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2025 Investment Outlook
December 19, 2024
At a glance
We begin the new year with a constructive outlook for clients, with solid underlying fundamentals for many asset classes intersecting with policy uncertainty domestically and abroad. Investors enter 2025 with two years of solid momentum for diversified portfolios, led by domestic stock returns. While we continue to focus on growth and inflation as the two principal capital market drivers, geopolitics will receive ample investor attention as 2025 begins.
In the U.S., the incoming Republican administration’s policy agendas regarding taxes, trade, regulation and immigration will be focal points. As we seek more details, our initial view is favorable for traditionally risky asset classes, although capital markets could react negatively to policies that stoke still-pesky inflation and inhibit the U.S. Federal Reserve’s (Fed’s) interest rate cutting bias. The domestic corporate profit cycle is strong, and while current earnings expectations for 2025 may prove overly optimistic, we still see domestic equities having favorable fundamentals.
From a global perspective, gauging trade relations and the state of global consumers will be key. Domestic growth impulses remain stronger than most developed countries, and emerging economies face a higher dollar and uncertain tariff outcomes. The world has witnessed political changes and challenges in major economies like Germany, France and South Korea, reminding investors that budgetary discipline matters. We start the year with a favorable view on diversified portfolios and see areas of opportunity despite stretched valuations in certain categories. We wish you and yours a happy and healthy New Year and value the opportunity to share our views.
― Eric Freedman, Chief Investment Officer, U.S. Bank
Global economy
Quick take: U.S. economic exceptionalism continues while foreign growth remains modest. Tarriff and trade policies are key to 2025 economic outcomes.
Sources: U.S. Bank Asset Management Group analysis, S&P Markit, 11/30/2023-11/30/2024.
- The U.S. economy appears likely to achieve a soft landing in 2025, aided by slowing inflation and solid domestic demand growth. Inflation rates continue to slow in 2025, nearing the Federal Reserve’s 2% target in the second half of the year. Liquidity, defined as the amount of money circulating in the economy, should improve in 2025. The Fed is likely to slow or cease the shrinkage of its bond holdings, which reduces investors’ required absorption of new bond supply. Finally, the U.S. Treasury’s cash balance remains high and could inject meaningful cash into the economy if the debt ceiling is not lifted by January 1. These factors contribute to a liquidity tailwind in early 2025 that may benefit financial asset prices. Meanwhile, questions remain around policy prioritization and magnitude as we look ahead to a majority Republican-led government in January. Tariffs and immigration are early focuses, which could lift wages and consumer prices. Deportations could tighten the labor market and higher tariffs could raise near-term costs for consumers.
- Tariffs pose some risks to slow but improving growth in developed markets, including the eurozone, the United Kingdom (U.K.) and Japan. There is a growing discrepancy between acceleration in U.S. services business activity and stagnation in the developed foreign economies. Despite these differences, economic activity should improve, especially in Japan and the U.K. The European Central Bank and Bank of England are cutting interest rates as inflation subsides and growth remains slow. Bond yields reflect expectations of multiple 2025 rate cuts in both jurisdictions. Meanwhile, Japan’s central bank is modestly increasing rates, with inflation and wage growth supplanting three decades of deflation. Japan remains a major exporter, and rising tariffs could hurt its economic rebound.
- Emerging markets remain diverse as trade policies take center stage while China struggles to rekindle consumer demand. India leads emerging market growth amid a population growth tailwind and as companies seek to diversify production away from China. In China, declines in foreign direct investment compound struggles of weak domestic demand, with the economy bogged down by excess housing and local government debt. Stable to slightly slowing growth appears to be the most likely outcome for many emerging market economies, with trade policies key swing factors. Asian technology producers such as Korea and Taiwan will be sensitive to artificial intelligence (AI) demand trends and trade challenges. Latin American economies such as Brazil and Mexico remain challenged by low energy prices and the potential for rising tariffs.
U.S. equity market
Quick take: Performance in 2024 was superb and broad-based. For 2025, we foresee a still-favorable environment driving stock prices higher but expect more muted returns relative to 2023 and 2024’s outsized gains.
*Through December 18, 2024
Sources: FactSet Research Systems, S&P Global. Reflects total returns.
- The fundamental backdrop promotes a pro-growth orientation in 2025. Waning inflation, moderating interest rates and stable earnings projections will likely support higher-trending U.S. equity prices in the new year. Our published year-end 2025 S&P 500 price target is 6,480; we will revisit our assumptions and price target near the conclusion of the fourth quarter reporting period in mid- to late-February.
