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Following consecutive years of robust returns across global equity, fixed-income, and alternative strategies, can 2025 offer a repeat performance?
Globally, positive fundamentals for growth, inflation, and interest rates, as well as the absence of significant imbalances or credit misallocation, offer favorable preconditions for positive returns across most asset classes and regions.
In particular, the re-election of President Donald Trump, accompanied by a Republican “clean sweep” that has given the party legislative majorities in the U.S. Senate and House of Representatives, should provide markets with strong support into 2025. We believe earnings-friendly tax cuts and deregulation, accompanied by supportive macroeconomic fundamentals, should set the stage for solid returns.
What does solid mean? Probably close to long-term averages in the upper-single digits, including dividends. Prevailing valuations (which are relatively high) and historically high levels of profitability (on almost every metric) suggest that the super-charged double-digit returns of the past two years are probably not in the offing.
Moreover, two caveats must be kept in mind.
First, a continuation of the extraordinary U.S. equity market returns of the past two years requires broader market participation. Narrow leadership must give way to more balanced returns. That rotation has been underway, albeit haltingly, for the past six months. Durable rotation is now required.
Second, a combination of stronger U.S. demand, courtesy of surging business investment, tax cuts, and fiscal easing, may not be accompanied by an increase in the economy’s supply side, especially if a combination of tariffs and immigration restrictions reduce foreign inputs of goods and labor supply. The support equity markets have garnered from falling inflation and falling interest rates could erode over the next 12-24 months. That is a risk factor we think investors should consider across equities and fixed income portfolio holdings.
Accordingly, a key conclusion of our outlook is the need for investors to place greater emphasis on portfolio construction. During times of soaring markets, it is easy to lose sight of the importance of proper risk management. As we transition to new sources of return and risk, investors are reminded of the importance of balance and diversification in their portfolios.
Within global equities, the United States has outperformed other major markets in recent years, led by a few megacapitalization companies in the technology sector – the so-called Magnificent Seven.1 But we believe that degree of outperformance is probably coming to an end. The top tech companies are now widely held in portfolios and do not offer compelling valuations.
Looking ahead, continued strong equity performance requires inclusion of out-of-favor stocks, sectors, and regions. That is most likely to develop within the United States, where rising after-tax corporate profits should expand performance across the market. Indeed, that is now underway.
That is less certain elsewhere, though in China the move to provide greater financial, fiscal, and monetary support to the domestic economy has rightly buoyed the Chinese equity market.
Similar catalysts are less evident in European, Japanese, or emerging equity markets. In its favor, Japan has lifted average shareholder returns in recent years via an increase in corporate profitability. But the Japanese economy remains low-growth, hampered by high levels of public indebtedness and poor demographics. Europe is also confronted with demographic challenges, as well as a war on its doorstep and the need to complete an energy transition away from unstable supplies. Europe has not demonstrated the political will to boost domestic demand via concerted fiscal or monetary stimulus, or to otherwise raise average returns on capital.
The conclusion is that growth, earnings, and valuations are likely to produce positive returns across global equity markets, with the U.S. market once again leading. Over the next year, we believe global equity market leadership will come less from mega-cap tech companies, but instead via rotation into other sectors (as noted, already underway).
Global equity investors can also tap into important themes to augment portfolio returns. Infrastructure buildouts in transportation, energy and communications remain pressing needs worldwide, and therefore offer sources of potential growth. Digital finance promises catalysts for financial disintermediation, innovation and growth. Demographic trends will continue to bolster asset gathering and asset management. And the rapid adoption of artificial intelligence (AI) creates vast opportunities across almost all industries as they integrate AI into their operations.
The outlook for global fixed-income markets is more mixed. Stronger U.S. growth and the risk of inflation reversing course and moving higher could reduce the scope of Federal Reserve (Fed) interest-rate cuts, which would be a headwind for longer duration U.S. Treasuries in 2025. Income-oriented investors may want to consider shortening durations until it becomes clearer where interest rates are headed, and despite relatively tight spread levels, increasing exposures to corporate credit, mortgage credit, and asset backed securities is appropriate.
Globally, modest growth and falling inflation will allow most other major central banks to ease further, led by the European Central Bank, the Bank of England, and the People’s Bank of China. But because European sovereign debt typically moves in tandem with U.S. Treasuries, European yield curves could steepen, and the euro may depreciate further.
That said, protectionist U.S. tariffs will probably escalate global economic tensions, which could lead to rising risk premiums. If so, global equity markets may struggle, leading to safe-haven flows that boost returns on higher quality sovereign bonds. Accordingly, risk management suggests that investors should include European longer-duration bonds as a hedge against trade-war risk. In foreign exchange markets, the U.S. dollar should continue to appreciate, as investors seek out higher returns in U.S. equities (public and private), U.S. fixed income (given higher U.S. interest rates), and via direct investment, as foreign entities localize production to avoid the risk of tariffs.
Next time: Five investment themes to guide strategy in 2025.
Stephen Dover, CFA, is Franklin Templeton’s Chief Market Strategist and Head of the Franklin Templeton Investment Institute. Originally published on the Franklin Templeton Institute website. Follow Stephen Dover on LinkedIn where he posts his thoughts and comments as well as his Global Market Perspectives newsletter.
Notes
1. The “Magnificent Seven” are Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.
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