Assumptions overboard: How our rapidly changing world will impact your investments

In 2025, investors will need to question many long-held assumptions about the global economic and investing landscape. After decades of globalisation, multilateralism, and relative geopolitical stability, the outlook has shifted. 

In developed economy elections around the world in 2024—from France to the United Kingdom to Japan to the United States—voters demanded change, as the lingering squeeze from prior years’ inflation ignited a desire to punish incumbents. 

The changing global backdrop could significantly affect prices across asset classes, with elevated dispersion within them. Investors will therefore need to reevaluate likely winners and losers across countries, sectors, and companies. 

What lies ahead for 2025 - and how difficult will it be to forecast what comes next?

Over the last three years, much of the macroeconomic discussion followed a predictable pattern. It began with inflation, which then connected to monetary policy, which then led to contemplation of recession risk and the probability of a soft landing. Through most of 2024, fears related to inflation and recession faded substantially and attention shifted to elections, with the US decision looming largest over the economic outlook. 

I expect the macro discussion to shift substantially toward the effects of the president-elect’s policies. The biggest challenge from a market perspective lies in quantifying the independent effects of potential policy changes and then attempting to understand how these countervailing impacts will interact. For example, economists can estimate the inflationary and growth impacts of increased tariffs, but even these estimates are subject to large error bands. 

Several questions remain unanswered: When will tariffs be applied? Will they be applied all at once, or gradually over time? Which items will they be applied to? Will they be applied uniformly? If not, what will the nuances be? 

Predicting the customer responses to policy changes is also imprecise. For example, if one million undocumented immigrants were deported in 2025, what might that mean to wage growth by sector? How will compensation increases resulting from deportations affect broader price levels? 

Even more difficult to forecast is the impact of broad price-level increases on wage demands in sectors that are not directly impacted by deportations. 

Finally, there is the complexity of measuring the impact that deregulation and lower tax rates could have on the “animal spirits,” or psychology of all market participants. I am elaborating on complexity because I want to emphasise the importance of humility in forecasting the impact of potentially significant policy changes on the economy and markets. 

What are the investment implications?

With that cautionary note in mind, my base case expectation is that inflation will increase moderately in 2025 due to tariffs and modest increases in consumption driven by wealth effects and optimism around perceptions of a more growth-oriented economic agenda. In 2026, I expect further increases in inflationary pressure as immigration policies and tariffs accumulate. 

Bond markets

With this backdrop, I see the US 10-Year Treasury yield moving back toward 5% and the fed funds rate staying at or above 4%. While it might be tempting for investors to extend duration in their portfolios if the 10-year Treasury reaches a 5% yield again, I would caution against any excessive reallocation. 

This is because the shifting policy backdrop could lead to a sustained grind higher in US government financing costs as key policy changes reignite inflation and budget deficits remain elevated. To the extent Fed independence is also called into question against a backdrop of elevated inflation and deficits, rates could rise sharply. 

With trade and immigration policy depressing growth and raising inflation, while deregulation and tax policy increase corporate profitability, I would expect credit spreads to remain tight as recession risk appears low. 

However, if I am wrong, the accumulated uncertainty created by so much change and an escalating global trade war could at some point negatively impact investor psychology, leading to wider credit spreads and perceptions of increased recession risk. 

Put simply, my preference remains to be more exposed to intermediate-duration and higher-quality borrowers rather than reaching for yield in riskier areas, such as the high yield market or leveraged loans, given the outsized risk of an unexpected downturn. 

US stocks

The initial response to the US election was positive as investors focused on the obvious tailwinds to profitability: lower corporate tax rates and less regulation. However, I expect much more dispersion within the equity market when the reality of a much-less-friendly trade environment sets in. 

Some companies, such as those in the financial services and energy sectors, will be less vulnerable to tariffs while others, such as those in the consumer discretionary arena, will be much more susceptible. 

After another year of narrow leadership in the S&P 500 Index, I expect a shift in leadership in the market and potentially a meaningful rotation of capital. To put a finer point on the narrowness, in 2024, the S&P 500 Index rose 26.8% through 25 November. But the median stock was only up 16.8%. Further, only 167 stocks beating the overall index return. 

Within the US equity market, investors might want to examine the opportunity in small cap stocks. After years of underperformance, the sector has been reinvigorated post-election on the back of optimism that smaller companies could benefit from deregulation and lower corporate tax rates, while also being less vulnerable to the negative consequences of a global trade war. 

That said, I would argue in favour of a strategy that takes quality into account, given how many small companies consistently lose money and given that the cost of debt financing is likely to be higher for longer than previously expected, due to the inflationary impact of US trade and immigration policies. In the immediate aftermath of the US election, non-US equities initially underperformed US peers. 

However, 2025 could present an excellent opportunity to add capital in non-US markets as investors recalibrate assumptions regarding the relative winners and losers from the reshaping of global supply chains against an evolving geopolitical backdrop. 

In three of the last five quarters, foreign direct investment into China has been negative, and I expect to see more capital being redirected away from China in the years ahead. 

The main beneficiaries are likely to be other emerging economies for everyday goods, while production of strategic and national security-related goods will increasingly shift back to developed economies. 

With record-high valuation discounts for non-US versus US equities, I believe investors would be well-served by taking another look at which companies are best positioned to benefit from this changing landscape. 

Beyond geography and diving deeper into themes

Looking beyond geography, I continue to believe the two most transformational economic themes in our lifetimes will be the advent of artificial intelligence (AI) and the energy transition. Investors are fully engaged in the AI trade but are increasingly discarding shares related to clean energy. 

I believe a great investment opportunity could be in the making, as climate change continues unabated and the profit opportunity from investing in both mitigation and adaptation grows. In the case of AI, the most attractive near-term opportunity might still be in the market leaders, but I believe it will increasingly shift to the companies that effectively deploy AI into their operations in a way that generates meaningful returns on investment.