- Policy decisions are likely to stoke volatility in 2025. Negotiations on the debt ceiling, tax cuts, immigration and foreign trade and keeping inflation at bay while avoiding a recession are among challenges facing President-elect Trump that could impact future equity price trends. It is unlikely that elevated price-to-earnings ratios expand meaningfully above current levels given post-election policy uncertainties.
- Consensus earnings growth projections in 2025 over 2024 seem optimistic, presenting a near-term headwind. As of December 18, analysts forecast S&P 500 earnings of approximately $240 per share for full-year 2024 and $273 in 2025, according to Bloomberg, FactSet and S&P Cap IQ, reflecting respective 9.0% and 13.5% year-over-year growth. Company guidance following fourth quarter earnings reports, beginning in mid-January, should improve earnings visibility for 2025. We anticipate companies will temper forward guidance given uncertainty around policy outcomes.
- Opportunities exist in all market environments; we favor balanced exposure to technology-oriented growth sectors, income-oriented alternatives and smaller companies. The world is experiencing a rate of change that has never been faster, and speed, scale and efficiencies do not occur without technology. This presents favorable conditions for AI-related buildout beneficiaries. Similarly, defensive/income-oriented sectors such as Real Estate, Utilities, Consumer Staples, Industrials and select Healthcare companies should continue to respond favorably to the Fed’s less-restrictive policy stance as lower Treasury yields reduce the competition from bonds for dividend-paying securities. Smaller companies are more sensitive to financing costs and stand to benefit the most from lower realized and anticipated policy rates in the U.S. and elsewhere.
International equity markets
Quick take: Accommodative monetary policies, stable but modest economic growth and strong shareholder distributions offset subdued earnings growth expectations informing our constructive foreign equity outlook. Improving economic forecasts and reasonably inexpensive valuations should benefit emerging market equities, although tariff and trade risks remain.
- European central banks continue to provide monetary policy stimulus to reignite corporate profit growth. Reduced borrowing costs should support increased credit demand and reaccelerate economic activity as inflation eases, driving a corporate profit upgrade cycle. While investors await improving fundamentals, we see benefit from an approximate 3% dividend yield plus 1.5% share buyback yield. Strong shareholder distributions paired with cheaper valuations bolster the defensive characteristics of developed foreign stocks, which complement the more growth-reliant characteristics of domestic stocks.
- Global equity performance, fundamentals and valuations diverged in 2024, but investor sentiment toward foreign developed equities appears overly pessimistic. Lower earnings growth in 2024 and lower expected earnings growth in 2025 explain the difference versus superb U.S. stock market returns. Elevated interest rates, stagnant economic growth and Europe’s proximity to an escalating Russia/Ukraine conflict continue to weigh on consumer sentiment. However, low foreign market valuation relative to historical averages presents an opportunity for prices to revalue higher if central bank accommodation and decelerating wage inflation boost 2025 earnings growth expectations or if investor sentiment turns less bearish.
- Emerging market equity valuations appear inexpensive when considering the region’s growth orientation and improving economic prospects. Improving investor sentiment hinges on positive 2025 outcomes for emerging markets’ growth drivers, such as India’s continued economic development and rising middle class and Taiwan’s key role in the global technology and AI supply chains, while Korea’s political uncertainty could impair the region’s near-term growth potential. Perhaps most importantly, China’s progress in shoring up property markets, stimulating domestic demand and addressing the decline in foreign direct investment will likely dictate the degree to which investors unlock emerging market price appreciation opportunities.
- Emerging markets represent a diverse and often disparate mix of investment considerations. India has been a powerful growth engine, yet lofty valuations raise the bar for continued share price appreciation. China temporarily boosted share prices via fiscal stimulus but has experienced deteriorating fundamentals that suppress valuations while potentially subject to elevated tariffs when incoming President-elect Trump takes office. Meanwhile, Vietnam has benefited from U.S. and European importers seeking to diversify supply chain dependencies out of China.
Bond markets
Quick take: Bond yields suggest strong income opportunities in fixed income for 2025, albeit with potentially limited price appreciation. Modest supplemental exposures to riskier high yield bonds and unique bond types such as structured credit, non-agency mortgages and reinsurance can further improve return potential in fixed income portfolios.
*Municipal bond yields are tax adjusted with the highest federal tax bracket of 37% plus the 3.8% Affordable Care Act income tax.
Sources: Bloomberg, January 2, 2004-November 26, 2024. Yields are based on Bloomberg Aggregate Bond Index, Bloomberg High Yield Corporate Bond Index, Bloomberg Municipal Bond Index, Bloomberg High Yield Municipal Bond Index. See index definitions in the disclosure section.
