Shaken, Not Stirred

In the latest faceoff between fear and fundamentals, the health and resilience of the global economy seems to be prevailing for now.

Fear—which ripped through markets in April after widespread tariffs and policy changes were announced—has largely been sidelined as signs of economic health continue to emerge. This is not unusual. Behavioral finance studies indicate long-term investors tend to let emotions cloud their judgment when volatility spikes before returning to a focus on fundamentals. This typical progression suggests our outlook for 2025 has been shaken, not stirred.

While policy uncertainty and geopolitical risks could result in more volatility this year, global stocks are benefiting from this more sanguine view and have roared back to all-time highs as of mid-June. Meanwhile, we spy risks of more lasting change in currency markets—the U.S. dollar for one—with important implications for portfolio strategy over the medium-term.  

Coming into 2025, our outlook highlighted the fragile balance between healthy underlying U.S. growth and uncertainty from how the new administration would prioritize the four pillars of its economic agenda—tariffs, immigration, taxes and deregulation. With rich stock valuations and heightened policy risk, our portfolios entered the year defensively positioned, albeit moderately, with an emphasis on diversification across asset classes and global regions. 

Looking into 2025, we anticipate a soft landing for the U.S. economy. Our assumption is that the new administration will ease its more aggressive stances on tariffs and immigration. With these dynamics in mind, here are our key economic views for 2025:

1. U.S. Growth and Policy Trade-offs

   The U.S. economy is expected to grow at a trend-like pace of 2.0% in 2025 in response to the lagged impact of tight Fed monetary policy. Core personal consumption expenditures (PCE) inflation is projected to move closer to the Fed’s 2% target, while the central bank eases rates gradually, with the fed funds rate likely to reach 3.25% by year-end—aligning with its neutral level.

   The Trump administration’s policies present a delicate balancing act. Tax reforms and deregulation are likely to stimulate growth, particularly in domestic and cyclical sectors. Tariffs and immigration restrictions, however, could trigger a stagflationary shock that might have the Fed contemplating a rate hike as the economy weakens.

   Our working assumption is that the new administration will not aggressively pursue policies that create inflation risk. One clear message from the election is that U.S. voters were unhappy with the inflation of the Biden years. Tariffs and immigration controls are likely to be implemented, but their extent will be constrained by the inflation outlook. On balance, we see the policy mix as supportive for business confidence, which is likely to drive a resurgence in capital markets and provide positive tailwinds for private assets.

    

2. Global Headwinds and Policy Divergences

   Outside the U.S., growth will likely remain under pressure. Trade policy uncertainty and tariffs will weigh heavily on Europe. The European Central Bank (ECB) is likely to cut its deposit rate to 1.5% by year-end to offset the tariff impact and the continued stagnation of the German economy.

   The UK faces sluggish productivity growth, labour constraints, and inflationary impacts from higher taxes under the new Labour government. The Bank of England’s (BoE) capacity to ease is constrained, with the base rate likely to decline only modestly to 3.75%–4.0%.

   Japan remains an outlier, supported by a virtuous wage-price spiral that will anchor inflation expectations near 2%, allowing the Bank of Japan (BoJ) to further normalisze policy. Rates could rise to a 30-year high of 0.75% by year-end.

   China faces headwinds from the property market collapse, deflation pressures, and U.S. tariffs. The policy response continues to be reactionary, rather than one where proactive steps are taken to solve structural problems such as high savings and low household consumption. There are downside risks to consensus expectations for 4.5% GDP (gross domestic product) growth in 2025.

    

3. Market Sentiment and Valuations

   Three defining features of the market outlook for 2025 are the elevated level of the S&P 500 forward P/E (price-to-earnings) ratio at 22x, the potential for further U.S. dollar strength, and the direction of the U.S. 10-year Treasury yield.

   Elevated equity valuations make the U.S. market vulnerable to negative surprises, and further dollar strength will challenge emerging markets. Sustained U.S. Treasury yields above 4.5% could challenge equities, diminishing the earnings yield advantage stocks have enjoyed over bonds since 2002.

