Why cautious optimism should be the investing mantra of 2025

2024 looked in many ways like a re-run of 2023. A year of positive investment returns overall, with a strong start and finish punctuated by a soggy summer. In both years, markets responded to changing expectations about inflation and interest rates. But last year, politics was also thrown into the mix and the re-election of Donald Trump was the defining event. 

The biggest mistake in 2024 was not to be bullish enough. As in the previous 12 months, markets were led higher by the US, and in particular the Magnificent Seven tech stocks. Japan performed well, despite a wobble in August. Gold did even better than it had in 2023, but it was still outpaced by its upstart cousin Bitcoin. Bonds were once again a disappointment as the unexpected strength of the US economy kept the Fed sitting on its hands for much of the year. Oil brought up the rear but the other disappointment in 2023, China, bounced back on hopes for further stimulus. 

Share prices were pushed higher by an unusual combination of stronger corporate earnings and rising valuation multiples. Traditionally, valuations move first and then fall back as profits growth emerges. 

When the two move in tandem, as they did in 2024, the impact on markets is powerful. Returns were underpinned by a bullish broadening out from the handful of stocks that fuelled the 2023 rally to a wider group of winners. 

Investment returns across asset classes

What does 2025 hold for investors? 

How a second Donald Trump term shapes up will be one of the key drivers of markets in 2025. So far, investors have responded positively to the new President’s pre-announced policy platform. The expectation is that Trump 2.0 will mean tariffs, tax cuts, immigration curbs, and less regulation. 

That’s not all good for business – it is likely to be inflationary and threatens a more unstable environment for global trade – but it does argue for continuing economic growth, especially in the US. 

At the same time, the fall in interest rates that got underway in the autumn should continue through 2025, even if it is slower and goes less far than was initially expected. Inflation is clearly not beaten yet, but it feels like it is under control. Growth, disinflation and rate cuts are a healthy combination for investors. 

The biggest potential headwind this year is the fact that this good news story is now well understood and has been priced into markets. The equity bull market is increasingly mature. The rise in share prices since the financial crisis is now on a par with the two great bull markets of the post-war years. When shares start this highly valued, future returns have in the past tended to be unexciting. 

Valuations tell us little about the short-term outlook, but they are a good guide to longer-term prospects. The key risks to keep an eye on in the coming months are inflation and trade tensions. There are some striking similarities between the path of inflation in the past couple of years and its trajectory in the late 1960s and early 1970s. Then, as now, it looked as if inflation had been tamed only for it to return with a vengeance. 

As for trade, Trump’s bark may be worse than his bite. But an America First philosophy naturally has negative implications for the rest of the world. 2025 could be another positive year for investors. But the challenge in the months ahead will be to maintain an exposure to the positive growth outlook while managing the increasing risks. 

Diversification is one good way of doing this. Dripping money into the market rather than going all in is another. Maintaining a good cash buffer to cover your expenses, so you are not forced to sell investments after a temporary setback, is one more. Cautious optimism should be the mantra this year.

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Please note that the views expressed in this article are my own.