- The increase in Treasury yields in the fourth quarter to incorporate more conservative Fed interest rate cut expectations improves the balance of risks for bonds. Bond yields suggest investors expect just one to two more 0.25% rate cuts in 2025, which would reduce the funds rate to around 4.00%. High-quality bonds can contribute important diversification benefits while generating stable income as the Fed patiently eases policy settings.
- Government spending is projected to remain elevated, but the supply versus demand backdrop for Treasuries may improve somewhat in 2025. We expect the Fed to moderate or conclude its ongoing effort to shrink its bond holdings in 2025, which should offset a portion of new supply. While fiscal concerns remain problematic over the long run and can dent investor sentiment, we believe yields adequately compensate for this risk for the time being.
- Solid issuer fundamentals back income opportunities in corporate and municipal bonds. High current valuations limit opportunities for corporate bond prices to richen further relative to Treasuries, but absolute yields, particularly for lower-rated bonds, remain compelling. Corporate bond yields generally range from 4.8% to 7.2% depending on credit rating, while highly taxed individuals can achieve tax-equivalent yields of 5.0% on investment-grade bonds to 9.0% on high yield municipal bonds.
- Spreading allocations across various bond types helps limit the impact of price swings of any individual bond category while still delivering meaningful income over time. Investors can achieve yields in the 6% to 8% range on mortgage bonds not backed by the government (non-agency mortgages). Most home-owners remain in solid financial condition from a stable labor market and having locked in low mortgage rates, providing solid fundamental support for non-agency mortgages. Insurance-linked securities (reinsurance) generate more than 10% annual income right now to compensate for the risk of natural catastrophes triggering insurance claims and the resulting payouts. In addition to the meaningful return potential, reinsurance, which is sensitive to weather events, provides added portfolio diversification versus traditional assets that are more sensitive to economic cycles.
Real assets
Quick take: Real assets present opportunities to aid portfolio returns in 2025. Solid income distributions and steady economic growth trends provide a positive baseline outlook for real assets with the added benefit that real assets can help protect against risk of a resurgence in inflation.
- Sound fundamentals support reasonable income returns for real estate investment trusts (REITs). Broad REIT exposures include properties that generate on average 6% net operating income yield, historically a normal reading that suggests prices are reasonable compared to fundamentals. Categories like industrial properties continue to exhibit fundamental tailwinds, with strong demand supporting low vacancies and solid rent growth.
- Office properties represent a small proportion of broader REIT exposures. While office vacancies are high, publicly traded REIT prices holding office real estate have already reset lower. Investor optimism should improve as additional private market transactions provide appraisal comparisons. Further, publicly traded office REITs comprise less than 4% of broader REIT indices, mitigating the impact to many investors of additional headwinds in this asset class.
- Rising Treasury yields became increasingly competitive with real estate income in the fourth quarter, but property income grew at a healthy pace. Public REIT dividend yields are near their long-run average, implying income opportunities are reasonable. However, valuations are slightly expensive when comparing REIT income opportunities versus Treasury yields. Looking forward, solid income growth supports somewhat elevated valuations, and higher interest rates already reflect resilient economic growth. These factors mitigate a degree of repricing risk for REITs and create incremental return potential if interest rates fall.
- Real assets are an important component of diversified portfolios that can help protect against inflation. Publicly traded real estate offers the benefit of income growing alongside real economic growth and inflation. Economists’ forecasts for around 2% real growth plus 2%-3% inflation in 2025 establish a healthy economic backdrop that should support real assets. Further, any hint of a resurgence in inflation could benefit sentiment toward real assets as investors look for return sources that adjust higher with inflation over time, such rental income from public real estate.
Alternative investments
Quick take: Hedge fund managers found ample trading opportunities within rapidly changing macroeconomic conditions in 2024, and tactical managers who stay nimble and can trade quickly remain well suited for the current environment.
- Hedge fund managers quickly increased their risk appetite in the final two months of 2024. Cautious positioning going into the U.S. election allowed for a starting point from which to tactically shift portfolios to a net long position (total securities invested long less securities sold short) and pursue high conviction opportunities.
- Overall, hedge fund performance in 2024 trailed the strong returns generated by U.S. equity markets. Equity market neutral, a strategy buying long select securities while selling short others to isolate security selection and hedge overall market risk, returned 8% through December 18 and was one of the best-performing strategies this year. Fixed income managers pursuing arbitrage opportunities (similar assets trading at dissimilar prices) produced returns comparable to broad bond market performance. Meanwhile, multi-strategy funds delivered the most consistent and positive performance, but returns among these managers varied widely.
