Market
Outlook
Market
Outlook
THE MECHAZILLA MOMENT
Successfully navigating markets in 2025 will demand more than relying on conventional wisdom about U.S. outperformance and global headwinds.
Andrew Pease
Chief Investment Strategist
“On balance, we see the policy mix of the new U.S. administration as supportive for business confidence, which is likely to drive a resurgence in capital markets and provide positive tailwinds for private assets.”
- Andrew Pease, Chief Investment Strategist
2025 Global Market Outlook:
The Mechazilla Moment
An enduring image from 2024 will be the capture of the SpaceX booster rocket by the Mechazilla robot arms on its return to Earth. This achievement served as a powerful metaphor for the year: the improbable not only became possible but redefined expectations.
Despite the tightest U.S. Federal Reserve (Fed) policy since the early 2000s and a deeply inverted Treasury yield curve, the U.S. economy defied expectations with above-trend GDP growth, robust job creation, a 25% surge in the S&P 500 Index, and double-digit earnings growth.
2025 will be another year of overcoming challenges and redefining limits against a backdrop of high U.S. equity market valuations, mega-cap dominance, and the uncertainty surrounding the policy agenda of U.S. President-elect Donald Trump.Key Economic Views
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:
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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.
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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.
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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.
Key Portfolio Themes
Portfolio Considerations for 2025
As we navigate 2025, the interplay between the shifting policy landscapes and evolving market conditions calls for thoughtful portfolio construction. Building on the macroeconomic backdrop—defined by resilience in U.S. growth, potential disruptions from trade and immigration policies, emerging opportunities in AI (artificial intelligence)-driven productivity and growth in private markets—three strategic themes guide our approach:
Balancing U.S. Growth Amid Policy Shifts
The U.S. economy is resilient as it enters 2025, but the road ahead will be shaped by shifting policy dynamics. On the positive side, tax cuts and deregulation could provide a meaningful growth boost, particularly to domestic and cyclical sectors. Given lower valuations and improving sentiment, we are more positive on U.S. small cap equity than we have been in prior years. Large cap dominance in both earnings and price appreciation will require a catalyst to shift returns in the small cap direction. Potential deregulation and lower interest rates could be such a catalyst. We believe companies leveraging AI technologies to enhance productivity—especially in industrials and healthcare—could see material improvements to operating fundamentals.
On the flip side, rising trade tensions and potential restrictions on immigration could disrupt labor markets and supply chains, creating risks to growth. This balancing act introduces greater volatility across markets, providing more opportunities for our active managers.
We also expect more opportunities in the next 12 months to tactically calibrate total portfolio risks around a robust strategic asset allocation. For example, in July 2024, we reduced equity risk as our analysis indicated that markets were stretched, and investor sentiment was overly optimistic. When markets corrected in early August amid concerns about slowing U.S. growth, sentiment shifted, creating an opportunity to add risk back into portfolios. This disciplined approach serves as a model for navigating the dynamic market environment we anticipate in 2025.
What could potential U.S. policy changes mean for your portfolio?
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.
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 favourable for private markets, with stabilising 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.
“The convergence of public and private markets is set to define opportunities, particularly in sectors like real assets, where integrating exposures can create diversified, resilient portfolios.”
– Kate El-Hillow, President and Chief Investment Officer
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 stabilises, we are concentrating on firms with strong fundamentals, a track record of innovation, and a capacity to scale effectively.
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.
Regional snapshots
Eurozone
The outlook for the eurozone economies continues to brighten as industrial activity picks up, bank lending growth improves, and inflation tracks toward the European Central Bank’s (ECB) comfort zone. The ECB delivered its first 25-basis-point (bps) rate cut in early June and the market anticipates a further 100 bps of easing over the next 12 months.
The recent European parliamentary elections have generated some political turmoil due to the success of right-wing populist parties. The decision by France’s President Emmanuel Macron to call an election in the national assembly (where the government is formed) has created fears that one of Europe’s largest economies could soon be governed by the far right. This has helped trigger a near 4.5% sell-off in eurozone equities as investors worry about the prospect of unfunded tax cuts against the backdrop of high government debt levels. These fears seem overdone, however. France’s two-stage electoral process means a far-right win is not assured. Furthermore, the example of Italian Prime Minister Giorgia Meloni shows that European populist parties can behave responsibly once in power.
We believe European stocks are attractively valued relative to U.S. stocks and can rebound once the political drama subsides and as earnings expectations are upgraded in line with improving economic conditions.
