Strong fundamentals are expected to contribute to positive performance in credit and equity markets in 2025.
One of the most bullish themes in the U.S. economy is broadening profit growth across sectors. Looking back, it was primarily mega-cap growth companies in the technology and communications sectors that generated almost all of the S&P 500’s earnings growth in 2024 (FactSet, December 13, 2024. S&P 500 CY 2024 Earnings Preview : Analysts Expect Earnings Growth of 9.5%). Recently, profit growth at large technology companies has slowed and previously lagging sectors have started to see profit growth.
In our view, this diversification of sources of earnings growth implies that the credit cycle still has plenty of room to progress in the mid-expansion phase. We believe investment grade, high yielding US corporate credits are attractive as we expect a limited number of downgrades and a very low default rate of around 3.2%. Yields in global credit markets look attractive and we believe they could fall slightly as central banks begin rate cut cycles.
Our views on macroeconomic drivers
Lower short-term interest rates, slightly lower long-term rates and decent economic growth should continue to support investors’ risk appetite. However, valuations are already fair, if not somewhat high.
- We believe the Federal Reserve (Fed) will make four 25 basis point cuts, one at each alternative 2025 meeting.
- The US labor market is expected to moderate slightly.
- With personal consumption spending accounting for two-thirds of U.S. gross domestic product, record household net worth is expected to support demand.
- We believe that the Monetary Policy Committee of the Bank of England (BoE) is in a similar position to that of the Fed.
- Inflation in the Eurozone is expected to fall faster than that in the United States because demand is much less robust.
- Conditions are different in Japan, where inflation is around 2.0
- % and small rate increases are possible.
Our views on business credit
Credit investors have the potential to outperform U.S. Treasuries due to higher yield levels and the possibility of tighter spreads.
- Based on bottom-up fundamental analysis, our credit research team suggests that 93% of the sectors in the Bloomberg US Aggregate Index are in the expansion phase of the credit cycle. Among the sectors covered by our credit analysts, 36% have a positive credit outlook, a significant increase from 13% in June 2024.
- Our analysts’ improved outlook is primarily based on better expectations for margins and free cash flow.
- Our risk premium framework estimates that credit losses in investment grade credit and high yield credit will be lower than historical averages in expansion/late cycle regimes. This could be a key reason why spreads are so tight.
- Yield spreads for BB and B rated high yield credits historically appear very tight, while CCC credits have only recently started to look rich.
- Our favorite US markets, ranked by expected total return, are Leveraged Loan, Investment Grade and High Yield. In global credit, the emerging market space has higher return potential than the euro or sterling markets.
Our views on public debt and politics
Disinflationary trends are expected to remain in place in the short term; therefore, we see potential for lower government bond yields.
- Under the new U.S. administration, we believe existing and possibly increased tariffs, tax cut extensions, and adjustments to current policies appear likely.
- The lack of clarity regarding U.S. fiscal policy makes it nearly impossible to accurately model economic outcomes. However, we have created a series of scenarios that suggest inflation could be a little higher than expected ahead of the election.
- Policy changes are not expected to interrupt economic expansion.
- The U.S. yield curve is expected to invert as the Fed cuts short-term rates and long-term yields do not fall as much. By the end of 2025, the federal funds rate could reach around 3.5% and the 10-year bond yield around 4.0%.
Our views on currencies
The valuation of the US dollar is high relative to emerging and developed market currencies. If the trend reverses, we could see foreign currencies improve quickly.
- With limited divergence in central bank policies, short-term interest rate differentials are less likely to influence the performance of the US dollar.
- Factors such as relative economic growth, trade policy, risk appetite and the expected performance of US assets could support the US dollar in the very near term. Globally, the relative economic performance of the United States could attract demand for dollars from abroad.
- Often the dollar is seen as a global safe-haven asset and there is no shortage of geopolitical risks.
- Risks from U.S. government deficits are increasing, and we do not see major changes in the trajectory going forward.
- We remain cautious on China, but view upside economic surprises as possible, which would benefit the country and its emerging market neighbors.
- Latin America and South Africa are attractive regions to add foreign currency exposure.
Our views on global stocks
The macroeconomic landscape could be more challenging for stock markets, especially after such a strong performance in 2024.
- Bottom-up consensus earnings expectations suggest that the MSCI Europe Index could rebound from zero growth to mid-single digit growth in 2025. Both the S&P 500 Index and the MSCI Emerging Markets Index are expected to post earnings growth. profits of more than 10%.
- We are cautiously optimistic about corporate earnings growth relative to consensus.
- The outperformance of US stocks has been significant in recent years. But the S&P 500’s price-to-earnings (PE) multiple has also increased, helping to boost total returns.
- Annual total returns are more likely to follow the rate of earnings growth that the S&P 500 index delivers.
- In global indices, tracking PE multiples are slightly below their five-year averages.
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