2025 market outlook: Interest rates, Trump, and AI

As we step into 2025, we picked three major themes that are believed to shape the markets in 2025: Growth, the return of Donald Trump, and the ongoing revolution in artificial intelligence.

Growth, inflation, and rate uncertainty

Towards the end of 2023, investors were convinced that the Federal Reserve would deliver six rate cuts in 2024 as US real GDP growth expectations for 2024 was a mere 1.3% and Core Inflation was coming down rapidly. 

However, 2024 turned out quite different as US real GDP growth is now expected to end up at around 2.7% and inflation has been stickier than expected. We even had episodes during the year (such as August) when the fear of slower jobs (and hence recession) coupled with the unwinding of the yen carry trade created volatility and sharp pullbacks in markets. The market focused on every macro data point and extrapolated growth and hence interest rate expectations.

As shown in the chart below, the market oscillated between expectations of many rate cuts to now much fewer rate cuts and increasingly more participants expecting even a rate hike over the next 12 months.

Heading into 2025, this stance will largely continue. While growth is showing signs of slowing, we think it should be at a manageable, non-shock-inducing pace. However,  volatility in the markets will likely increase as macro and geopolitical uncertainties increase thus we think we should continue to diversify our portfolios and re-assess the risk in our portfolios.

As earnings season kicks off in mid-January, the market will be closely watching for signals about the health of financial markets and the US consumer, as well as any insights from companies about what may lie ahead in 2025.     

Trump is back: What this means for 2025

Trump’s return has been welcomed by some market participants who hope that his pro-growth and pro-business policies, including tax cuts, deregulation, and lower corporate taxes, will boost risk assets such as equities. 

Bitcoin also reached its all-time high in mid-December, driven by investor euphoria as Trump’s favourable stance on cryptocurrency.

However, investors should also consider the potential negative impacts of Trump’s policies on market growth. 

For example, if Trump follows through with his promise to increase tariffs (60% or more on Chinese goods, 25% on Canadian and Mexican goods, and 10% on other imports, although there are also doubts among market analysts that such aggressive tariffs will actually come through), the global economy could face pressure. US households would likely bear the brunt of price increases resulting from tariffs, reducing purchasing power and potentially leading to significant destruction of domestic demand.

China would be heavily impacted by aggressive Trump policies, although it might respond with a large fiscal stimulus to boost domestic demand.

Moreover, US domestic price pressures are likely to intensify further if proposed immigration policies — deportations and reduced inflow — are enacted. Illegal migrants often fill labour-intensive jobs in construction, agriculture, and industrial services, so wage pressures could emerge in these sectors in 2025. 

A worst-case scenario involving mass deportations could lead to a ‘stagflationary’ environment, where a smaller labor force reduces economic activity and potential growth, causing a slowdown or recession while pushing up inflation through higher wage costs for businesses.

Of course, this analysis presents a drastic consideration of the positive and negative impacts of the Trump administration, and the reality is that these effects could occur simultaneously, resulting in varied impacts on the economy. Nonetheless, it is prudent for investors to be aware of the various forces at play.

The future of AI: Continued growth or a bubble?

Just a year ago (which feels like yesterday, oh how time flies), we published our 2024 outlook piece centred around the rise of AI, highlighting its significant impact on US equities, particularly the Magnificent Seven stocks.

Not much has changed since then. Investors and financial media have been shifting their focus from the Magnificent Seven to a new group of stocks named after a Gotham vigilante – the BATMMAAN stocks. This group isn't really entirely new; it's essentially Broadcom plus the Mag Seven stocks (Apple, Tesla, Microsoft, Meta, Amazon, Alphabet, NVIDIA). The BATMMAAN stocks gained attention after Broadcom's market cap surpassed $1 trillion in December, joining the ranks of AI-related mega-cap stocks.

As we carry this déjà vu investment thesis into 2025, investors are still questioning whether this AI-driven mega-cap rally is sustainable, when it will start benefiting small caps, and if it can maintain its momentum in the longer term. 

Much will depend on the broader market environment – for example, Trump’s pro-growth policies and fiscal stimulus, along with the Fed’s monetary easing, could provide the economic tailwinds needed to boost both large and small tech and AI stocks. 

