cutting cycle across the G10 markets, providing an anchor for sovereign bond markets through the course of the year.

Learning the lessons

Although the Fed was late to the rate cutting party in 2024, it did signal an important shift in its approach. This was to renew its focus on maximum employment – a goal that constitutes one half of its dual mandate, alongside stable prices. The shift to pre-emptive, front-loaded rate cuts suggests the Fed has learned lessons from previous economic cycles, where policy restraint typically stayed in place for too long, unnecessarily raising recession risks. The Fed’s actions have, for now at least, increased the probability of a US soft landing in 2025, even though history tells us that this is a rare outcome.

The macroeconomic landscape has been more challenging in other parts of the world. The Chinese economy disappointed expectations of a durable recovery in domestic demand – largely because of multi-year deleveraging in the property sector. Fears have grown that the economy faces a deflationary spiral akin to Japan’s experience of the last two decades. In the euro area, growth has been anaemic at best, with the largest economy, Germany, at risk of a second consecutive year of recession. Not surprisingly, central bankers in Europe have also shifted their approach; rate cuts are now priced at consecutive European Central Bank meetings well into the first half of 2025. The Chinese authorities have also recognised the perils of a deflationary spiral. They signalled a series of monetary, fiscal and market stimulus measures, raising hope that Chinese growth prospects will be a little less dim in 2025.

Looking into 2025, the monetary and fiscal policy stance – particularly outside the euro zone – provides a supportive backdrop for global growth prospects, although we expect economic trajectories to diverge. Debt fundamentals, the transmission of monetary policy and the degree of fiscal support will determine these different trajectories. Mr Trump’s second term as US president – and its implications for future US trade policy – is likely to be the biggest challenge to a constructive global growth outlook. Mr Trump’s policies may lead to another year of elevated bond and FX market volatility. 

The macro and geopolitical backdrop certainly raises the possibility that we may also see more volatility in risky asset markets in 2025.

Agility – and active management – needed

We think the fixed income asset class looks attractive given these risks, although navigating challenges in 2025 will require an agile investment approach between duration, yield curve, FX, spread and inflation products. Selectivity is key and therefore we think active investment management is critical.  

We think the global macro and policy backdrop supports our conviction in US and euro yield curve steepeners – trades where we take a bullish position in short-dated bonds and reduce long-dated exposure in anticipation of the yield curve steepening. This is because monetary policy easing and yawning fiscal deficits support the view that investors are not adequately rewarded for holding longer-dated bonds. We prefer this position to outright duration risk. To balance a steepening expression in portfolios, we also favour curve flatteners in Japan. The Bank of Japan is on a path towards monetary policy normalisation using rate hikes and balance sheet reduction, as inflation stirs in the Japanese economy after more than two decades.

Bond market volatility may well remain elevated in 2025, so we think it’s also a good idea to trade duration tactically, by adjusting portfolio sensitivity to interest rates in light of changing market conditions. In the US, we have a bias to add risk when we see upward spikes in yields and when markets show signs of becoming too complacent, by failing to price in the possibility – albeit unlikely – of a hard landing. Country selectivity will also be key. Countries offering better risk/reward dynamics for duration include the UK and Australia, which we think are currently priced for shallower interest rate cutting cycles and offer attractive real yields. 

Reflation risks

Having some inflation protection in portfolios also makes sense in this environment. There are several factors that could cause prices to rise: the degree of policy accommodation currently being priced, trade wars, the risk of oil and energy price spikes given geopolitical uncertainty, and structural issues – such as shortening supply chains and the policy implications of the climate transition. Together, we think these risks are underpriced in break-even inflation rates.

In currency markets, the relative outperformance of the US versus the rest of the world may have some scope to diminish through 2025. This would be less supportive for the US dollar, although we think the process could be uneven and dependent on US trade policy. Mr Trump’s victory has given an initial boost to the US dollar, though it remains to be seen whether this will prove long-lasting. 

In spread assets, emerging market debt has proved to be resilient through heightened geopolitical risks, market volatility, elections and changes to Fed rate cut expectations. Into 2025, emerging market fundamentals are robust and investment flows appear to be returning to the asset class. In this environment, we see plenty of opportunities in local currency bonds and select hard-currency high-yield credits, without trying to call the direction of the US dollar. In emerging market FX, we prefer a relative value approach in which we seek to benefit from temporary differences in price between currencies.

