Justin Onuekwusi, Chief Investment Officer at St. James’s Place says: “As we enter 2025, events from the past year present us with a landscape rife with challenges and opportunities.
“In 2024, markets demonstrated resilience amid dynamic global conditions. Equity markets saw robust returns, driven by technological innovation, a decisive US election outcome, and an expansion in valuation multiples, particularly among US mega-cap technology stocks. Tightening spreads in bond markets, while offering higher yields than much of the past decade, highlighted the importance of navigating credit risk in a prudent manner.
“The macroeconomic backdrop remains complex, with fiscal policies expected to play an increasingly pivotal role, as governments balance election pledges against questions of debt sustainability. Trade frictions, tax policies, and protectionist measures are adding layers of uncertainty, particularly as the US leverages its economic heft, while Europe grapples with slower growth and fiscal constraints.
“Inflation, along with a higher-for-longer interest rate environment, although having moderated throughout the year, remains a potential source of volatility, especially in bond markets. This evolving landscape demands a nuanced investment approach, where diversification, discipline, and flexibility are paramount.
“Equally, there are opportunities for those prepared to take a long-term view. Non-US equity markets, particularly in emerging regions, alongside Europe and Japan, are offering compelling relative valuations, and fixed income continues to provide a stabilising role within diversified portfolios.
“Funds that are actively managed struggled in concentrated markets dominated by a few large-cap stocks, but could regain importance as markets broaden and volatility creates
inefficiencies. These dynamics set the stage for an investment approach that balances resilience with a readiness to capitalise on new opportunities.
“Political and economic factors will continue to influence markets in the year ahead. Against this backdrop, our focus remains on balancing risk and reward through diversification, targeting valuation opportunities, and leveraging the active/passive spectrum to navigate uncertainty and identify potential growth areas.”
Hetal Mehta, Head of Economic Research at SJP on her 2025 economic outlook: “Through 2025, we expect the economic landscape to be shaped by fiscal policy, evolving trade dynamics and divergent regional growth trajectories.
“In a year peppered with many notable elections, the global economy was marked by heightened economic uncertainty in 2024. Despite concerns at the start of the year that restrictive monetary policy would weigh on GDP, growth surprised to the upside and recessions in the key developed market economies were avoided. A gradual cooling of labour markets – lower vacancies and lower wage growth without a significant increase in unemployment – combined with progress in taming inflation, has allowed central banks to pivot policy towards gradual rate cuts. But with the major elections behind us, it’s now time for governments to start implementing their policies.”
Trade and investment dynamics
“Trade frictions remain a key concern, driven by protectionist policies President-elect Trump both campaigned on and said he intends to implement early in his first term. In his first presidency, such policies re-shaped global supply chains. We expect to see this again if his proposed policies are implemented. Tariffs are likely to be inflationary, prompting a slower easing of interest rates.
“However, considerable uncertainty remains, as the full extent of the tariff increases and the retaliation is still unknown. This uncertainty is likely to weigh on sentiment and business confidence.”
Fiscal policy under scrutiny
“Fiscal policy will come under intense focus, as governments work to reconcile their election promises with mounting market concerns about debt sustainability. In many advanced economies, the balance between stimulating growth and maintaining fiscal discipline will be critical, especially in the face of aging populations and structural budgetary pressures. For the US, there could be some growth from expectations of lower taxes in the near term, but higher inflation (and more modest interest rate easing) will most likely weigh on growth eventually.
Regional divergences
“This year is likely to see growing economic divergence between the US and Europe. While the US is expected to leverage its economic scale and exceptionalism to pursue large fiscal deficits, this approach is not available to the euro area. Furthermore, continued headwinds in manufacturing, including high energy prices and competitive pressures from China, will pose significant challenges for the euro area.”
Business confidence
The chart below shows businesses’ changing assessment of their production or output. A reading above 50 indicates expansion, while numbers below 50 indicate a contraction.
What’s next?
“Overall, 2025 will test the resilience and adaptability of economies as they navigate a complex interplay of policy, trade, and structural change.
“While risks are evident, the US economy is likely to perform relatively well. Our base case is one of a soft landing (i.e. modestly slowing growth) for the global/US economy but with inflation likely to remain higher as tariffs and immigration curbs take effect. We attach a 60% probability to this outcome.