For small caps, some investors view the current valuation levels as more reasonable compared to large caps, suggesting they could benefit more from economic expansion and easing monetary policy. 

However, the critical question remains whether AI will prove to be a long-term disruption worthy of the investor optimism currently priced into stocks like BATMMAAN, or if it will fizzle out like previous hype cycles, such as the metaverse. 

As individuals like you and I increasingly adopt AI in our daily lives, and tech giants ramp up capital expenditure spending on AI infrastructure, some market participants note that the payoff from this spending has yet to be realised so far – AI adoption remains modest across industries. 

Nevertheless, the potential for AI to transform companies, industries, and societies is vast, and the market continues to place its trust in these players to deliver meaningful advancements in 2025.

December & Q4 2024 market update

While equities, fixed income, and commodities concluded 2024 on a positive note, December returns were more tempered as the market navigated ongoing uncertainties around the rate cut trajectory, anticipated policy changes under the incoming Trump administration, and continued optimism around AI.

Global equity market

To the surprise of many investors, there was no Santa Claus rally in the final month of 2024. The global equity market experienced a pullback as the Federal Reserve scaled back the number of interest rate cuts expected in 2025, with sticky inflation remaining a concern. This occurred despite a 25 basis point rate cut in December and strong US economic growth.

The only sector that shined in December was the tech sector, although the rally was concentrated among US large-cap leaders and AI-focused stocks – throughout the year, the median performance of all tech stocks was only a modest 2%. 

Investors are now looking ahead, evaluating the sustainability of the tech rally and the potential for market strength to broaden out to smaller companies.

Despite the subdued December performance, 2024 overall was a strong and memorable year for equity market returns, especially for risky asset classes. The rally throughout the year was fueled by growth expectations surrounding artificial intelligence, anticipated interest rate cuts from the Federal Reserve, and the likelihood of deregulation policies from the incoming Trump administration.

Global fixed income market 

In December, the fixed income markets generally underperformed despite the Federal Reserve cutting rates for the third consecutive time to a target range of 4.25%–4.5%. The Fed shifted to a rather hawkish stance as persistent inflation concerns led Fed Chair Jerome Powell to signal fewer cuts in the future, leaving the path forward uncertain with no additional cuts expected before March 2025.

2024 was a dynamic year for fixed income assets, shaped by fluctuating interest rates, evolving monetary policies, and increasing geopolitical risks.

Overall, the fixed income market mirrored trends seen in the equity markets, with risk assets performing strongly. High yield bonds continued their impressive performance for the fourth consecutive year, driven by elevated yields and tightening spreads.

Emerging markets debt also had a strong run in 2024, though December’s increase in US Treasury yields, ongoing US dollar strength, and a cautious tone from the Fed weighed on their overall returns. In contrast, longer-duration investment grade credit underperformed amid rising government bond yields.

Commodities

Oil prices eased in December as US dollar strength offset hopes for additional fiscal stimulus in China, the world's largest oil importer. Oil prices fell around 3% in 2024, marking the second consecutive year of declines. This was due to a combination of stalled post-pandemic demand recovery, economic struggles in China, persistent tensions in the Middle East, and increased supply from the US and other non-OPEC producers. With a gloomy outlook for rate cuts in 2025, investors are projecting slower demand for oil in the new year. However, the oil supply could tighten depending on President-elect Donald Trump's policies, including those on sanctions.

Trump’s election drove Bitcoin to a new all-time high of $108k at the start of December, although the rally fizzled in the final days of a record-breaking year for the digital asset.

Building a long-term resilient portfolio with Endowus Hong Kong

It is almost impossible to predict exactly how macro events would play out. However, spreading your investments across asset classes and geographies will help with diversifying your risk. With market volatility comes opportunities. If you have a long-term investing horizon, as many of us do, these developments may offer an opportunity through steady, regular investing in diversified and risk-adjusted portfolios.

With digital wealth platform Endowus, you can plan and manage your money — by investing in Best-In-Class Funds and globally diversified, low-cost model portfolios seamlessly.

Click here to get started on your investing journey with Endowus Hong Kong today.

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