- In response to economic uncertainty, geopolitical unrest and potentially contested elections, investors seeking risk mitigation strategies helped drive hedge fund capital to record highs this year. Hedge fund assets grew from a combination of performance and new investor inflows. Biotechnology and financial services stocks may now be attractive areas for hedge funds focused on sector dislocations. Event-driven strategies are also gaining renewed interest from investors anticipating an increase in corporate merger and acquisition activity. Finally, we are also watching the increase in hedge fund strategies launched to investors as semi-liquid mutual fund products.
Private markets
Quick take: Private market investments stand to benefit from more balanced conditions after a bumpy ride following the COVID pandemic. Stubborn inflation and high Fed interest rates delayed merger and acquisition (M&A) deal activity for a second consecutive year in 2024, an unusual occurrence even when compared to the global financial crisis of 2007-2008, when activity reverted within a year.
Sources: U.S. Bank Asset Management Group research, Coatue, June 2024. Includes U.S. listed and SEC registered IPOs exceeding $30 million, along with 34 special purpose acquisition companies in 2020 and 19 in 2021.
- Conditions are favorable for greater deal activity in 2025. Lower borrowing costs benefit private equity, and benefits will continue to accrue as the Fed cuts rates further, provided inflation trends lower. Meanwhile, economic growth, supported by resilient consumer activity, boosts confidence for corporate and private equity buyers. Corporate M&A activity already increased by 15% in 2024’s third quarter compared to last year, and private equity should follow suit.
- Policy shifts by the incoming Trump administration may provide a mixed picture. Deregulation would be positive while a reversal in net immigration and tariffs on imports create potential headwinds. Under the new administration, regulators could take a less stringent stance toward M&A, unlocking deals that were previously likely to be blocked or scrutinized. As deal activity picks up, we believe returns on private equity should catch up to public equity returns, and investors can expect more distribution of capital from fund managers.
- Attractive opportunities exist in 2025 informed by our thesis-driven research, including sports and media-related ecosystems. Growth in online media and merchandizing related to intellectual property presents opportunities that can benefit investors. Commercial real estate debt is attractive, with banks and insurance companies pulling back due to dislocation in this portion of the real estate market. Capital investment in traditional oil and natural gas is at historical lows, presenting an opportunity for investors. Finally, we see opportunities in the marriage of electrons and atoms in the application of AI. Advancements create opportunities in AI’s physical world applications, including cars, biotech, industrial automation and at home.
This commentary was prepared December 2024 and represents the opinion of U.S. Bank. The views are subject to change at any time based on market or other conditions and are not intended to be a forecast of future events or guarantee of future results and are not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable but is not guaranteed as to accuracy or completeness. Any organizations mentioned in this commentary are not affiliated or associated with U.S. Bank in any way.
U.S. Bank and its representatives do not provide tax or legal advice. Your tax and financial situation is unique. You should consult your tax and/or legal advisor for advice and information concerning your particular situation.
Diversification and asset allocation do not guarantee returns or protect against losses. Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio.
Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for investment. The S&P 500 Index is an unmanaged, capitalization-weighted index of 500 widely traded stocks that are considered to represent the performance of the stock market in general.
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible difference in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities is subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investments in debt securities typically decrease in value when interest rates rise. The risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Investments in high yield bonds offer the potential for high current income and attractive total return but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer’s ability to make principal and interest payments. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes but may be subject to the federal alternative minimum tax (AMT), state and local taxes. There are special risks associated with investments in real assets such as commodities and real estate securities. For commodities, risks may include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults). Hedge funds are speculative and involve a high degree of risk. An investment in a hedge fund involves a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage and short sales, which can magnify potential losses or gains. Restrictions exist on the ability to redeem or transfer interests in a fund. Private capital investment funds are speculative and involve a higher degree of risk. These investments usually involve a substantially more complicated set of investment strategies than traditional investments in stocks or bonds, including the risks of using derivatives, leverage, and short sales, which can magnify potential losses or gains. Always refer to a Fund’s most current offering documents for a more thorough discussion of risks and other specific characteristics associated with investing in private capital and impact investment funds. Reinsurance allocations made to insurance-linked securities (ILS) are financial instruments whose performance is determined by insurance loss events primarily driven by weather-related and other natural catastrophes (such as hurricanes and earthquakes). These events are typically low-frequency but high-severity occurrences. Private equity investments provide investors and funds the potential to invest directly into private companies or participate in buyouts of public companies that result in a delisting of the public equity. Investors considering an investment in private equity must be fully aware that these investments are illiquid by nature, typically represent a long-term binding commitment and are not readily marketable. The valuation procedures for these holdings are often subjective in nature. Private debt investments may be either direct or indirect and are subject to significant risks, including the possibility of default, limited liquidity and the infrequent availability of independent credit ratings for private companies.
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