“We see the economy as being in the latecycle phase but not close to recession. We assign a 15% probability to a recession, broadly in line with historical averages.”
Ali Malik, Portfolio Research Analyst at SJP on the team’s Capital Market Assumptions:“The SJP Capital Market Assumptions (CMAs) are compiled by experts in the SJP Investment Management team, and calculated by taking the average across a panel of world-leading forecasters. A key input into our portfolio construction process, these CMAs inform our 10-year expectations of various asset class returns.
“Since our previous Market Outlook in mid-2024, we’ve seen shifts in our forecasts for cash, fixed income and equities, driven by a number of macroeconomic developments.”
Cash and fixed income
“Q2 2024 began with concerns that persistent inflation would delay central banks’ rate cutting cycles. However, by mid-Q3, the Federal Reserve, the Bank of England and the European Central Bank had each begun cutting interest rates, thereby lowering the starting yield for fixed income assets.
“The impact of rate moves was broadly flat for our UK Cash and UK Government Bond CMAs. However, our return forecasts for Global Government Bonds, Global Investment Grade and Global High Yield return were negatively impacted. For Global Investment Grade and Global High Yield, tightening credit spreads over the past year also helped to lower their respective CMAs.”
Equities
“US equities performed well over the past year, buoyed by strong earnings, ongoing enthusiasm around AI, and optimism of a soft landing driven by US interest rate cuts. However, for sterling investors, some of these US Equity returns were lowered due to the strengthening of the pound through much of 2024.
“In contrast, a weakening Japanese Yen caused losses in sterling terms for Japanese Equity investors in Q2. In Q3 Japan’s unexpected interest rate hikes drove unprecedented volatility and further declines.
“That said, the CMA for US equities has improved since Q1 2024 despite recent gains, thanks primarily to the positive impact of a stronger pound on US Equity return forecasts.”
Carlota Estragués López, Equity Strategist at SJP on equity markets: “The key theme driving equity markets over the past year has been technology and innovation, spearheaded by ongoing advancements in artificial intelligence (AI).
“In 2023, the world started paying close attention to AI, and 2024 was the year businesses accelerated their adoption, use and investment in this area, translating into strong earnings growth for certain areas of the market. As a result, US mega cap technology stocks, such as Nvidia and Microsoft, dominated markets throughout 2024.
“Over the course of the year, the concentration of the US equity market into a select group of companies reached near all-time high levels, comparable to those last seen in the 1960s. In addition to the rise of AI, a decisive outcome in the US election was positive for equity markets as it lifted the uncertainty that had preceded Trump’s victory.
“Although there has been much focus on the US election, as long-term investors, we remind ourselves to look beyond such short-term noise and focus on the key drivers of equity returns – a company’s ability to generate and grow earnings.”
Will the US continue to dominate equity markets?
“In 2024, US mega cap stocks influenced market-weighted indices and a valuation gap grew between the US and other markets. The first chart shows that valuations for companies listed outside the US were trading at a 38% discount relative to those listed in the US (as of 31 October 2024), levels rarely seen throughout history.
“The second chart shows that smaller companies were priced at a 20% discount relative to their larger counterparts heading into the end of the year. The last time we saw such levels was in the lead-up to the dot.com bubble in the late 90s.”
How are we positioned heading into 2025?
“The relative valuations of stocks outside of the US appear compelling given their historic lows, and could benefit from either improved sentiment or stronger earnings growth.
“Predicting the catalysts that may cause a shift in the market backdrop as well as when, is difficult. Despite that, given the rising exposure to US markets in global stock market indices and rich valuations, we think it prudent to diversify exposure into non-US markets in a measured fashion.
“Consequently, our current equity views lean us towards more attractively valued areas in what we believe is a supportive market environment.
Sean Hutcheson, Fixed Income Analyst at SJP on fixed income markets: Looking across fixed income markets as we move into 2025, it’s fair to say that the additional reward for taking on credit risk is limited. This is despite the fact bond yields are starting the year higher than they have been for much of the past decade.
“In our view, credit is generally expensive relative to history. Heading into the finale of 2024, spreads over government bond yields in some lower quality areas were as tight as they had been since 2007. In light of this, our view on fixed income has moved from positive to neutral.
“Given valuation levels, it can be tempting to chase higher yields by taking on more risk. However, the risk of default and loss is far greater in lower quality bonds, particularly when there is only a limited cushion from the additional yield available.
