A continued winning streak for equities
US stocks have just concluded their best two-year stretch in 25 years, as 2024 marked the second straight double-digit percentage return for the S&P 500 (all market return data in sterling terms). The tech-focused Nasdaq Composite fared even better, rising 31%, its fifth year of returns above 20% in the past six years. The performance of other stock markets has been more mixed. In Europe, Germany was the biggest gainer with a 13% gain, while France ended down 7% – the only major market other than Korea to post a negative return in 2024. The performance of US stocks has been slightly less assured in the first few days of 2025. Economic data has been mixed: the Atlanta Fed revised down its estimate of fourth-quarter US GDP, from 3.1% to 2.6%, although the ISM manufacturing PMI reached a 9-month high in December. Mixed news for several large companies, including Apple and Tesla, has also weighed on broader sentiment.
US economic strength weighs on bonds
2024 was another difficult year for bond markets. The Federal Reserve’s final policy meeting of 2024 spooked investors with the idea that the central bank may be unable to keep cutting rates as planned, because Trump’s return – particularly his proposed tax-cut and tariff policies – could fuel inflation. This is keeping Treasuries under pressure, especially longer-dated bonds. The 10-year treasury benchmark yield now exceeds 4.6% and could continue moving towards the 5% level it last breached (briefly) in October 2023. Over the course of 2024, the yield on the 10-year treasury rose 70 basis points, marking a fourth consecutive annual increase. This is the longest run of rising yields since the 1980s.
Data in focus as Trump takes office
A key question for the Fed will be the strength of the US jobs report for December and whether it is above or below the 143,000 six-month average. In Europe, meanwhile, an uptick in Spain’s inflation rate adds to the data encouraging policymakers at the European Central Bank towards a cautious reduction in borrowing costs. They may take time before cutting interest rates again due to rising energy prices and, if the US introduces trade tariffs, further declines in the euro. Still, ECB President Christine Lagarde reiterated that inflation was on track to hit the 2% target in 2025, suggesting that rates remained on a downward path.
Positioning
The strong performance of equities in recent months leaves us slightly overweight the asset class compared to our long-term strategic targets. We are comfortable with this position, given our view that growth remains robust. Trump’s plans to cut taxes and regulation should also boost US growth in 2025 and 2026. However, given the high degree of uncertainty about US policy in a range of areas, we are prepared for higher volatility. We currently have a neutral stance on fixed income, given more attractive opportunities in equities and uncertainty about the outlook for interest rates. As in 2024, we will take advantage of tactical opportunities as rate expectations evolve. We remain underweight alternatives, which look relatively less attractive in today’s interest rate environment. Having said this, we still like alternatives that can provide inflation protection, including commodities and gold.
Key
Positive
Positive/Neutral
Neutral
Negative/Neutral
Negative
Outlook
| Economics | US growth remains robust. The consumer is in good shape and labour markets are cooling rather than collapsing, whilst business sentiment is improving.The outlook for Europe and EM is more challenging. Europe’s manufacturing sector faces headwinds, whilst China is struggling to reignite domestic demand. Headline inflation is close to target, but core inflation is likely to remain above central bank targets. Risk is to the upside for the UK, Europe and US.Market expectations for interest rates are close to fair, with this year likely to mark the end of this easing cycle. |
| Valuations | US mega cap equities remain expensive based on traditional metrics, but fundamentals are strong. Most other regions look fair value vs history, but expensive vs cash and bonds.Earnings growth estimates remain positive and negative revisions have slowed. Earnings strength is expected to broaden out beyond US mega caps this year.Credit spreads – the difference in yields relative to government bonds – have largely retraced August’s widening and remain expensive relative to history. |
| Sentiment | Sentiment towards equities has cooled and market breadth has narrowed again.The continued strength of US mega-caps has increased the divergence vs non-US markets further, although US stocks have fallen slightly from highs.Non-US markets have mostly been weak over the last few months.Volatility (based on US stocks) is elevated, having risen to 4-month highs in December, but remains below long-term averages. |
| Risks | A resurgence in inflation, which would warrant continued hawkish central bank policy.Labour market weakness could challenge the developed market growth outlook. Potential spillover effects from slowing growth in China on the global economy.Escalation in geopolitical tensions, e.g. Middle East, Russia/Ukraine, US/China.Mounting levels of government debt, particularly in the US, pose a longer-term risk.Tariffs under a Trump presidency could pose further challenges to global growth.Political instability. |
Asset Classes
| Asset classes | Current positioning | Current views |
| Equities | | Benign growth coupled with falling interest rates should be positive for equities, whilst Trump’s pro-growth agenda should be positive for US firms in the near-term. Earnings remain reasonable, particularly for the US and Japan. US mega cap valuations are expensive vs history (albeit with strong fundamentals) whilst other regions and smaller US companies are fair value. Sentiment has cooled from ‘overbought’ levels, which is generally a healthy sign. |
| Bonds | | Although central banks are cutting interest rates, government bond yields look attractive relative to the last decade. Given the recent increase in market interest rate expectations (now close to fair value), we have taken profits and increased duration closer to neutral. After a run of strong performance, we have also reduced our emerging market debt exposure. Across the credit spectrum spreads look tight (expensive), so we prefer more defensive positioning such as asset backed securities and short duration high-quality credit. |
| Alternatives | | Select alternatives continue to offer diversification in a potentially volatile environment, albeit with a higher hurdle given yields available on bonds and cash. We favour assets with the ability to deliver less correlated returns to traditional markets and those which hedge against risk scenarios, such as gold and other commodities. |
