Monthly Investment Letter: What we will be watching over the holidays

In our Year Ahead outlook, we detailed how we believe investors should prepare for 2025, including positioning for lower interest rates and for more upside in US stocks and in gold, and selling the US dollar on further strength.

While we remain confident in our base case projections, with equity markets rallying against a backdrop of the new US administration taking shape, political turmoil in the core of Europe, and promises of increased economic stimulus in China, we should not lose sight of the wider range of outcomes.

In this letter, we will share what data points we will be watching and evaluating against our base case. In keeping with my tradition, I also include my annual list of New Year’s resolutions for your portfolio in 2025.

Trade is likely to be one of the fastest-moving areas of US policy. Since my last letter, President-elect Donald Trump has threatened tariffs on China, Mexico, Canada, and the BRICS countries. At the same time, the nomination of Scott Bessent as Treasury Secretary has raised optimism about a more transactional and pragmatic approach. In our base case, we expect selective (rather than universal) tariffs—enough to hurt individual countries and sectors, but not so large as to knock the US economy off track.

European political uncertainty is high following the respective collapses of the French government earlier this month and the German government in November. At the same time, market expectations for Europe are low, so we see scope for an upside surprise in Germany following its election in late February. Our base case is for a steady improvement in Eurozone consumer spending as inflation and interest rates fall and income growth stays solid.

Chinese markets have rallied again following recent announcements that suggest a greater commitment to fiscal policy easing. We will watch for more concrete details to assess whether stimulus measures will be sufficient to offset structural and external challenges. Following the conclusion of the Central Economic Work Conference, the next potential policy catalyst is the National People’s Congress in March.

We will also closely monitor the Federal Reserve’s last policy meeting of the year, where we expect another interest rate cut. Focus will be on how the Fed views political and economic developments and their potential effect on the path for rates. The Fed has so far signaled its commitment to bringing rates toward “neutral.”

Overall, we see upside for US and global equities in the year ahead. Falling interest rates, decent economic growth, and the structural AI trend remain positive drivers. We forecast the S&P 500 to reach 6,600 by the end of 2025 and see the US as an Attractive market. We are Neutral on European and Chinese equities, though we like the diversified Asia ex-Japan market.

Outside of equities, we like quality fixed income and expect the 10-year US Treasury yield to decline modestly. In currencies, we believe the US dollar’s valuation is stretched and recommend selling on further strength. We also expect gold to continue its rally.

US trade policy: Universal or selective?

With the Trump administration taking shape, in the coming weeks we will monitor for any progress in negotiations between the US, Canada, and Mexico and for signs of how far the administration is willing to go with trade tariffs more generally.

Within the last month, President-elect Trump has threatened to impose new punitive tariffs on all imports from Mexico, Canada, and China. While the threats against China were not unexpected, large tariffs on Canada and Mexico are more worrying from an economic perspective. Large taxes on key US imports like crude oil or softwood lumber would risk increasing US consumer inflation—and higher food and fuel prices would be highly visible to US consumers.

Nevertheless, we believe that the threats against Mexico and Canada are primarily targeted at solving non-trade-related issues (such as drugs and migration). So these threats are more tactical rather than strategic in nature, in our view. We’ll be looking out for progress on bilateral drug and migration policy, leading to trade threats being dialed down.

More generally, Congressional Republicans and the administration are exploring the idea of levying new tariffs and using the income to offset the loss of revenue from extending the 2017 personal income tax cuts. They could do this formally through budget reconciliation or informally if they settle on a higher budget deficit.

In our base case, we expect selective, rather than universal, tariffs to be levied. While these would have a negative impact on individual sectors and countries—including the US—we do not believe they would derail the US economy’s growth momentum.

Universal tariffs are less likely, in our view, because of the higher cost to the economy and financial markets. Even if the Trump administration were to implement blanket tariffs through executive action, they would likely face legal challenges. Pursuing widespread tariffs through Congress would be most legally expedient, but we doubt there is enough support to approve them.

In last month’s letter, we assigned an only 25% probability to a universal tariff scenario. This is also due to the notion that President-elect Trump has been known to use the level of the stock market as a barometer for his success as president. If in the weeks ahead we see further evidence that his administration is willing to adjust policy in the face of market volatility, it would be a long-term bullish signal for stocks, in our view.

The relatively low probability of universal tariffs and the potential for policy adjustments if they are taken negatively by the market keep us positive on the outlook for the US economy and US equities. Pronouncements in the coming weeks are likely to give us greater clarity about our base case, or whether the risk scenario is becoming more likely.

Europe: Can it beat low expectations?

Earlier this month, the French government lost a vote of no confidence and broke up, less than a month after the German government also broke up. Now, without governments in place, France cannot progress measures to address its deficit (close to 6% of GDP) and Germany cannot implement measures to boost investment.