In corporate credit, spreads are rather tight for high yield and somewhat tight for investment grade. As rates come down, we do not think tight spreads will stop many investors from reallocating some of their money-market funds into credit. Yields in credit remain attractive and supportive of the strong technical backdrop. In high yield, we see a stronger case for shorter-dated credit, since extending spread duration risk doesn’t offer a sufficient yield premium at the moment. Floating-rate notes issued mostly by highly rated companies also continue to provide an attractive yield-spread. They also serve as a hedge against any unexpected repricing of expectations towards higher-for-longer inflation and interest rates.

Dynamic approach required

“In 2025, an agile approach to asset allocation will be crucial. A well-diversified portfolio is an important starting point, while actively managing volatility will be key to building dynamic protection. We think the environment calls for a focus on bottom-up security selection and active investment management.“

Gregor MA Hirt

Global CIO Multi Asset

We expect 2025 to begin with continued positive momentum for risky assets, particularly equities, and favour active investors overall. Historically, the opening months of the year have been supportive, and recent economic data, especially from the US, remains constructive, bolstering sales and corporate earnings. We expect the Fed to cut interest rates further, at least for a while, helping enhance liquidity in the market.

Mr Trump’s promises of lower corporate tax rates and deregulation will bring further positivity to the market and should benefit company margins, as we saw after 2016. If these measures lead to a period of calm in equity markets, investors may increase equity positions.

We see this environment as particularly favourable for US equities, especially in the following areas:

1. Smaller caps already offer attractive valuations in our view, and we expect them to benefit further from fiscal support and economic growth.
2. The broad technology sector should continue to perform well despite high valuations, helped by lower energy prices and the reduced likelihood of anti-monopolistic measures under the Trump administration.
3. US banks should thrive with the prospect of rapid deregulation.

Stronger economic growth in the US economy compared to Europe is one reason we expect US equities to outperform those in the euro zone. But equity markets should not be confused with the underlying domestic economy. For example, many companies within the Euro Stoxx 50 draw a significant portion of their sales from the US and stand to gain from a resilient US economy.

But while the European market is under-owned and has attractive valuations, it lags the technology and artificial intelligence powerhouses of the US and China. Labour laws and other structural deficits pose another headwind for European companies. Meanwhile, China remains a wild card, held back by structural issues but potentially benefiting from supportive policies.

Decoupling to be a major trend

High yield fixed income will likely profit from generally resilient economic conditions. However, we prefer equities over US high yield in our multi asset portfolios, especially as retail investors tend to favour more liquid assets at the end of a constructive cycle.

In a reversal of our equities outlook, we think European bonds may decouple from their US peers. While inflation is trending down, the European Union faces a more challenging environment, particularly with upcoming elections in Germany and potential political instability in France.

A key factor to watch in 2025 will be how the Fed responds to a potential reflation of the economy resulting from the new US administration’s fiscal policy and the impact on markets. The US dollar is overvalued and – in a normal environment – should trend lower as the Fed cuts rates and risky assets outperform defensive ones. However, if Mr Trump’s spending plans overheat the economy, the Fed might have to raise rates – a scenario that would negatively impact risky assets. Given high valuations and significant gains since March 2020, equity markets might pause in 2025 to reassess the situation.

In this scenario, emerging market local currency bonds may suffer, making flexible allocations uncorrelated to the market more attractive.

Bond markets have already priced some risk of overheating in the economy, as seen in a flattening of the US yield curve between September and the fourth quarter of 2024. However, a rebound in inflation and renewed perception of the Fed being late to tackle the problem could lead to increased pressure from so-called bond vigilantes, who push back on policy they do not like by selling bonds. Observing the evolution of the demand for longer-dated Treasuries will be key to assessing upcoming market risk.

In the longer term, de-dollarisation could gain traction if Mr Trump pushes ahead with radical geopolitical policies. In such a scenario, other economies might look to build their own currency blocs.

Geopolitical forces set to steer commodities

Commodities typically perform well against a backdrop of fiscal largesse and rate cuts. However, this time might be different. Mr Trump’s desire to ramp up oil and gas exploration could increase supply, while a potential end to hostilities between Russia and Ukraine could further pressure oil and gas prices. We might see oil prices moving to around USD 50-70 per barrel, compared to USD 70-90 recently. In terms of tail risk, an escalation in tensions between Israel and Iran could cause a short-term spike.

Copper may benefit from short-term economic relief in China. Gold remains a favourite due to its decoupling from the US dollar and real yields, supported by emerging market buyers in a tense geopolitical environment.

In 2025, an agile approach to asset allocation will be crucial. A well-diversified portfolio is an important starting point, while actively managing volatility will be key to building dynamic protection. We think a likely disruptive environment – and worrying levels of equity market concentration in places – call for a focus on bottom-up security selection and active investment management.

