Well, wasn’t that quite the year? In 2024 the S&P 500 added USD 11.4 trillion in market capitalization, the equivalent of the entire market cap of the eurozone, Switzerland and Australia combined. While valuation expansion explains half of this year’s gains, the other half was driven by strong earnings growth – a trend we expect to continue, and to broaden out across the economy in 2025.
Our optimistic take on the economy and markets – building upon two back-to-back years of solid growth, falling inflation, and rising equity markets – is supported by four key factors: a series of pro-growth policies extending the business cycle and U.S. economic exceptionalism; manageable impact from tariffs that doesn’t deter the Fed from further rate cuts; broadening out of earnings growth from big tech to mid- and small-cap firms; and resilient private sector balances sheets mitigating risks.
We see strong U.S. growth in 2025 with GDP moderating to trend of 2.0% only by the fourth quarter. Even allowing for tariff and deficit fears, lower rents and energy prices suggest that inflation is set to cool to around 2.8% in CPI terms (2.5% in PCE terms) by year end. Moderating inflation can in turn allow the fed funds rate to fall to around 4% by mid-year. This positive backdrop calls for a risk-on tilt. But buckle up – the ride may still be a little bumpy.
We expect President-elect Trump’s economic policies to be broadly positive for the U.S. economy. But the order in which specific polices are implemented will determine the trajectory of growth over the next two years. Greater emphasis on deregulation and fiscal boost from extending tax cuts could improve corporate confidence, open up capital markets, and accelerate growth and asset returns. But if the emphasis is on immigration and tariff policies, disruption to labor supply or trade could have negative consequences, potentially dampening growth and leading to volatility in asset markets.
Despite this uncertainty, the U.S. economic exceptionalism of the last few years looks set to continue. While a strong U.S. economy provides a global growth tailwind, the threat of tariffs is an acute issue for China. In addition, Europe faces political turmoil in its biggest two economies and a tangled web of regulation stifling corporate dynamism across the bloc.
Nevertheless, issues facing economies outside the U.S. are already well discounted in asset markets. Should tariff threats strengthen China’s policy response, or corporate pressure ease European regulation (even at the margin), then these unloved assets could rebound swiftly.
Our portfolios reflect a pro-growth outlook and a strong preference for U.S. assets, but we continue to seek opportunities to diversify both within the U.S. market and globally. We remain overweight (OW) equities and credit, we are broadly neutral on global duration, we see increasing opportunities in real estate, and we are underweight (UW) the euro.
Within equities we expect U.S. leadership to persist and fears over concentration risks may be overdone. In 2025, we think the share of earnings growth coming from the biggest six names vs. the other 494 stocks in the S&P 500 will even out: big-6 earnings growth likely moderates from 40% in 2024 to a still-punchy 22% in 2025, while earnings growth for the remaining 494 stocks jumps from 3% to 13%. Valuations may appear demanding, but as profit growth extends across the index, we see a strong case for remaining OW U.S. equities and extending exposure to include mid- and small-caps.
Internationally, we are OW Japanese equities as our quant models pick up on their attractive earnings yield and bottom-up profitability. Hong Kong equities also screen favorably despite China tariff fears. Our preferred UW is European equities given ongoing political instability and weak economic growth. But the German election in February may clear the way for fiscal and regulatory easing – and a better backdrop for euro area stocks – in the second quarter.
High yield (HY) credit spreads have narrowed by over 50 basis points (bps) since September, but with all-in yields at around 7% credit looks attractive. There may be limited scope for further spread tightening, but given the resilience of corporate balance sheets, low distress ratios, and persistent strong demand for new issues we are comfortable holding credit. For those seeking diversification away from credit after the strong rally in spreads, real estate appears increasingly attractive.
We are neutral duration overall but with a preference for European government bonds over the U.S. and Japan. The growth differential between the U.S. and Europe looks set to widen and European rates will likely fall further than those in the U.S. in 2025 – simultaneously supporting European duration and weighing on the euro. But since Europe has a growth problem, not a balance sheet problem, we also see Italian government bonds (BTPs) as offering attractive carry.
Broadly, our portfolio is designed for an extension of the business cycle and a continuation of U.S. economic exceptionalism. As the policy priorities of the new administration become clearer over the first quarter, asset markets may be tested at times, but we expect any dips to be enthusiastically bought. After two years of above-trend U.S. growth and a 60% two-year rally in the S&P 500, some may be tempted to cash in their chips. But we believe that the rally has further to go and that 2025 will see growth and returns broaden out meaningfully.