United Kingdom
The UK outlook is beginning to improve, albeit from a low base. Consumer and business confidence are rebounding and there are signs that house prices are beginning to recover. Core inflation, however, is proving sticky, and at 3.9% is preventing the Bank of England from signalling near-term rate cuts. Interest rate markets have priced 100 basis points of Bank of England (BoE) easing over the next 12 months, which seems realistic given inflation should get closer to the BOE’s 2% target over the next year.
Prime Minister Rishi Sunak has called an election for July 4, which current public opinion polls indicate is set to be resoundingly won by the Labour Party led by Keir Starmer. The Labour Party is running a cautious campaign, promising that there will not be substantial changes to taxation and government spending.
The FTSE 100 Index is relatively attractive with a 12-month-ahead price-to-earnings ratio of 11.4 times and a 3.5% dividend yield. UK gilts are attractively valued with a 10-year yield at 4.1%.
United States
The U.S. economy at mid-year 2024 is on firmer footing. The labour market has painlessly rebalanced back to 2019 levels–strong but no longer overheated enough to generate significant inflation. Core personal consumption expenditures (PCE) inflation has moderated to 2.6% from a cycle-high of 5.6% and appears on track to drop toward the Federal Reserve’s goal next year. On the back of this progress, we expect the Fed to start carefully cutting rates later this year, with September the likeliest timing for the first move. Corporate earnings were robust in Q1 with growth led by the Magnificent Seven. Importantly, we also saw profits stabilise for the broader large-cap S&P 500 and small-cap Russell 2000 indices in the period.
We think it is more likely than not that the U.S. economy can avoid a recession in the year ahead, but macro uncertainty is high. The Fed has exhibited reversion aversion, demanding a high bar on the inflation data to kick off rate cuts. This leaves some risk that the gradual slowing in the cycle could extend into a downturn. Markets are priced for the expected soft landing but without the uncertainty and humility around this outcome that we also see. Equity valuations are expensive and credit spreads are tight. Our proprietary measure of market psychology shows investor optimism, but it is not at extreme levels of euphoria at mid-year that would warrant a sharp risk-off posture. Treasury yields remain extremely volatile into the combination of choppy data and a data-dependent Fed. We see good value in bonds over the medium-term; both in terms of their starting real yield and as a diversifier to more adverse economic scenarios.
Japan
Japan is the land of rising inflation expectations, after having experienced more than 20 years of near-zero inflation. The chart below shows professional forecasters are expecting inflation to be close to the Bank of Japan’s (BoJ) target next fiscal year. In March, the BoJ raised interest rates for the first time in 17 years and seems likely to raise rates further, albeit in a patient manner. The economic outlook looks decent, with manufacturing picking up and the China outlook becoming more supportive. The depreciation in the Japanese yen is supporting inbound tourism.
Japanese government bonds look unattractive on valuation, especially given rising inflation expectations. Japanese corporate earnings are expected to be robust, although equities have priced in a lot of good news. The Japanese yen screens as one of the cheapest G103 currencies but will only likely strengthen when the interest rate differential between the U.S. and Japan starts to narrow.
Core inflation forecasts: Japan
China
Chinese policymakers have become more forceful in trying to turn the nation’s property market around. They have effectively created a program that will allow local governments to purchase excess inventory in different cities. The size of this pilot program is not large, but we think this shift in the stance of policymakers is an important turning point in China’s economy. We expect it will be expanded should it prove successful.
Additionally, Chinese corporates have become more focused on governance and shareholder returns. For years, Chinese equities have suffered from dilution i.e., companies issuing more shares. We have seen an increase in buyback announcements, which will allow better economic activity to flow through more meaningfully to earnings per share. Chinese equities continue to look cheap relative to broader global and emerging market equities.
There are still risks on the horizon for China. There could be tensions with the U.S. in the leadup to the November federal government elections. There is also the risk of more aggressive action from the European Union following the dramatic growth in electric vehicle exports to Europe. These risks, along with the upcoming Chinese government plenum4 in July, need to be closely monitored by investors.
Canada
The Canadian economy has avoided recession as population growth has supported consumption and, in turn, GDP growth. However, the persistent increase in the unemployment rate (from a low of 5.4% to 6.2% over the past 12 months) and the greater than 3% contraction in the per-capita GDP since the second quarter of 2022 both indicate the economy has been weaker than the headline GDP suggests.
Given that backdrop, it makes sense that the Bank of Canada (BoC) was the first G7 central bank to ease policy, cutting its target rate by 25 bps to 4.75%. We see the potential for three additional cuts this year, so long as the disinflation trend continues. Our path for the BoC is slightly more dovish than the industry consensus view, but that's also because we are somewhat more concerned about the economy. While a recession in Canada is no longer the consensus outlook, we believe the risk of the Canadian economy slipping into a recession over the next 12 months remains above average.