The U.S. administration hit the pause button on tariffs shortly thereafter, taking off all the reciprocal measures from Liberation Day. The pause proved decisive for markets, neutralizing the most extreme downside scenarios for the economy and revitalizing investor sentiment. While equity and credit markets have recovered as we approach the midpoint of 2025, volatility in policymaking and geopolitics is still reverberating across the economic landscape and asset prices.

Asset Class Implications:

• Equity: We are focused on U.S. small caps, where post-election dynamics, improving earnings, and attractive valuations may create compelling opportunities. We also see growth managers targeting high-growth cyclicals like software, while value managers identify M&A (mergers and acquisitions) potential in financials and healthcare. Core managers are balancing cyclical exposure and managing risks in rate-sensitive sectors.

  In addition, we expect increased market volatility from U.S. foreign policy actions to create opportunities for active managers to find quality companies temporarily impacted by headline risks.

• Fixed Income: We see a steepening yield curve offering opportunities in short-term bonds, as short-term rates are expected to decline faster than long-term yields. Credit markets may have limited upside due to tight spreads, particularly in U.S. high-yield and investment-grade bonds. This creates an opportunity to expand fixed income exposure into areas with more attractive risk/return trade-offs, such as emerging-market U.S. dollar bonds and private credit.

• Currencies: The U.S. dollar is expected to face upward pressure from tariffs, the strength of the U.S. economy, and a less dovish Fed compared to other central banks. However, its valuation remains high, and emerging market currencies have already been under pressure. Given this, we are keeping currency bets in portfolios limited for 2025, while staying alert to any opportunities and risks that may arise throughout the year.

2. Private Markets: The New Growth Engine

Private markets continue to play an increasingly vital role in the evolving landscape of capital flows, as the shift away from public markets accelerates with fewer IPOs (initial public offerings) and later-stage listings. This transformation is particularly evident in AI opportunities, where venture capital investments now make up 27% of deals and 41% of capital raised.¹ In our view investors can benefit from broadening portfolios into private markets. The upcoming policy environment may also be more favorable for private markets, with stabilizing interest rates, easing regulations, and rising M&A activity. However, the influx of capital into U.S. private markets has led to sourcing challenges, which makes international opportunities more attractive. In particular, Europe offers compelling middle-market consolidation opportunities in fragmented industries, Japan benefits from ongoing corporate reforms and asset divestitures, and the Persian Gulf states are emerging as dynamic investment hubs thanks to progressive regulations and large-scale development initiatives. Infrastructure also presents a key opportunity, as hybrid investment models that incorporate both private and public markets unlock substantial growth potential.

We believe a multi-manager approach is crucial in this landscape. By diversifying across specialized managers, particularly in real assets, investors can access a broader range of opportunities that blend public and private market investments. This strategy creates more resilient portfolios and allows investments in sectors such as data centers and warehousing, where combining private and public market exposures is especially productive for a total portfolio.

Our global economic outlook is glass-half-full. Tariffs and trade policy uncertainty have driven a rift in the macro picture. The soft data—including surveys and measures of consumer and business confidence—are at levels normally indicative of a downturn. Meanwhile, the hard data—measures of actual consumer and business spending—shows resilience into early June. This tension leaves uncertainty but our more optimistic read reflects:

• Strong Balance Sheets
  The ability of the U.S. economy to power through a similar divide between pessimistic vibes and resilient fundamentals occurred as recently as 2022. We view this resilience as being supported by generally healthy household and corporate balance sheets.
• Softer Trade Policy
  In early April, tariffs looked large enough to push the economy close to stall speed, with risks amplified by extreme uncertainty and the sharp decline in financial markets. After the tariff pauses in April and May, those headwinds are receding. While there is still a risk for more changes in tariff policies to come, the pauses are still an important signal that there might be room for negotiation. 