“Despite lower quality high-yield bonds (CCCrated) offering higher headline level yields, it comes with a greater probability of default. This dilemma is often referred to as a ‘fool’s yield’ – an attractive headline return, which often is never received by the investor.
“But for active fund managers, the lower quality parts of the credit market may provide interesting opportunities as their analysis may offer an edge in selection.
“Quoting Howard Marks, founder of credit manager Oaktree: “if we avoid the losers, the winners will take care of themselves”. In this light, and in the context of rich valuations in credit, our fixed income managers are heading into 2025 with an acute awareness of the potential for market volatility and the alpha-generating opportunity this may bring.”
Chart 1: As we approached the end of 2024, spreads over corporate bond yields in certain lower-quality segments had narrowed to levels not seen since 2007
Chart 2: Although lower-quality, high-yield bonds (rated CCC) offer higher headline yields, they also carry a heightened risk of default and greater drawdown (peak to trough decline during down markets).
Hamish Gibberd, Portfolio Strategies Manager gives a multi-asset view: “As long-term multi-asset allocators, exceptional performance in 2024 (see chart below) sets the investment environment for 2025, where we believe managing risks will be just as important as seeking opportunities.
“The past year saw exceptional returns across a range of assets. Relative to history, investment grade bonds and high-yield bonds provided investors with top quintile returns as interest rates normalised and credit spreads tightened.
“However, the US equity market was by far and away the standout performer, with GBP investors seeing returns nearing 30%.
“Partly driven by outsized earnings growth throughout the year, investors also benefited as valuation multiples expanded. The MSCI US index closed the year with a valuation surpassing 25 times earnings, while the US mega-cap stocks, collectively known as the “Magnificent 7”, reached a valuation of 33 times earnings.”
Where do the risks lie?
“Last year was one of the most politically active years on record, with some two billion people heading to the polls. The most headlined election was in the US, with Donald Trump winning a surprisingly decisive victory on 5 November.
“As financial markets continue to price the impact of President Trumps signposted trade tariffs and tax cuts, the spectre of inflation has returned. This brings with it an increased potential for volatility in bond markets.
“Adding to the risk, many of the mega-cap stocks in the US equity markets appear priced to perfection and may be particularly sensitive to downside risk. While we expect some bond market volatility, yields on offer continue to outpace US dividend yields as valuations have pushed higher.”
Diversification matters
“While we expect volatility across fixed income, we believe the yields on offer in traditional diversifiers, such as sovereign bonds, are likely to provide protection to a significant drawdown in equities.
“We believe a globally diversified approach is prudent to managing some of the more acute equity valuation risk in the current environment. As 2025 gets underway, our allocations are closely aligned with our house view. With an underweight position in US equities our portfolios are more regionally diversified and trading at a valuation discount to the broader market. We believe this both mitigates risk and sets up our portfolios for more attractive forward returns.
Rising opportunities?
“We remain vigilant to emerging risks and relative value opportunities across fixed income and equity markets. As long-term investors, we see compelling opportunities outside the more expensive areas of US equity markets, and further down the marketcap spectrum.
“We also believe active managers adhering to growth, quality and value investment approaches are now well-placed to capitalise, following a period of reasonably concentrated market returns.”
Final thoughts from Justin Onuekwusi, CIO at SJP: “As we move into 2025, managing elevated equity prices and credit market risks will require an unwavering focus on diversification and valuations. Our portfolios are positioned to navigate these challenges, with a clear focus on maintaining resilience while seeking opportunities for growth.
“A prudent underweight in US equities, coupled with overweight positions in emerging markets, non-US developed regions, and smaller company equities reflects our view that diversification can mitigate risks and unlock returns in areas with strong structural growth drivers.
“Our fixed income allocations remain neutral, taking advantage of higher yields while providing stability in volatile environments. However, the combination of higher yields and historically tight spreads reinforces the need for vigilance. While bond markets provide valuable diversification benefits, the risk of taking on unnecessary credit exposure without adequate rewards, remains significant.
“As markets evolve, our investment framework remains adaptable, rooted in global diversification, active decision-making, and a commitment to long-term value creation. By maintaining this approach, we are confident our strategies will continue to deliver outcomes that align with our clients’ goals, navigating the challenges and seizing the opportunities of an everchanging global market.”
