Global inflation inched down toward central banks’ targets in 2024, opening the door to long-expected policy rate cuts. Equities outperformed in a better-than-expected growth environment, led by a narrow group of high-flying US stocks. In fixed income, credit has been a bright spot, driven by tightening spreads and attractive carry. Meanwhile, government bond markets remained volatile. Despite the onset of easing, longer-term bond yields finished higher as growth surprised to the upside and investors braced for possible expansionary US fiscal policy.
In the near term, we expect this backdrop to hold and remain supportive for multi-asset income strategies. But rising geopolitical tensions and uncertainties over policies from a new US administration cloud the picture further out, so a watchful eye will be key.
The World Readies for a New US Policy Direction
US economic fundamentals held fast throughout 2024, thanks to steady consumption, wage growth and strong services output. We see no reason for this momentum to reverse in early 2025, unless there’s an external shock. The second half of the year looks less certain to us.
We see two possible narratives emerging from the US Republican election sweep. On one hand, possible tax cuts and looser regulation in key industries could boost US productivity and gross domestic product. On the other, proposed trade and immigration policies could raise the risk of a more stagflationary environment.
The 2016 playbook offers some guidance, but macro and market conditions for the incoming administration are very different from those prevailing the last time around—richer capital market valuations and less fiscal wriggle room among them (Display).
While there is uncertainty around what 2025 may bring, one thing is clear to us: US exceptionalism will likely persist, with further decoupling of economic output and monetary policy from other regions.
2025 Backdrop Supports Risk Assets—But Selection Is Key
We expect an environment of reasonable economic growth, falling inflation and normalizing monetary policy in 2025. This should provide support for risk assets, such as equities and credit, as well as government bonds—all key pillars of a multi-asset income strategy.
However, a strong rally for equities and credit in recent years has left many areas of the market priced for perfection, in our view. This could amplify the impact of any market volatility, which makes a selective approach more important than ever now.
US Equities Look Most Compelling but a Broad Lens Is Better
We believe equities should have more room to run as long as the economy holds up. We currently see more opportunity among US companies relative to other developed markets. Despite richer US valuations, we expect tailwinds from continued AI development, stronger earnings and the potential for a looser regulatory backdrop. Moreover, US equities have historically performed well after Fed rate cuts, except during recessions (Display).
We expect US equities to outearn their global peers and for earnings growth to broaden among US companies. Earnings for the so-called Magnificent Seven still appear positioned to outperform, but the 2025 expected gap has closed versus the rest of the market—and is forecast to be the narrowest in seven years (Display).
We expect this market broadening to benefit multi-asset income strategies that have the scope to diversify across equity markets—especially areas like high-dividend and minimum-volatility stocks, where valuations are more palatable.
On a more tactical basis, we’re finding attractive opportunities in US small-cap stocks. Small businesses tend to be more domestically focused, so they could benefit disproportionately from the new administration’s US-focused agenda and expected corporate tax cuts. Small-cap companies also generally carry more leverage on their balance sheets, and therefore could see further tailwinds as interest rates normalize.
Prioritize High Quality Within Fixed Income
While credit spreads look expensive versus history, all-in yields remain very attractive. We think high-quality investment-grade bonds offer “sweet spot” income for multi-asset strategies, with the potential to deliver solid total returns even if we don’t see a meaningful drop in yields (Display).
Investment-grade bonds are also appealing from a risk management perspective, in our view. While not our base case, a hard landing scenario should help investment-grade bonds perform strongly, with a fall in yields more than offsetting wider spreads.
Corporate fundamentals remain generally strong, and we don’t anticipate any significant deterioration in credit quality next year. Spreads are tight, but historically have shown the ability to remain in a tight range for some time and could further benefit from investor demand as cash rates continue to fall.
Extend Duration but Position for a Steeper Yield Curve
We believe it’s also prudent to extend duration, or sensitivity to interest-rate risk, in 2025, generally achieved through adding exposure to government bonds. Moreover, we think the entry point is attractive: the US 10-Year Treasury yield has surpassed the three-month cash rate, as measured by the US 3-Month Treasury yield, for the first time since 2022.
While we expect yields to generally move lower, market concerns over growing US budget deficits and higher inflation could keep them higher for longer at longer maturities. The yield curve also tends to steepen during easing cycles, so we currently believe the risk-reward trade-off is more favorable in shorter to intermediate maturities (2–10 years).
To sum things up, we expect US market leadership to persist, supported by a stronger economic backdrop, deregulation and a potentially more business-friendly administration. While stock valuations are back at 2021 levels, bond yields look more reasonable and offer ample buffer for further policy easing.
We also expect stock-bond correlations to move lower. This should reassert the complementary dynamic that could support risk-adjusted returns for multi-asset income strategies. Diversification across styles, sectors and factors within asset classes will also be key—particularly if we see stagflationary risks rise across the year.
In our view, the environment for multi-asset income strategies to generate both yield and upside potential remains attractive, but as always, a flexible and dynamic approach will remain key as opportunities broaden in 2025.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.
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