Outlook for 2025: Navigating Opportunities Amidst Geopolitical Tensions and Economic Shifts
As we look ahead to 2025, the global financial landscape is poised for a period of significant evolution, shaped by a complex interplay of factors. Among these, global economic growth, Federal Reserve policy, geopolitical dynamics, technological change, and a continuation of market trends will define the investment landscape in 2025, in our opinion. Specifically, we believe 2025 promises a continued divergence in performance between large-cap and small-cap stocks, a preference for U.S. equities over international markets, a likely continuation of accommodative monetary policies from the Federal Reserve, an increase in mergers and acquisitions activity, and a stock market that will increasingly rely on earnings growth to fuel returns. These dynamics, while offering opportunities, also highlight the risks inherent in an unpredictable global economy.
Large Cap Over Small Cap: The Dominance of Stability and Technological Change
We believe one of the most significant trends in 2025 will be the continued outperformance of large-cap stocks over their small-cap counterparts. Over the past decade, the equity markets have seen large-cap stocks, particularly those in the technology, consumer, and healthcare sectors, post impressive gains, dwarfing those of most all other asset styles, including small cap. While small-cap stocks often benefit from higher growth potential and agility, large-cap companies offer stability, resilience and scale during most periods of an economic cycle. This trend is likely to continue in 2025 for several reasons.
First, large-cap stocks typically have more diversified revenue streams, both geographically and across different sectors. Their brands are strong and trusted. They have access to capital from many different sources, typically at favorable terms. They are able to take advantage of scale, spending money on innovation, M&A, or expansion. Under the new administration that benefit may get even stronger. These factors combine to drive robust earnings growth for large-cap equities.
The continued preference for large-cap stocks is also a reflection of our vote against small cap stocks, in general. We continue to believe that the Russell 2000 has become a very difficult index own, as 40% of the index’s companies are unprofitable. For small cap index exposure, we are recommending the S&P 600, as only 20% of its companies are unprofitable (the S&P 500 has 6% of unprofitable companies). The most optimal manner to gain exposure to small caps is through active management (a mutual fund or separate account), as this asset class is “less efficient” than its more intensely researched large capitalization counterpart.
U.S. Outperforms International Markets
Another key theme for 2025 will be the continued outperformance of U.S. equities over international markets, in our opinion. While the global economy is interconnected, significant differences in economic growth rates, monetary policies, and geopolitical risks make the U.S. a more attractive destination for investment in the near term. We have also become the technology growth engine of the world, with many of our largest companies dominating the landscape as change-agents. It is also important for investors to note that our indexes are much more “growth” oriented than the rest of the world, and an overweight to the US also means that we believe that growth investing (as opposed to value investing) will continue to lead in 2025.
The U.S. also benefits from a large and relatively resilient domestic consumer base, which is expected to drive steady demand across a wide array of industries. Moreover, the U.S. Federal Reserve's actions, as discussed below, will likely support economic growth by maintaining accommodative monetary policies in the year ahead, as it believes that inflation is making its way down to its 2% target.
In contrast, international markets face a range of challenges that could inhibit their performance. In Europe, for example, the European Central Bank's struggle with inflation and its more cautious approach to rate cuts could weigh on economic growth and equity performance. Similarly, political instability and economic stagnation in regions such as Latin America, the Middle East, and parts of Asia could present risks for international investors. In China, despite its large economy, the ongoing structural challenges—including a slowing demographic trend, regulatory crackdowns, and a fragile property market—may further depress growth prospects.
Currencies tend to be valued based on relative interest rates and relative economic strength. We continue to believe that the U.S. has an advantage in both these categories when compared to most of the world, and the U.S. dollar will likely retain much of its strength in 2025. Investing in foreign equities exposes U.S. investors to the risk of unfavorable (strengthening dollar) currency fluctuations. The U.S. stock market, with its relative stability and strong earnings growth potential, should continue to attract capital, further supporting our view of a strong currency and the US stock market’s outperformance over its international peers.
Source: FactSet, MSCI, Standard & Poor’s, J.P. Morgan Asset Management.