Market Implications:

• Private Equity: We are focused on private equity opportunities in European middle-market consolidation, along with continued growth in Japan and the Persian Gulf states. Managers with sector-specific expertise are outperforming generalists, and we believe that portfolios can benefit from this trend.
• AI and Tech: We believe private market ventures in AI, particularly those focused on scaling innovative technologies across industries, will continue to be key drivers of long-term growth. We are actively looking for investments in AI-driven companies that are poised to enhance productivity and reshape industries.
• Private Credit: We see private credit as a resilient asset class, particularly in the current higher-rate environment. With asset-based lending and European direct lending providing attractive relative value, we are broadening our fixed income exposures into these areas to capture higher yields and better diversification.
• Infrastructure: We are favourable to infrastructure as a long-term growth anchor and a hedge against inflation. The asset class has proven resilient during recent market volatility and benefits from long-term trends such as the energy transition, renewable energy, and digitalization. Increasing demand for sustainable and digital infrastructure continues to drive significant capital inflows. Additionally, hybrid models combining private and public market exposure are unlocking new growth potential.
• Venture Capital: We see significant opportunities in AI-driven venture capital, particularly in early-stage companies with the potential to reshape industries. As the VC market stabilizes, we are concentrating on firms with strong fundamentals, a track record of innovation, and a capacity to scale effectively.

3. The Broadening out of Market Leadership

While mega-cap AI stocks have driven market returns in recent years, leadership is shifting to companies using AI to create real-world efficiencies. The new U.S. administration’s focus on deregulation and tariff-based policies may provide an added boost to smaller, domestically oriented companies, which are less exposed to international trade disruptions than mega caps with significant foreign revenue, such as Apple.

We see this shift reducing market concentration and opening the door for alpha opportunities. Active managers will likely play a critical role in identifying under-covered firms that are adopting AI to drive productivity and gain competitive advantages. As AI adoption accelerates, driven by falling costs, we expect companies leveraging these innovations to benefit from enhanced productivity and improved competitiveness. Additionally, with interest rates stabilising and valuations improving, real assets such as real estate and infrastructure are becoming increasingly attractive, offering growth, income stability, and inflation protection amid policy uncertainties.

Market Implications:

• Equity: Active equity managers have been challenged by the recent severe market concentration. Our research indicates that even a flattening out of these trends—which could be driven by policy shifts, or changing sentiment around earnings growth and valuations for mega caps—can be quite supportive for active manager outperformance. We and our active managers are focused on sectors where AI adoption is accelerating, such as industrials, healthcare, and consumer goods. We believe companies leveraging AI for productivity improvements are well-positioned to gain a lasting competitive edge and generate strong returns. Skilled active managers can seek out these companies, especially those in less-covered segments of the market.
• Real Assets: We see attractive investment opportunities in real estate and infrastructure, particularly in areas benefiting from stabilising long-term interest rates and favourable relative valuations compared to other growth assets. AI applications in real estate, such as data centres and healthcare facilities, are emerging as key growth areas. Additionally, infrastructure investments are gaining momentum from energy utilities and pipeline exposures, especially with the U.S. administration's focus on expanding LNG (liquified natural gas) production.

We often get asked if U.S. exceptionalism is over. We see the potential for a pause in the outperformance of U.S. markets. But we believe the United States is likely to retain much of its strategic fundamental edge. America’s advantages include a stronger demographic profile than Western Europe, leading technology firms that remain at the cutting edge of AI and robust new business formation which is likely to support the country’s ongoing productivity margin.

Still, we see the balance of risks as being skewed toward U.S. dollar weakness over the medium-term. The greenback looks historically expensive, and its return patterns appear to be shifting with signs that global investors are hedging their exposure to dollar-denominated assets.

Our asset class preferences are measured with the extreme market volatility from early April having abated. But we think the outlook for a weaker dollar amplifies the strategic case for running globally diversified portfolios. In fact, our managers are finding attractive opportunities in non-U.S. investments across both the public and private markets.