Quarterly Global Asset Allocation Portfolio 2025 Outlook

Reasons for Optimism

US assets usually perform well in the year after an election. Hence, given that we expect less inflation, easing central banks and more growth, we think 2025 should be a good year for financial markets. However, we embrace risk cautiously after strong price gains in 2024.

Apart from stretched valuations for some assets, there a number of other reasons for the cautious approach: fiscal consolidation is needed in many countries and this could dampen growth; the global economy may be too fragile to shrug off a potential trade war; inflation may pick up earlier than expected as economies accelerate and, finally, 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).

Central Bank Actions and Inflation Trends

The chart shows that inflation continues to decline across major economies and that, therefore, central banks have been easing throughout 2024 (the 20 economies featured are expected to account for 86% of global GDP in 2024, according to the IMF).  Importantly, the Fed is now among the almost 60 central banks that have cut rates during 2024, which paves the way for further easing elsewhere.  We expect the Fed policy rate will be around 3.50% at the end of 2025 (versus the current 4.75%), with a similar reduction expected from the BOE but slightly less from the ECB.  The BOJ is the obvious exception, and we expect 50 bps of rate rises by the end of 2025.

Even before these interest rate cuts, there were signs of improving monetary conditions in both the U.S. and the Eurozone. Although money supply growth remains modest, it is trending in a positive direction. The combination of falling inflation, central bank easing, and an increase in money supply suggests that the risks of an economic accident are diminishing. In the absence of significant shocks, we anticipate that recession will not be a concern in 2025, with economies more likely to be in recovery mode. However, the critical question remains: what has already been priced into financial markets?

Inflation Concerns and Market Performance

While inflation has faded as expected, the post-pandemic surge in prices leaves us wary of a potential recurrence. Current data shows that headline inflation is still declining across the largest economies, including the U.S. and Europe. Also, there appears to be no upward pressure from commodity prices or supply chain disruptions now.  It is surprising how little effect Middle East tensions have had on either energy prices or trade flows.  That may not always be the case, and tariffs could also boost headline inflation.  Of course, it is the path of core inflation that is more important, and we believe that wage inflation will be an important factor. Wage inflation is trending lower on both sides of the Atlantic but a pick-up in economic growth could reverse that.

Historically, U.S. asset returns have tended to improve in the year following elections compared to the year before. Although fixed income results can be erratic, equity returns have consistently outperformed in the post-election period. The exception was the election of 2000, which serves as a cautionary reminder given that it coincided with the bursting of the internet bubble. 

While we are cautious about inferring causality, data suggests that U.S. stocks have generally performed better under Democratic presidents. However, one of the most favourable environments for stocks has been when Congress has been supportive of a Republican president, a scenario expected to continue for at least the next two years (based on data since 1853).