The Federal Reserve and Interest Rate Cuts
Monetary policy will play a pivotal role in shaping the financial landscape in 2025. Following a period of aggressive rate hikes to combat inflation in 2022-2023, the Federal Reserve has since pivoted toward a more accommodative stance, with rate cuts likely to continue in 2025, albeit at a measured pace. These cuts will help support the economy by lowering borrowing costs for businesses and consumers, further stimulating investment and consumption.
The Fed's pivot is driven by several factors. First, inflation, which has been a significant concern in recent years, is expected to continue its gradual decline toward more sustainable levels and near the Fed’s target of 2%. Additionally, the U.S. economy, while still growing, is likely to experience slower growth in 2025. We project the US economy will grow 2.5% (inflation adjusted), reducing the need for restrictive monetary policy, as this growth rate isn’t strong enough to induce higher prices.
As the Fed cuts rates, interest-sensitive sectors, such as housing, consumer discretionary, and technology, are likely to benefit. Lower rates will make it cheaper for consumers to finance purchases and for companies to invest in capital expenditures and research and development. This supportive environment should fuel further economic expansion and corporate earnings growth, bolstering the performance of U.S. equities in 2025.
Source: Bloomberg, FactSet, Federal Reserve, J.P. Morgan Asset Management.
Mergers and Acquisitions Activity
Another trend to watch in 2025 is a likely uptick in mergers and acquisitions (M&A) activity. After a period of relative caution during the pandemic and its aftermath, the M&A market is expected to rebound, driven by several factors.
First, as the economic environment stabilizes and borrowing costs decline, companies will have more access to cheaper capital, making acquisitions more feasible. In particular, companies in high-growth sectors, such as technology, healthcare, and finance, will continue to pursue strategic acquisitions to expand their market share, diversify their product offerings, or gain access to new technologies.
Moreover, private equity firms, flush with capital, will continue to play a significant role in the M&A landscape. With rising corporate valuations and increasing competition for assets, private equity firms are expected to ramp up deal-making activity, targeting undervalued companies and potential turnaround opportunities. This should be good for US markets overall, as this process should serve as a signal that certain firms, or even whole industries, are undervalued. These mergers will thus likely contribute to overall market growth, benefiting both acquirers and target companies, as well as boosting investor sentiment. The increased M&A activity may also contribute to further consolidation within certain sectors, creating opportunities for investors in more concentrated industries.
Earnings Growth Driving Stock Returns
The most important factor driving stock returns in 2025 will likely be earnings growth, expected to be in mid-teens when compared to 2024. While market conditions and interest rates will influence stock prices, it is the underlying performance of companies—reflected in their earnings growth—that will ultimately determine whether stocks appreciate or decline. We feel that P/E (price / earnings) multiples are nearing their highest levels, and will have difficulty expanding from here. Please note that P/E multiples have little ability to predict near term returns, but do much better, and are inversely correlated with, 10-year returns.
Source: LPL Research, FactSet, Haver Analytics, Yahoo Finance, 10/28/24
For the U.S. market, earnings growth should be driven by continued innovation, demand for technology and healthcare products, and resilience on consumer spending. Companies that can effectively manage costs, invest in growth initiatives, and navigate geopolitical challenges will continue to see their earnings grow, providing support for higher stock prices. This will be particularly critical for sectors such as technology, healthcare, and consumer discretionary, where innovation and strong demand are expected to drive profitability. Additionally, as interest rates decline modestly, businesses with strong earnings and cash flow will benefit from lower borrowing costs, further enhancing their financial performance. Because not all companies will be able to grow earnings uniformly, stock selection will remain crucial for investors in 2025, with a focus on companies that have demonstrated resilience and a strong competitive advantage in their respective industries.
Inflation
Inflation is one of the most critical economic indicators and should remain front and center in 2025. The Fed’s latest 25 basis point cut and press conference in December disappointed markets, resulting in a pullback in equites and an increase in interest rates at longer maturities. This event illustrates how focused markets are on inflation, and also shows how important this variable is for all financial markets and economies. While we will not discuss politics, we can discuss policies. As such, when Donald Trump returns to office in 2025, his policies could have significant implications for inflation in the U.S. economy.