Given our macroeconomic views, we maintain a positive outlook for government bonds, which are likely to benefit from economic turbulence, while being cautious about the outlook for Canadian equities.
Australia and New Zealand
Australia remains on the narrow path of avoiding recession. The consumer is under stress from the increases in the Reserve Bank of Australia’s (RBA) cash rate and variable rate mortgage interest rates. Consumer spending has slowed materially. Tax cuts will start on 1 July. It is unlikely that all the increase in disposable income will be spent, but it may provide some support, particularly to lower-income consumers. Improvement in Chinese economic activity will also be supportive.
The inflation pulse in Australia lags the rest of the world by about six months (due to a later reopening from the pandemic lockdowns), and so the RBA will likely lag major central banks to reduce rates. Our current base case is for a cut in November, but there is growing risk that the RBA may stay on hold until early 2025.
New Zealand’s economy has contracted in three of the last four quarters, illustrating the pressures that the economy is facing following the aggressive action from the Reserve Bank of New Zealand (RNBZ). The outlook remains challenging, with credit growth still soft and a large current account deficit. Despite the unemployment rate having risen more than 1% from its low, wage pressure has not abated yet. This leaves the RBNZ in an uncomfortable position. We expect that the RBNZ will commence cutting rates after the U.S. Federal Reserve.
“European stocks are attractively valued relative to U.S. stocks.”
- Andrew Pease
Fat tails and alternative scenarios
It’s a cliché to say that uncertainty is high, but the return of Donald Trump to the White House adds an additional layer of complexity to the 2025 outlook. Alongside the usual business cycle risks, there is the unknown of how the new administration’s policy priorities and sequencing will unfold. We don’t know how aggressively President-elect Trump will implement his campaign promises of sweeping tariffs, lower immigration, and forced deportations. An early focus on tax cuts and deregulation would likely be well-received by equity investors. However, if the first major policy moves target tariffs and immigration, investor sentiment could sour.
On the business cycle, we expect the U.S. economy to slow to trend-like growth as the lagged effects of Fed tightening take hold. The risk remains that the economy could tip into a mild recession, with job market weakness triggering a consumer pullback. We’re closely monitoring jobless claims—sustained claims above 260,000 per week would signal a more painful adjustment. Claims below that level would suggest the economy is resilient despite tight monetary policy.
“If U.S. initial jobless claims consistently exceed 260,000 per week, it would indicate a more severe economic adjustment. We haven’t seen that yet, and we expect the U.S. labor market to remain strong.”
- Paul Eitelman, Senior Director, Chief Investment Strategist, North America
Key indicator: U.S. weekly initial jobless claims
The other scenarios we will be monitoring are U.S. inflation risks and potential positive surprises for Europe and China.
U.S. inflation risks could arise from economic overheating fueled by tax cuts and deregulation, which may sustain stronger-than-expected demand and limit the Fed’s ability to ease policy. Additionally, tariffs and immigration controls could tighten labor markets and disrupt supply chains, driving costs higher. If these pressures keep inflation elevated, the Fed might raise rates rather than ease, pushing U.S. Treasury yields above 4.5%. This would challenge the equity market, as the S&P 500’s earnings yield of 4.5% has consistently exceeded 10-year Treasury yields since 2002. A sustained reversal of this dynamic would strain equity valuations.
Despite a pessimistic consensus on Europe and China, both regions present potential for positive surprises. Europe’s equity valuations are compelling, with forward price-to-earnings multiples at a 45% discount to the U.S. Aggressive ECB easing could revive eurozone demand, with improving bank lending—a key indicator—signaling potential outperformance.
In China, policy shifts or improved corporate governance could deliver unexpected upside. Share buybacks have begun reversing years of dilution, enabling 11% earnings-per-share (EPS) growth in the year to November 2024, despite a struggling economy. With a low forward multiple of 10 times, another year of double-digit EPS growth could drive outsized returns for the MSCI China Index.
Conclusion: Overcoming the improbable requires discipline and strategy
Markets in 2025 will demand more than conventional wisdom about U.S. outperformance and global headwinds. While our composite contrarian sentiment indicator signals investor optimism, it remains below critical correction thresholds. This creates a tactical opening for disciplined investors.
We believe success will require nimble allocation across public and private markets, backed by rigorous analysis and unwavering investment discipline. A projected U.S. soft landing, coupled with expected policy moderation on trade and immigration, opens specific opportunities for well-positioned portfolios.
Just as robot chopsticks can catch spacecraft in 2024, it’s plausible that markets can remain resilient through policy uncertainty in 2025. A disciplined approach to building total portfolios will be critical to investor outcomes.
Composite Contrarian Indicator
