Going into 2025, strong company fundamentals and trends in innovation could be outweighed by increased geopolitical risk and policy uncertainty
For equity investors, 2025 is about finding opportunities in a new equilibrium. The macro environment has shifted, with lower rates easing some of the financial pressure on companies and consumers. And while there are always risks to watch out for, our overall thesis hasn’t changed: companies with strong fundamentals that have learned how to weather the challenging operating environment of the past few years will likely continue to lead.
Lower rates are here, which should be good for equities
When the US Federal Reserve started its easing cycle this year, it was an important milestone in the changing landscape for equities. Going forward, the cost of capital for companies will likely be lower, so it is going to be easier to make capital allocation decisions and plan ahead.
One caveat: rates are currently declining because inflation is falling. But if rates begin to get cut to fend off a recession, or inflation reasserts itself, that’s a different story – and an environment which could negatively impact stocks. It is also important to keep in mind that lower rates don’t mean low rates. Interest rates are still high relative to history, so we are looking closely at how companies we invest in are making capital allocation decisions in a higher terminal rate environment.
We are also keeping an eye on the labour market, which is one of the key signals for overall economic health. We are seeing some weakening, but the unemployment rate is still relatively low and there are plenty of new job openings.
Elevated valuations shouldn’t keep investors out of the market
Historically on a price-to-earnings basis equity valuations continue to appear stretched, especially in the US. But we think these valuations are reasonable when you consider that they are being driven by healthy earnings. Investors should also be encouraged by the fact that this earnings strength is coming from a broader-based group of sectors and companies compared with the past few years – moving beyond the narrow scope of the “Magnificent Seven” (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, Tesla).
As we look around the world, there are opportunities to take advantage of attractive valuations outside the US. Most of Europe’s developed-market countries are relatively inexpensive compared with the past 10 years. That is true for China as well. And while cheap versus expensive is generally not an effective investment thesis, it can be a useful data point to challenge investor assumptions and evaluate allocations at the country level.
In the event of a harder landing, bond markets may experience increased volatility. High-quality and longer maturity fixed income securities are likely to benefit in such a scenario, as investors seek save haven assets during periods of economic stress.
The biggest uncertainty is geopolitical risk
If the overriding uncertainty of the past few years was macro-driven, today the primary risk is geopolitical. And it is a risk that will almost certainly stay elevated in 2025. For global companies this means an increasingly difficult operating environment. The overall cost of doing business will likely be higher, and companies will need to be resilient and able to adapt as their operating and market environments continue to shift. More immediately, with the US election and the related noise behind us, investors can shift their focus to potential policy impacts and what that means for their investments and outlook.
Opportunities driven by innovation are expanding across the market
We think 2025 will be another year to stay focused on longer-term growth trends, like artificial intelligence (AI) and energy transition, as well as rapid innovation in sectors like healthcare. As technologies advance and mature, these opportunities continue to evolve. For example, most people think about AI strictly as a “technology” play, but that is only where it starts. Today, AI as an investment theme is really a cross-sector opportunity. Particularly at this stage in its development when we are seeing increased infrastructure spending to integrate AI into business models for almost any kind of business. We are keeping an eye on these bigger growth themes, and we think investors should, too.
Bottom line
Like any other year, we are going to see a mix of risks and opportunities in equity markets. As we head into 2025, investors will continue to question the sustainability of market returns, particularly in the US. Although lower rates, strong earnings and a wave of innovation are creating a favorable backdrop for equities, geopolitical uncertainties and the evolving labour market could elevate the risks of a downturn.
By focusing on companies with solid fundamentals and being open to opportunities beyond the US, investors can navigate this new equilibrium with confidence.
