2025 Outlook: Regaining Balance

The 19th century author Balzac wrote that “our worst misfortunes never happen and most miseries lie in anticipation.” This quote perfectly captures 2024: a year where concerns over a “hard landing” recession, market pullbacks, and election turmoil drove market sentiment to the extreme. Despite these fears, the U.S. economy remained resilient and began to cool – as the Federal Reserve cut interest rates and inflation subsides, and the S&P 500 neared record levels. This year, being fully invested in a diversified portfolio has certainly paid off.

If the past few years have been about extremes – with the bear markets of 2020 and 2022 and the sharp rebounds in 2021, 2023, and 2024 – then 2025 could be about regaining balance, where long-term investment discipline will only grow in importance.

In this article, we highlight key insights on the U.S. economy, monetary policy, government policies, and opportunities in both public and private asset classes to help investors better position themselves for 2025.

The U.S. Economy: Consumer Spending Is a Key Risk Factor

The U.S. economy has turned out to be more resilient in 2024 than expected. The Consumer Price Index, the Fed’s preferred measure of inflation, has slowed to 2.6% year-over-year. Unemployment remains low at 4.2%, and 2.3 million new jobs have been created over the past 12 months. GDP growth, at 2.8% in the third quarter, has been stronger than many economists anticipated.

This economic resilience has propelled many asset classes. U.S. stock market indices are near all-time highs; international stocks have continued to rise; and bonds have performed better in recent weeks, with interest rates moderating (Figure 1). Gold is near record levels, due to demand from investors and central banks; and Bitcoin has also risen to historic highs following the presidential election.

Figure 1: A Positive Year for Most Assets

However, higher asset prices can distract us from economic fundamentals. A key risk factor is that consumer spending could slow, as excess savings are spent. The personal savings rate of 4.4% has dipped below the historic average of 6.2% (Figure 2), while debt levels are high for both households and businesses. As such, while most economic forecasts have a base case of “soft landing,” with economic growth entering a more stable period and inflation not returning to above 4% (including the potential impact of government policies), the probability of a recession has also increased.

Figure 2: Personal Savings Rate is Below Historical Average

The Fed’s Monetary Policy: 2-3 x 25 bps Cuts Expected in 2025

The Fed began to cut policy rates in September, following months of investor speculation. Thus far, the Fed has lowered rates by three-quarters of 1%, with markets expecting another 25 bps cut in December and two or three more additional cuts by the end of 2025 (Figure 3).

Figure 3: Additional Rate Cuts are Expected Through 2025

While the timing and magnitude of additional rate cuts will depend on economic data, the monetary policy headwinds that began in 2022 are now turning into tailwinds. Just as higher rates slowed economic growth and led to investor concerns, lower rates can help to stimulate the economy, support corporate earnings, and partially alleviate the burden of interest payments on the growing national debt. 

The Treasury yield curve steepened in 2024 – primarily due to lower short-end yields. The 10-year Treasury yields dipped below 4%, following the initial September rate cut, and have since remained above 4%. Long-end yields may stay at current levels, given muted demand in Treasury auctions. 

Figure 4: Treasury yield curve steepened as short-end yields declined

Government Policy: Watch for Timing and Extent of the Proposals 

The stock market has rallied since the election, due to less policy uncertainty and hopes of a pro-growth environment – with the Republican party having the majority in both the House of Representatives (albeit by a thin margin) and Senate, as well as the presidency. Of course, the business cycle is what matters most: with the economy and stock marketing performing well across various combinations of party control.

Most provisions of the Tax Cuts and Jobs Act will likely be extended – it is just a matter of timing. The Trump administration is expected to raise tariffs across many trading partners, especially China. However, it is important to remember that the worst-case predictions during Trump’s first term did not materialize, many tariffs were continued during the Biden administration, and China’s trade deficit has declined in recent years. (Figure 5)‍

Figure 5: U.S. Trade Balance By Country

When it comes to debt ceilings and the growing federal deficit, there are no simple solutions. The national debt has grown to $36 trillion, with no signs of slowing down anytime soon. Without a sustainable path, interest payments on the federal debt will continue to rise, and credit rating agencies may continue to question the quality of U.S. debt. Without minimizing the severity of the situation, we are not at a tipping point just yet (Figure 6).‍

Figure 6: Federal Budget Deficit to GDP

Please refer to our Q3 Market Commentary on the Election and Fed Rate Cut for more details on potential policy changes. 

