- Head of Multi-Asset Strategy
United States, Intermediary
Change
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I’ve updated my annual 10-step checklist to help allocators chart a path for the year ahead. As a believer in process, I think creating and reviewing a checklist every year is a good way to define and document priorities, which in turn paves the way for greater focus and impact. As I work through each step of the checklist below, I propose a set of key takeaways that I hope can help any asset owner set an agenda for 2025.
2. Consider your opportunity set
3. Assess the near-term outlook
4. Try to understand the market consensus
5. Consider possible surprises
7. Spend some time in the alternatives world
8. Rouse your inner risk manager
1. Review the trailing year
In Figure 1, I’ve highlighted areas that worked in 2024, with the green checkmarks indicating a repeat from 2023. It was another strong year for many equity markets. Some higher-risk/higher-return areas in fixed income, including high yield and emerging market debt, also did quite well. Gold and Bitcoin did even better in 2024 than in 2023 (hence the double checkmark). One standout in the equity market that wasn’t a repeat is China, which rallied back from a challenging 2023.
The list of what didn’t work the past two years — at least on a relative basis — includes duration, emerging market equities, and commodities broadly. US small caps and broad US equities again trailed the Magnificent Seven by a wide margin in 2024, though they closed the gap compared with 2023.
Figure 1
There were also a few surprises and lessons learned in 2024:
Markets can rally even if the Fed disappoints. We started 2024 with six rate cuts expected in the first half. We ended up with none in those six months, as the Fed held off given moderating inflation and solid growth, and yet the stock market did well.
The US election was less of a market event than expected. The market anticipated the result relatively well and it was not a major source of volatility.
Mean reversion can be delayed for an extended period. We saw trends continue in areas like value/growth and large cap/small cap, seeming to defy rules of thumb (a topic I discuss here).
Key takeaway: Be prepared for a world where current trends continue into 2025 (even if you expect them to reverse in the long term).
2. Consider your opportunity set
Let’s turn our attention to longer-term opportunities. Allocators may want to consider this from several vantage points:
Capital market assumptions — Figure 2 shows the intermediate (10-year) capital market assumptions (CMAs) developed by our Investment Strategy & Solutions Group, as of 30 September 2024 (updated CMAs will be available later in January and are available upon request). We expect the strongest returns in non-US equities, emerging market equities, and private equity. We expect the US to have the strongest earnings growth globally but think the market will underperform as a result of valuations and dividend yields. I’d note that because the US has a large weight in global equity indexes, it drives down the global equity return expectation, and that in turn drives down private equity. On a relative basis, the fixed income expectations look attractive thanks to today’s yield environment.
Figure 2
We also used these CMAs to calculate the 10-year expected return for a 60% equity/40% fixed income portfolio (Figure 3). Given the valuation changes we’ve incorporated into our CMAs, we only expect about a 5% return from this asset mix — meaningfully lower than at this time last year and a reason to think about diversification and other potential sources of returns, such as hedge funds (where we see a positive market backdrop as discussed in this recent paper).
Figure 3
Capital scarcity — Allocators should be attentive to areas where capital could be more or less scarce and what that could mean for investment opportunities. Themes I’m watching include deglobalization (need for new factories as production migrates, risk of oversupply in places facing export headwinds); private equity (signs the IPO market is opening up, but risk of less capital from current investors if that doesn’t happen); and private credit (ample supply of capital as investor interest remains strong, but perhaps demand will keep up as companies transform the way they finance themselves). While there are big questions about whether the largest players in artificial intelligence will generate sufficient returns on investment, the capital needed to support AI development remains massive and could be another area of opportunity.
Key takeaway: High valuations should keep investors humble about the long-term outlook for broad asset classes and portfolios. Now is the time to plan for more challenging long-term prospects.
3. Assess the near-term outlook
It’s a good idea to start the year with a view on where we’re headed in the near term. After starting 2024 with a relatively neutral view on the next 6 – 12 months, our Investment Strategy & Solutions Group closed it out with somewhat more decisive directional views, including moderately overweight views on global equities and commodities, the latter of which is expressed largely through our view on gold. We have a couple of notable relative views as well, favoring US over European equities and European government bonds over US government bonds. Read more on our latest views here.
As we evaluate our tactical views moving into 2025, we’ll be focused on:
- US decisions on tax cuts, regulation, tariffs, immigration, and fiscal policy
- The Fed’s efforts to balance inflation and growth objectives
- Europe’s ability to weather political and economic challenges
- The impact of recent stimulus on China’s economy
- Credit market conditions and whether they’re as good as they’re going to get
- Gold’s ability to remain an appealing store of value
Key takeaway: Despite more muted long-term expectations, the near-term outlook remains upbeat.
