2025 Market Outlook
It is a new year and with a fresh start comes hopes and dreams about what 2025 may bring. One of the many areas in focus is what may happen in the economy and stock markets for the year ahead. We are coming off the back of two very strong years in the markets, so how will they react in 2025? Can we experience a three-peat?
Both 2023 and 2024 brought healthy, double-digit returns to investors. As a result, the bears suggest it cannot be done again, while others suggest it will continue. Historically, when we experienced back-to-back years as strong as the past two, a third year of strong returns is more likely than not. Although we do believe we will have another strong year in the US stock market, we do expect it to be more muted than in the past two years. We are already seeing signs of volatility that may pop up throughout the course of 2025. As a result, it may be wise to put risk management measures in place as well as to be prepared to maneuver as markets shift.
While we feel it is likely we see positive returns in the markets in 2025, there are signs we may be in a late market cycle. Late cycles are a phase where economic activity peaks, but growth slows. They should not be seen as doom and gloom. Late cycles can last a long time, and we have started to see the market breadth broadening out. Although this may mean slower growth, it often can still mean growth overall, with certain sectors seeing accelerated market growth. When we see markets broaden out, it means more companies are contributing to the total return of the S&P 500 and often signals that we are entering into a “late cycle”. As a result, we think it will be more important to be allocated effectively with a thoughtful approach that allows you to be nimble as markets shift in 2025.
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Even though stock valuations are a bit stretched at the moment, especially in some of the high-flying equities of the recent years, we do feel there are plenty of attractive opportunities in the markets that may provide growth potential.
To create an effective allocation, some of the themes we are watching ahead include:
1) US Stocks Over International
Although a diversified approach is always important, we do see a very different story overseas compared to the US markets. We still see strength in pockets of the US markets, while the international equity markets have lagged looking backward and are still working through further challenges ahead. That said, we do believe a thoughtful approach to your US equity allocation is going to be critical in 2025 as we see markets broadening out and may see some of the undervalued companies with great financials begin to bear fruit.
2) Emerging Markets
Emerging markets can provide great opportunities in strong market cycles. However, this investment category can often cover a broad range of countries. While we think EM exposure may still benefit your portfolio, where and how you invest to provide your EM exposure may be even more important in 2025.
3) Bonds
There was a lot of excitement around the bond market in 2024 that fell flat. There likely will be pockets of opportunities throughout 2025 at times when rates are abnormally high. That said, the Fed is suggesting a slower rate cut path ahead, and the market is concerned about inflation, which may leave yields higher for longer. Although higher rates sound good for bonds in terms of the income you may receive, if rates stay high the appreciation opportunities in the bond market are limited. One way we have handled this risk in the past is with very short duration bonds and cash instruments, but it will be important to be ready to pivot in 2025 if cash yields drop too far and longer-term rates stay higher. Bonds do still have an important place in a portfolio, but the nuances need to shift with the markets, which we believe will be especially true in 2025.
4) Commodities
Given the market concerns and around inflation resurfacing, some portfolios may benefit from a slight allocation to commodities to hedge risk and provide opportunities in 2025. Gold was one of the shining stars in 2024 and a proper commodity allocation may benefit your portfolio as we look ahead as well. In addition to the potential growth opportunities in commodities, certain assets within the broad commodity basket may provide some limits to downside risks, providing a great risk/reward opportunity with the proper allocation.
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As we kick off 2025, we are optimistic about where things are headed. That said, we expect this year to come with surprises. The theme for 2025 is to allocate assets effectively and be ready to pivot. It may not be as simple as buying into a broad asset class and watching the gains mount up, instead we believe each of the broad categories mentioned above will require a thoughtful approach, investing specifically in the assets that will provide opportunity and reduce risk. In addition, markets move quickly and in 2025, we expect the ability to pivot, while still maintaining a long-term perspective, is going to be extremely important to take advantage of opportunities and to manage risk effectively. There may be some volatility that peeks its head in 2025, but with the proper allocation and the ability to maneuver quickly you may find great opportunities ahead!