Invesco’s Global Market Strategy Office (GMS) has published its annual asset allocation outlook for 2025, which outlines a constructive environment for financial markets based on a combination of declining inflation, easing central banks and stronger growth – an environment in which riskier assets are expected to generate higher returns than more defensive alternatives.
“Despite everything the global economy continues to grow. In the absence of shock, falling inflation, central bank easing and acceleration in money supply in the US and the Eurozone suggest to us that the risks of an economic accident are fading and that recession will not be an issue in 2025. Hence we think next year should be a good year for financial markets,” Paul Jackson, Global Head of Asset Allocation Research, Global Thought Leadership, says.
The GMS projections for asset returns are based on the assumption that global GDP growth will recover towards trend in 2025, while global inflation will fall towards central bank targets, with major western central banks continuing to cut rates towards “neutral”.
Despite the constructive economic and policy backdrop, their projected returns are lower than a year ago because of the intervening sharp rise in some asset prices. “The biggest dilemma we face is that cyclical assets such as equities and high yield had a second strong year in a row in 2024. This means that some valuations are now stretched and we fear that a lot of the policy easing and economic recovery has already been priced in,” Jackson explains. For example, US equities appear very expensive when viewed on a market capitalisation weighted basis, and high yield spreads are tighter than the Invesco experts would normally expect at this stage of the cycle, while gold has recently touched record highs in real terms. At the same time, the new Trump administration in the US brings a lot of uncertainty about fiscal and trade policy, as well as geopolitics.
Invesco’s Global Market Strategy Office uses an optimisation process to help balance risk and reward. With a view to the coming year, the outcome unambiguously favours bank loans, investment grade credit and commodities, while gold and equities are out of favour.
“Although equities normally perform well in economic upswings, they have already shone in 2023 and 2024 and stretched US valuations make it hard for us to be optimistic about global equity returns,” Jackson notes.
As the Invesco expert points out, US stocks have been given a new lease of life by Donald Trump’s victory in the recent US presidential election, presumably in anticipation of a combination of tax cuts, reduced regulation and protectionism. However, Jackson sees a number of risks in this analysis: First, he says, there is no clear relationship between the rate of corporate tax and future stock market returns; second, unfunded tax cuts could worsen an already desperate fiscal situation, potentially causing bond yields to rise, and protectionism could raise inflation, reduce growth and make US companies less efficient.
In addition, Jackson believes that valuations are an important determinant of future returns and his analyses suggest that when the US market has been this expensive in the past, it has delivered poor returns over the medium term. He expects non-US equity markets to perform better than the US market and sees particular value in China. “Recent policy initiatives in China suggest to us that economic growth will continue to outstrip that in the West, and we are optimistic that Chinese equities will outperform, given how cheap they remain,” he says.
In the absence of recession, Jackson sees limited scope for a big decline in long term government bond yields over the next year and expects most yield curves to steepen. He prefers bank loans to cash among short duration assets. While cash rates are lower than they were, bank loans’ high current yield leads him to expect stronger returns than on assets with similar volatility. “We believe bank loans offer the best risk-reward potential and we expect better returns on bank loans than on any other global asset except commodities,” Jackson says. In the investment grade space, he expects the best returns in the UK and the emerging markets. High yield credit is expected to do relatively well as economies accelerate but spreads are already tight.
Jackson predicts the US dollar will weaken from expensive levels, as Fed rates decline and the consequences of the new economic regime in the US become clear. In his view, this could further boost industrial commodities that he also expects to benefit from economic acceleration. He doubts that those factors will be enough to help gold, which he believes is very expensive.
According to Jackson, Fed easing and a weakening dollar could also help emerging market assets. He considers emerging market valuations to be relatively attractive and expects higher than average returns in most asset categories.
While the GMS asset allocation outlook for 2025 paints a constructive picture overall, Jackson also sees some risks that investors should keep in mind. For example, he cautions that much-needed fiscal consolidation in many countries could dampen growth, and the global economy may be too fragile to shrug off a potential trade war. In addition, inflation could pick up earlier than expected as economies accelerate, and a worsening of an already extreme fiscal position in the US could push treasury yields even higher and weaken the dollar – especially if the Fed’s independence is called into question. This balance of tailwinds and headwinds leads the Invesco expert to embrace risk cautiously for now.