4. Try to understand the market consensus
Another useful exercise, especially for allocators with a longer-term horizon, is gauging the views already being priced in by the market. Currently, I think there’s an assumption that in 2025 we will see some of the same trends we saw in 2024:
- The US leading the world in economic growth
- Inflation continuing to decline toward central bank targets
- The Fed continuing to ease, albeit more slowly
- US equity valuations still stretched but justified by rapid earnings growth
- The 10-year Treasury yield remaining relatively range-bound
- Value investing remaining largely broken
- Private equity and credit offering investors a meaningful illiquidity premium
- China facing persistent economic headwinds
- Europe challenged by the Ukraine war, energy needs, a lack of innovation, and politics
Key takeaway: Markets are already assuming continuity, so any surprises could be quite unsettling.
5. Consider possible surprises in 2025
This is an exercise made famous by the late Byron Wien, who defined surprises as events to which the average market participant would assign a probability of 30% or less but that he saw as more likely than not (50% or higher probability). My definition is more flexible — events that are generally viewed by the market as unlikely but in my estimation have at least a reasonable chance of occurring. With that, here’s my list for 2025:
1. The White House strikes trade and immigration deals that forestall the imposition of most of the threatened tariffs.
2. US GDP growth outperforms consensus (2.1%) by more than 50 bps.
3. Thanks to robust growth and fiscal restraint, the US deficit shrinks twice as much as projected.
4. Core PCE inflation in the US exceeds consensus (2.3%) by more than 75 bps, driven by higher wages and strong growth.
5. The Fed’s next move is a rate hike.
6. Despite European Central Bank action, Europe enters a recession.
7. US equities experience a peak-to-trough sell-off of more than 20%.
8. Emerging market equities outperform developed markets.
9. Global credit spreads blow out at some point during the year.
10. President Trump launches a Canadian-style immigration system that welcomes skilled workers.
Key takeaway: Be prepared for faster growth, higher inflation, and surprises on the political front. (Though, in the interest of full disclosure, only three of my 10 surprises came to fruition last year, so take all of this with a grain of salt!)
6. Think about the long term
One way to approach longer-term decisions is to consider which trends are likely to persist and which are likely to change. I would put technology leadership in the former category and central banks’ ability to serve as economic stabilizers in the latter category, given stubborn inflationary pressure. We could also see change brought about by geopolitical risks, shifting energy and climate policy (particularly in the US), and the rise of populism.
Allocators thinking about the long term should also consider thematic strategies, which are typically focused on enduring structural trends and, as a result, may be less tied to the economic cycle (read more on thematic allocations here). The left side of Figure 4 lists some of the themes our Next Generation Thematic Team is most excited about, looking out over the next six months or so. The right side includes other themes where they see long-term opportunities (find the team’s research here).
Figure 4
Key takeaway: Beyond capital market assumptions, think about structuring portfolios to take advantage of long-term opportunities and sidestep long-term risks.
7. Spend some time in the alternatives world
Alternatives represent a significant area of exposure for many allocators and warrant a dedicated review to begin 2025.
Hedge funds — As a colleague and I discuss in a recent paper, we appear to be in an environment marked by higher macro volatility, higher security-level dispersion, and higher interest rates — all of which could be positive for hedge funds. If this coincides with a period in which stocks and bonds are more correlated, it could make the uncorrelated returns offered by some hedge funds even more valuable.
Private equity — Private equity still has a role to play, but it’s worth thinking about the “tax” on leverage from higher/rising interest rates, which can make it harder to get deals done — as could high valuations in the US, particularly for the LBO space. With this in mind, I think PE strategies with little or no reliance on leverage may have a better investment opportunity set today. In addition, if allocators pull back somewhat from private equity, the resulting capital scarcity, as noted earlier, could create attractive opportunities.
Private credit — This is where we could see the flipside of the higher interest-rate challenge facing LBOs, as refinancings may drive some transfer of value from private equity holders to private debt holders. However, allocators should be attentive to the risk of crowding in areas of private credit that have grown at high rates for an extended period. This is also a relatively new asset class that has really not been through a period of significant market stress, which argues for remaining very focused on managers’ underwriting standards, use of leverage, and ability to be opportunistic if the asset class does face challenges down the road. Lastly, I think allocators should spend some time considering the blurring lines between public and private markets, including collaborations between public and private lenders and strategies that try to toggle between the two markets depending on where opportunities are most interesting.
Key takeaway: Alternatives may have a more prominent role to play in portfolios going forward, but make sure your approach is up to date for the current backdrop.
8. Rouse your inner risk manager
At the top of my “risks to watch” list for 2025 is duration risk, given the potential for the policies of the new US administration to drive inflation higher and/or increase the term premium; equity market vulnerabilities, including high valuations and benchmark concentration (read more on the latter in our Factor team’s new paper); geopolitical and trade volatility; and economic and political challenges in the euro area.
I would also highlight a few risks that market participants may be overlooking. They include US duration (Macro Strategist Mike Medeiros suggested in an earlier Top of Mind article that a Republican sweep in the US election could lead to a 6% yield on the 10-year US Treasury); shifts in the energy market driven by Trump policies that alter supply and spur responses from other global producers; and the possibility that the performance of the Magnificent Seven weakens (which could of course be a positive for the broader market).