Windows of opportunity

“The so-called democratisation of private markets means more private capital is available for transformation while allowing retail clients to participate in the growth potential of this asset class.“

Deborah Zurkow

Global Head of Investments

Transactions and fundraising picked up in 2024 after a slowdown in the year before. As we move into 2025, we expect more momentum based on increased deal origination. While there has been a shift to private debt in the last two years, which will continue, we also saw valuations reassessed on the equity side. With prices normalising, there are more transactions on the market. Valuations have not yet reached levels seen before the dampening factors of inflation, rate hikes and the energy crisis that followed the attack on Ukraine.

Geopolitical crises also have an impact on private markets and valuations. But the asset class has proven it can navigate uncertain times with its floating-rate and inflation-linked attributes. Furthermore, geopolitical crises tend to be short-lived, whereas investors in these assets often have a long-term investment horizon – perhaps stretching over decades.

In 2025, we believe we will see more fundraising in private markets. Investors feel comfortable with recent performance, which has been delivered in a more volatile environment. With rates going down again, the market environment is rebalancing, which should lead to new opportunities at attractive terms.

In private debt, especially, there is a large and expanding universe for investors to choose from, with new opportunities in impact, secondaries, infrastructure debt and private credit thematics – as well as in trade finance where institutional investors have gained importance.

Urgent need for investment

A recent report by Mario Draghi, former European Central Bank President, estimates that to stay competitive the European Union needs to invest EUR 750-800 billion a year in areas such as digital transformation, green transition and defence.¹

In a reversal of our equities outlook, we think European bonds may decouple from their US peers. While inflation is trending down, the European Union faces a more challenging environment, particularly with upcoming elections in Germany and potential political instability in France.

While the need for investment is urgent, public deficits are growing. Without private capital, these investments will not be made. This opens a window of opportunity for investors, who can expect an attractive risk-return profile given the revaluation of projects. Many huge projects such as the modernisation of roads and public transport and the build-out of digital infrastructure and data centres, as well as social infrastructure and utilities, require financing. They need partners that have a proven track record and experience with long-term projects.

Infrastructure is driving the economic and societal development of countries. During the intense election cycle of 2024 we saw some projects being delayed, but given the critical natural of these basic services, the backlog of projects will be tackled when new governments are formed. The provision of essential services is particularly important against a backdrop of growing populism, which is causing political instability. 

“Impact” accelerates

New projects will continue to consider environmental, social and governance aspects. The relevance of impact private credit is accelerating, reflecting the need for private capital to support decarbonisation and digitisation while generating positive impacts for society – and returns for investors. We expect this trend to continue with broader interest from institutional investors in Asia and elsewhere, who are showing more interest in strategies that help drive the energy transition.

Another trend we expect to continue is the growth of secondaries. While these are established instruments on the private equity side, the market for private debt and infrastructure equity secondaries is still being established. Secondaries not only speed up the deployment of capital but also help diversify a portfolio. Given the size of private debt and infrastructure primary markets, in combination with liquidity constraints, we expect many more secondary transactions in 2025. These will be available to those who have a good network as primary investor, the in-house knowledge to execute these transactions, and the negotiating power to close relevant deals at significant discounts.

Last but not least, with the introduction of the European Long-Term Investment Fund (ELTIF) 2.0 regulation, private markets are now more accessible to retail clients. The so-called democratisation of private markets means more private capital is available for transformation while allowing retail clients to participate in the growth potential of this asset class. Analyst platform Scope Group predicts that ELTIF volumes will rise to between EUR 30-35 billion by the end of 2026, with at least 20 new ELTIFs on the market in the next year.² Nevertheless, investors should be aware of the characteristics and risks associated with private market investments, such as the long investment horizon. They should seek advice to make an educated decision.

Like-minded partners

Private markets investments are a key pillar in the portfolios of many institutional clients. We believe private debt and infrastructure will continue to provide attractive opportunities. Following regulatory changes, private markets are now more investable for more clients, which comes with more responsibility to enable these new cohorts of investors to make informed decisions. With more client groups, more projects that need financing, and fewer players in private markets, we expect to see many new projects and companies that need financing. By their side will be like-minded partners with proven, long-standing expertise and experience.

Exhibit 3: North America and Europe tussle for lead market

Infrastructure AUM* by region focus

Source: Preqin
*AUM figures exclude funds denominated in renminbi.
Values related to end of year. To avoid double-counting, total exclude secondaries and funds of funds.

¹ EU competitiveness: Looking ahead - European Commission, September 2024.
² A new era: overview of the ELTIF market 2023/2024, Scope Fund Analysis, published 15 May 2024