Portfolio: Improve Security Selection and Diversify Beyond Public Markets 

In public equities, we continue to favor the U.S. over international, due to supportive monetary and government policies, as well as the long-term potential of artificial intelligence.

• Multiple compression risk remains high, as valuation (22.3x forward P/E vs average 17x with similar interest rates of ~4%) approaches tech-bubble highs (24.5x) (Figure 7). The market expects 15% earnings growth, as well as margin expansion in 2025. Security selection is crucial in this environment across all market capitalizations. 
• U.S. small- and mid-cap stocks could benefit more from the above policies, though a significant percentage will remain unprofitable, if long-end rates remain around 4% with no reprieve in borrowing costs. 
• In terms of sectors: energy, financial, real estate, defense, telecom, and infrastructure can benefit from more favorable trade policies and regulations. 

• As stock markets can often continue to rise at extreme valuations with heightened volatility, low volatility and hedging strategies can help lower systematic risk. 
• Globally, FX-hedged-developed equities may benefit from continued USD strength. Despite the volatility post BoJ raising rates by 25 bps, Japanese equities have the potential to outperform other international markets, given an improving economy and a favorable exchange rate.

Figure 7: Equity Valuation is Approaching the Tech Bubble Highs

We see opportunities in fixed income for higher yield and greater diversification than the benchmarks at similar duration: 

• The “belly” or the intermediate (3-7 years) part of the Treasury yield curve remains attractive, as the short-end faces reinvestment risks with Fed rate cuts and long-end yields, which depend on the economy and fiscal deficit, potentially remaining elevated. 
• The municipal yield curve continues to be barbelled, where overweighing both the short- and long-end of the curve can produce a duration-neutral exposure with higher yields. 
• In the spread sectors, high quality securitized loans and asset-backed securities are relatively attractive, as corporate credit spreads tightened in 2024. 

Gold and Bitcoin reached all-time highs in 2024 and may continue to benefit from global central bank demand and supportive policies toward digital currencies in the U.S., respectively.

In addition to hedged and digital assets, private markets can provide additional diversification and relative stability during economic downturns (Figure 8). Thanks to the emergence of investment vehicles designed for wealth management, private assets are no longer just synonymous with long-lockups, capital calls, and prohibitively high minimums. With these vehicles, investors of every accreditation level have options to invest fully on day-one, with more favorable terms of liquidity and minimums. 

Figure 8: Alternatives can protect returns during economic slowdowns

 Source: CAIS

• Heading into the third year of the stock market rally where returns were historically mixed: private equity – including venture capital – can benefit from policy and capital market tailwinds, as M&A and IPO activities pick up. 
• In private credit: while private corporate lending has offered reliable returns to investors over the last five years, spreads have also tightened. Security selection within corporate credit, securitized loans, real-estate debt, and asset-backed securities can enhance yield and serve as an alternative to public fixed-income. 
• Commercial real estate valuation has remained depressed at historical lows for over two years, presenting opportunities for long-term investors, given its longer cycles of 15-20 years. As market activity gains momentum and inventory remains constrained, real estate lending in select sectors, geographies, and special situations involving performing properties offers the potential for compelling returns and valuable tax benefits.
• Last but not least, infrastructure may be the fastest-growing alternative asset class in 2025, with favorable policy and secular (energy transition and AI power gap) tailwinds, as well as the ability to protect against inflation long-term. Private infrastructure has also been the most underinvested alternative in wealth management, as access to it was primarily limited to institutional investors. 

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For 2025, we look to strengthen portfolios with security selection via active strategies, volatility management, and additional diversification – as exemplified by our approach with the Farther Dynamic Asset Allocation Portfolios. 

We invite you to connect with your Farther advisor for any questions related to our 2025 Market Outlook.