How can all of this be brought into a risk-management process? I’d suggest two approaches. The first is scenario analysis — sketching out scenarios for how some of these things could go awry and trying to understand what that means for a portfolio. The scenarios we’re modeling in our own work include “America unplugged” (the impact of American isolationism); “Victory over inflation” (the impact of central bank success and what it means for interest rates); and a “US soft patch” (a classic recession in the US).
The second approach is stress-testing portfolios with some extreme outcomes — e.g., a 20% decline in the S&P 500, a sudden spike of 100 bps in the 10-year Treasury yield, or a stock/bond correlation of 0.75 or higher. If allocators are comfortable with the results, they’ll be better positioned to manage through such a scenario. If not, it may be an opportunity to do some hedging or adjust current allocations.
Key takeaway: Focus on risk management heading into 2025 and look beyond equities to include potential interest-rate risks.
9. Evaluate your liquidity picture
Is there a potential economic or market outcome that could change liquidity needs in 2025 — perhaps related to a market crisis, a credit event, or shifting private asset flows (a topic I discuss here)? Have there been any changes in strategic priorities that might alter liquidity needs or are there any sources of unexpected liquidity demand ahead (e.g., regulatory changes)? I think allocators should regularly stress test one- and three-year liquidity needs, and I offer a framework for testing liquidity in normal and stressed conditions here.
Key takeaway: Liquidity stress-testing should be an evergreen agenda item for allocators.
10. Set a finite number of 2025 priorities
As a final step, I think allocators should narrow their priorities to a manageable list for 2025. I would propose several possibilities:
- Review strategic asset allocations (SAA) — As noted, our CMAs have changed, which might suggest it’s time to review allocations in line with where markets are expected to be over the next 5 and 10 years. It may also be a time to review the SAA process itself. We’ve given a lot of thought in recent years to optimization techniques, the role of hedge funds and privates, and other SAA best practices, and would be glad to share our views.
- Have a game plan for the end of the bull market — The bull market may not end in 2025, but it will eventually. I’m not necessarily suggesting a market-timing exercise, but I think it’s at least worth considering steps that could be helpful once the cycle shifts, including rebalancing and taking advantage of opportunities that emerge.
- Seek ways to increase dynamism — Given some of the market dynamics I touched on earlier, it may be a time to position portfolios to be more nimble. That might include employing tactical asset allocation, dynamic or rotational bond or equity strategies, global macro and other hedge funds, or currency strategies.
- Create governance for a more volatile world — Finally, coming off two strong and relatively stable years for markets, I think allocators should take a fresh look at their governance structure and ensure it’s built to navigate a potentially more volatile environment in the year ahead. Even if 2025 ends up looking a lot of like 2024 and 2023, it doesn’t hurt to think about what a shift could look like and prepare stakeholders for it.
Key takeaway: Whether you take some of my priorities or set your own, start the year with a few specific objectives around investment policy.
A final note: I hope this checklist is helpful. If we can be a thought partner on any of the topics discussed or your specific objectives, we would welcome the opportunity for an in-depth discussion.
Important disclosures: Capital market assumptions
Intermediate capital market assumptions reflect a period of approximately 10 years. If we developed expectations for different time periods, results shown would differ, perhaps significantly. Additionally, assumed annualized performance and results shown do not represent assumed performance for shorter periods (such as the one-year period) within the 10-year period, nor do they reflect our views of what we think may happen in other time periods besides the 10-year period. The annualized return represents our cumulative 10-year performance expectations annualized. The assumed returns shown do not reflect the potential for fluctuations and periods of negative performance.
This analysis is provided for illustrative purposes only. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares, strategies, or other securities. References to future returns are not promises or even estimates of actual returns a client may achieve. This material relies on assumptions that are based on historical performance and our expectations of the future. These return assumptions are forward-looking, hypothetical, and are not representative of any actual portfolio, or the results that an actual portfolio may achieve. Note that asset-class assumptions are market or beta only (i.e., they ignore the impact of active management, transaction costs, management fees, etc.).
The expectations of future outcomes are based on subjective inputs (i.e., strategist/analyst judgment) and are subject to change without notice. As such, this analysis is subject to numerous limitations and biases and the use of alternative assumptions would yield different results. Expected return estimates are subject to uncertainty and error. Future occurrences and results will differ, perhaps significantly, from those reflected in the assumptions. ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY AND AN INVESTMENT CAN LOSE VALUE. Indices are unmanaged and used for illustrative purposes only. Investments cannot be made directly into an index.
This illustration does not consider transaction costs, management fees, or other expenses. It also does not consider liquidity (unless otherwise stated), or the impact associated with actual trading. These elements, among others, associated with actual investing would impact the assumed returns and risks, and results would likely be lower (returns) and higher (risk).
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Monthly Market Review — October 2024
A monthly update on equity, fixed income, currency, and commodity markets.
By
Brett Hinds
Jameson Dunn