Bonds remain attractive, while stocks require more caution in the face of overvaluation.
Looking ahead to 2025, the global economy and financial markets face a mix of opportunities and challenges. Interest rates are returning toward neutral levels, but they are expected to stabilize at levels higher than during the 2010s. Positive labor supply and increased productivity have supported U.S. growth in 2024, but new political risks could dampen this growth in 2025. The US market has momentum, but high valuations will limit long-term returns.
US economic growth under pressure
In 2024, the U.S. economy experienced strong growth, supported by a dynamic labor market and increased productivity. However, new political risks, such as tariffs and stricter migration policies, could dampen this growth in 2025. We expect a moderation in real GDP growth in the United States, which should be around 2%, with core inflation likely above 2.5% for most of the year. These uncertainties highlight the importance of a prudent and diversified investment approach.
US economic resilience does not depend on Fed policy
Over the past two years, the market narrative has focused on whether the U.S. Federal Reserve (Fed) could perfectly time its rate cut cycle to achieve painless disinflation. Despite tight monetary policy, the U.S. economy has experienced a favorable combination of strong real GDP growth, easing labor market tensions, and falling inflation. However, we believe that the resilience of the US economy is probably more due to fortuitous supply-side factors than to a “soft landing” orchestrated by the Fed. While these positive supply-side factors may continue into 2025, emerging political risks could offset some of the gains. If these risks materialize, U.S. real GDP growth could slow from its current rate of around 3% to close to 2%.
Economies outside the United States have not been as fortunate on the supply side and have not achieved the same combination of strong growth and significantly reduced inflation. Eurozone growth is expected to remain below trend next year, with a slowdown in global trade posing a key risk.
Bond Yields: The Era of Sound Money Lays a Solid Foundation
The era of sound money, characterized by positive real interest rates, continues. Although central banks are currently easing monetary policy, we expect policy rates to stabilize at higher levels than during the 2010s. This environment sets the stage for strong bond returns over the next decade.
-Higher starting yields have improved the risk-return ratio for bond investments. Bonds remain a solid option. This outlook reflects a gradual normalization of policy rates and yield curves, although significant near-term risks remain. The strong outlook for bonds, combined with a more cautious long-term view for U.S. stocks, suggests that more defensive portfolios may be appropriate for investors with a suitable risk profile.
Stock Returns: Rational or Irrational Exuberance?
Our view of stocks is more cautious. US stocks have delivered strong returns in recent years, and 2024 was no exception, with earnings growth and price-to-earnings ratios beating expectations. The key question for investors is: “What happens next?”
Although the outlook for U.S. stock returns may seem overly conservative, the range of possible outcomes is wide, and valuations are rarely a good timing tool. High initial valuations risk dampening long-term returns. However, history shows that in the absence of an economic shock or earnings growth, U.S. stock market returns can continue to defy the gravity of their short-term valuations.
Equity market valuations outside the United States are more attractive. In recent years, modest growth in economies and profits outside the United States has kept global stock returns outside the United States relatively tepid compared to the remarkable returns in the U.S. market. We suspect this trend may continue, with these economies likely to be most exposed to global economic and public policy risks. Over the long term, differences in price-to-earnings ratios are the main driver of relative returns. Over the next decade, we expect developed markets outside the United States to return 2.9% to 4.9% (All forecasts are from the perspective of a Swiss franc investor) .
A new point of tension emerges
The investment challenge lies in a growing tension between momentum and overvaluation. Assets with the strongest fundamentals often have the most stretched valuations, and vice versa. Economic and political risks for 2025 will help determine whether momentum or valuations will dominate investment returns in the year ahead.