| Cash | | Although some central banks have started reducing interest rates, they remain attractive relative to recent history. Additionally, cash allows us to take advantage of tactical opportunities in potentially volatile markets. |
Equities
| Asset | Current positioning | Current views |
| Equities | | Benign growth coupled with falling interest rates should be good for equities, whilst Trump’s pro-growth agenda should be positive for US firms in the near-term. Earnings remain reasonable, particularly for the US and Japan. US mega cap valuations are expensive vs history (albeit with strong fundamentals) whilst other regions and smaller US companies are fair value. Sentiment has cooled from ‘overbought’ levels, which is generally a healthy sign. |
| US | | Domestic growth remains robust, and the election result is supportive, as corporate tax cuts and deregulation will be beneficial for many firms (particularly domestic firms). Inflation has fallen closer to target, but the imposition of tariffs poses a risk. Valuations still look expensive, but this is concentrated in the mega caps and these companies typically have stronger fundamentals. |
| Europe | | Consumer confidence has fallen, whilst manufacturing remains weak. Political risk is elevated and rising, whilst proposed tariffs under a Trump presidency are a risk for exporters. Given the risks, favour targeted exposure rather than broad market. |
| Japan | | Japanese earnings are robust, beating expectations and delivering growth, whilst valuations are now below historical averages. Sharp yen moves have created market volatility, however monetary policy is expected to normalise slowly alongside signs of sustained inflation and wage growth. Corporate governance reforms are accelerating and remain supportive. |
| Asia/ Emerging markets | | In China, weak domestic consumption and troubles in the property sector have led to a deterioration in economic data. Stimulus measures are likely not yet sufficient to reignite domestic consumption. Tariffs under a Trump presidency could also cause further headwinds to the Chinese economy. However, sentiment is at lows and valuations are cheap. Elsewhere, growth prospects look more robust, whilst valuations are reasonable. |
| UK | | An improvement in business and consumer confidence has been stalled by the budget, but growth should improve modestly over 2025. Headline inflation has returned to target, but stronger demand may add to inflation. This is likely to prevent the Bank of England from cutting interest rates much further. Valuations are cheap, unlike most other developed markets. |
Bonds
| Asset | Current positioning | Current views |
| Bonds | | Although central banks are cutting interest rates, government bond yields look attractive relative to the last decade. Given the recent increase in market interest rate expectations (now close to fair value), we have taken profits and increased duration closer to neutral. After a run of strong performance, we also reduced our emerging market debt exposure. Across the credit spectrum spreads look tight (expensive), so we prefer more defensive positioning such as asset backed securities and short duration high-quality credit. |
| Government bonds | | Yields remain attractive relative to the last decade, but we remain cautious that investors are not being paid well, relative to history, to extend duration, particularly in the US or Europe. Whilst market expectations for interest rate cuts are currently close to fair value for the UK and US, they still look excessive for Europe. Uncertainty around US government borrowing and central bank independence also poses a risk to US yields. |
| Credit | | Absolute yields continue to look attractive, but spreads are less supportive at current levels. We prefer shorter-duration and higher-quality (investment grade) corporate credit, as well as higher quality asset backed securities where we feel relative valuations are attractive given the strength of the consumer. |
| Inflation-linked | | Many developed market real yields remain in positive territory; however, market inflation expectations have moved higher. Whilst we expect inflation to exceed central bank targets, this is now priced into bond markets and so we have reduced exposure to inflation linked bonds. |
| Emerging markets | | Emerging market growth prospects look relatively robust compared to developed markets. While developed market central banks are cutting interest rates (generally a positive for emerging markets), this is already priced into markets. Given their recent strong run, valuations now look elevated vs history. |
Alternatives and cash
| Asset | Current positioning | Current views |
| Alternatives | | Select alternatives continue to offer diversification in a potentially volatile environment, albeit with a higher hurdle given yields available on bonds and cash. We favour assets with the ability to deliver less correlated returns to traditional markets and those which hedge against risk scenarios, such as gold and other commodities. |
| Absolute Return | | Select opportunities in equity long/short and trend following strategies given diversification characteristics. However, government bonds are now looking more attractively valued and may provide a better source of portfolio diversification over the medium term. |
| Liquid private real assets | | Long-dated revenue streams and income characteristics remain attractive in select parts of the market. We see good opportunities in renewables, infrastructure, specialist property and exposure to private companies. Valuations are more attractive following recent market volatility. Falling rates are supportive for the sector. |
| Commodities | | Broad commodities can hedge against further disruption to energy markets, although areas of the asset class are sensitive to slowing economic growth, particularly in China. Increasing demand from infrastructure spend and energy independence goals could support metal prices against a backdrop of tight supply. |
| Gold | | Gold should act as a hedge against growth or inflation shocks, as well as a further escalation in geopolitical tensions. Central bank buying is a long-term support, as is weakness in China’s property market, but strong performance over the last year may result in temporary pullbacks. |
Terms
Spread: the difference in yield between a non-government and government fixed income security.
Duration: approximate percentage change in the price of a bond for a 1% change in yield.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