Fiscal stimulus in the form of tax cuts could increase demand. The immediate effect might be an increase in consumer spending and business investment. In the short term, this could boost demand, potentially leading to inflationary pressures. However, if the tax cuts are not accompanied by corresponding spending cuts, the increased fiscal deficit could exacerbate inflation in the medium-to-long term. Trump’s potential cut in taxes as well as new trade policies and tariffs could raise costs for goods. In his first term, tariffs raised the cost of foreign goods, leading to higher prices for consumers and businesses. If Trump reinstates or escalates trade barriers in 2025, the price of imported goods may rise again, contributing to inflation. Additionally, Trump’s stance on monetary policy and energy could create a complex landscape that affects inflation. Ultimately, the extent to which inflation rises will depend on the broader global economic context and how these policies interact with existing market conditions.
Fixed Income and Interest Rates and Overall Economic Conditions
As we head into 2025, we believe the Federal Reserve will cut rates at least twice throughout the year, signaling a continued shift towards a more accommodative monetary policy. After a prolonged period of aggressive tightening, the central bank will likely continue to ease rates to support economic growth, particularly in light of what we believe will be moderate inflation. Inflation is expected to remain under control, with consumer prices rising at a modest pace, driven by stable demand and supply chains that have largely normalized post-pandemic. This balance of soft inflation and a resilient labor market will allow the Fed to continue its cautious rate reductions, aiming to stimulate economic activity without reigniting inflationary pressures.
We will have to keep an eye on some policies which, if enacted, could have an impact on our views. These would include high tariffs on imported goods, or a mass deportation of immigrants. Both policies would tend to put upward pressure on prices and may change our view that inflation remains well-behaved in 2025.
In the bond market, we project the 10-year Treasury yield will hover between 4% and 5% for the year. This range reflects a more stable economic backdrop, where yields stabilize as inflationary fears subside and the Fed’s rate cuts begin to take effect. Investors will likely adjust to the new interest rate environment, with long-term yields still reflecting the lingering uncertainty about global economic conditions and policy decisions, but without the sharp upward pressures seen in the past few years. The result will be a yield curve that is somewhat steeper than in prior years, signaling moderate optimism about growth but also a recognition of ongoing risks in the global economic landscape.
We believe investors will be best served within the bond portion of their portfolios by sticking close to a neutral benchmark duration. We expect some downward pressure on short rates as the Fed cuts, but believe that rates out the curve will remain more static. We do not see an economic downturn in 2025. As such, investors should continue to feel comfortable moving a portion of their bond portfolio a bit down in quality in order to enhance yield in their bond portfolios.
Geopolitical Risks Remain Front and Center
Geopolitical risks will, unfortunately, remain a key concern for investors in 2025. Tensions between major global powers, including the U.S. and China, the ongoing war in Ukraine, and the instability in the Middle East, will continue to create uncertainty in the financial markets. While global markets have seemed to take these political issues in stride in 2024, increased tension in any or all of these areas in the year ahead may cause renewed volatility.
The ongoing U.S.-China trade and technology disputes, as well as the omni-present concern over the potential invasion of Taiwan, will have implications for global supply chains, trade flows, and investor sentiment. Similarly, the war in Ukraine, while not expected to escalate dramatically in 2025, will continue to impact global energy and grain markets.
Geopolitical risks also manifest in the form of cybersecurity threats, terrorism, and trade protectionism, which could create shocks in the global economy. Equity markets have historically weathered these storms, but they always require investors to remain agile and consider the potential impact of such events on the markets and individual investments, especially in the short term.
Conclusion
We believe 2025 is shaping up to be a year of moderate growth, driven by key factors such as the dominance of large-cap stocks, outperformance of U.S. markets, accommodative monetary policy, increased M&A activity, and earnings-driven stock returns. However, geopolitical risks remain a persistent threat, and investors will need to carefully navigate these uncertainties. By focusing on companies with strong earnings growth, while maintaining a preference for large-cap U.S. stocks, investors can position themselves to capitalize on the opportunities of 2025.
While we expect modest equity gains in 2025, we also want investors to understand that volatility should increase. In fact, we expect a 10%+ correction in markets to transpire in 2025. Preparing for this volatility in advance should help investors take advantage of this volatility instead of potentially becoming a victim from it. We look forward to helping you navigate what is going to be a very interesting year.
Elyxium Wealth LLC (“the FIRM ”) is a registered investment adviser located in Beverly Hills, California. The FIRM may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements.
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