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This year has reinforced that we are not in a typical business cycle. Instead, mega forces – big structural shifts like the rise of artificial intelligence (AI) – are transforming economies and altering their long-term trajectories. That calls for a new way of investing: being more dynamic and putting more focus on themes and less on broad asset classes. We stay risk-on in our 2025 Outlook and up our U.S. equity overweight as the AI theme broadens out – but stand ready to dial down risk.
We think investors should no longer think in terms of business cycles, with short-term fluctuations in activity leading to expansion or recession. Instead, mega forces are driving an economic transformation that could keep shifting the long-term trend, making a wide range of very different outcomes possible – on the upside and downside.
Building the transformation – such as with AI data centers – requires a major infrastructure buildout. Financing the transformation given constrained public finances means that capital markets, including private markets, will be key.
Markets are starting to reflect these shifts: The “Magnificent 7” of mostly mega-cap tech shares now make up almost a third of the S&P 500’s market capitalization. See the chart below. We think this calls for rethinking investing, and challenges investment strategies based on valuations converging back to historical trends.
We follow that playbook as we stay pro-risk headed into 2025. We increase our overweight to U.S. stocks as we expect AI beneficiaries to broaden out beyond tech. We’re also confident U.S. equities can keep outpacing global peers given the ability to better capitalize on mega forces, a favorable growth outlook, potential tax cuts, and regulatory easing.
Signposts for changing our view include any surge in long-term bond yields or an escalation in trade protectionism. Pricey U.S. equity valuations, based on price-to-earnings ratios and equity risk premiums, don’t yet change our view. Why? We find valuations affect near-term returns less than long-term returns. The equity risk premium – a common valuation gauge – for the equal-weighted S&P 500 is near its long-term average, according to LSEG data, and thus looks less affected by the transformation.
U.S. outperformance is unlikely to extend to government bonds. We go tactically underweight long-term Treasuries as we expect investors to demand more compensation for the risk of holding them given persistent budget deficits, sticky inflation, and greater bond market volatility. We favor government bonds in other developed markets. Globally, Japanese equities stand out due to corporate reforms and the return of mild inflation that are driving corporate pricing power and earnings growth.
More broadly, we think investors can find opportunities by tapping into the transformation we expect in the real economy. AI and the low-carbon transition require investment potentially on par with the Industrial Revolution. Major tech companies are starting to rival the U.S. government on research and development spending. Plus, meeting growing energy demand will generate US$3.5 trillion of investment per year this decade, according to the BlackRock Investment Institute Transition Scenario.
We see private markets playing a vital role in financing the future. Big spending on AI and the low-carbon transition plus rising geopolitical fragmentation is likely to cause persistent U.S. inflation pressures. And an aging workforce could start to bite as immigration slows, likely keeping wage growth too high for inflation to return to the Fed’s 2% target. We think that means the Fed will keep rates well above pre-pandemic levels even after cutting some in 2025.
Bottom line: Mega forces are reshaping economies and markets. That requires a new playbook challenging old investment rules. We stay pro-risk to kick off 2025 but stand ready to dial down risk as catalysts emerge. Read our 2025 Global Outlook.
Jean Boivin is Managing Director, Head of the BlackRock Investment Institute at BlackRock Inc.
Wei Li is Global Chief Investment Strategist, Blackrock Investment Institute at BlackRock Inc.
Vivek Paul, Global Head of Portfolio Research – BlackRock Investment Institute, and Ben Powell, Chief Investment Strategist for the Middle East and APAC — BlackRock Investment Institute, contributed to this article.
Disclaimer
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.
© 2024 BlackRock Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. This article first appeared Dec. 9, 2024, on the BlackRock website. Used with permission.
Image: iStock.com/Popartic
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