In our base case, we expect modestly stronger economic growth in Europe in 2025. Household balance sheets are strong after years of high savings rates, inflation and interest rates are falling, and the labor market has been resilient. At the same time, this political upheaval and limited budgetary flexibility, as well as competition from China, trade uncertainties, and the Russia-Ukraine war, are weighing on consumer and business confidence.

While a definitive path forward for France may be hard to find in the weeks ahead, we believe the German election on 23 February could open the door to economic reform and higher public spending, both of which could bolster business confidence. New stimulus in China or a ceasefire in the Russia-Ukraine war could further improve conditions.

We remain watchful of French government borrowing costs. But while they do indicate longer-term credit concerns for France, they are not at levels that indicate a near-term or wider crisis, in our view.

China: More concrete announcements?

Chinese equities have been volatile since September, with markets oscillating between optimism about new stimulus and fears about a debt-deflationary spiral. Markets have rallied recently following announcements at the December Politburo meeting that suggested a “more proactive fiscal policy” and that monetary policy will shift from a “prudent” to a “moderately loose” stance.

In the weeks and months ahead, we’ll be watching for details of concrete policy measures that could support a more sustained rally. December’s Central Economic Work Conference confirmed the easing stance announced at the Politburo meeting, but substantive measures may not be unveiled until the National People’s Congress in March.

For now, absent more concrete measures, we believe a Neutral position on Chinese stocks is appropriate, and we expect the Chinese yuan to depreciate further. We maintain our barbell approach within Chinese equities, favoring defensive, high-yielding sectors balanced against a lighter allocation to leading internet companies.

While stimulus promises are encouraging, external headwinds (including tariffs) represent a challenge. And after a strong rally since early September, China equities are no longer abnormally cheap. The Hang Seng index has erased some of its post-US-election losses, suggesting tariff risks have been at least partially priced out. On a valuation basis, MSCI China currently trades at a 12-month forward price-to-earnings ratio of 10.3 times—not demanding relative to its historical average, but well above the recent post-election low of 9.6 times.

Central banks: What will they signal for the policy outlook?

Recent data suggests US consumer spending remains healthy. Retail sales rose by more than expected in October, and Black Friday and Cyber Monday spending reached new records this year. But at the same time, the Fed has signaled its commitment to bringing rates toward “neutral,” and we expect inflation to moderate toward the central bank’s 2% target in the months ahead as shelter inflation slows. Tariffs may cause a one-time increase in the price level, but we would not expect them to trigger the kind of sustained higher inflation that would lead the Fed to stop cutting rates.

Consistent with this, in our base case, we expect the Fed to cut rates by 25 basis points at its December meeting and by a more gradual once-per-quarter pace in 2025. Signals from the Fed that could reinforce this base case would be a bullish signal for markets, whereas signs that economic data or policy changes are shifting the Fed’s calculus toward a more hawkish stance would likely lead to volatility.

Elsewhere, we also expect the global rate-cutting cycle to continue well into next year. By the end of 2025, we anticipate a further 100 basis points (bps) of cuts from the European Central Bank as it seeks to revive a weak Eurozone economy. We also forecast the Bank of England to deliver a further 100bps of rate cuts and the Swiss National Bank to cut 25bps more, after its surprise 50bps cut at its December meeting.

What does it all mean for investing?

In the weeks ahead, we’ll be watching for signals from the Trump administration, the Fed, and China’s leadership. Signs that the US administration is sensitive to market volatility and that the Fed remains committed to bringing interest rates down toward a “neutral” level would reinforce our base case view that US stocks have further to run. Meanwhile, more concrete economic stimulus announcements from China or signs of emerging political stability in Europe could enable other global markets to join the US rally.

Against this backdrop, we recommend the following investment ideas:

Position for lower rates

• With returns on cash likely to erode further in the year ahead, we recommend that investors consider quality bonds, diversified fixed income, and equity-income strategies as ways to sustain portfolio income. We believe investment grade bonds offer attractive yields and expect mid-single-digit returns in US dollar terms.

More to go in stocks

• We remain watchful for tariff risks, but with US growth still robust, the Fed likely to cut interest rates, and the structural AI story still playing out, we see further upside for US equities. Elsewhere, we like the Asia ex-Japan market, including Taiwan and India. In Europe, while political uncertainty remains high, we like Eurozone small- and mid-caps, the health-care sector, and quality dividend stocks in Switzerland.

Transformative innovation opportunities

• We continue to believe that artificial intelligence will prove to be one of the biggest investment opportunities of the decade. We expect high rates of investment to soon be followed by growth in applications, and we expect companies across the AI value chain to generate more than USD 1.1 trillion in revenue by 2027. AI advancements, alongside the decarbonization trend, are also boosting electricity demand, and we believe the investment opportunity in power and resources is set to grow in the years ahead.

Sell further dollar strength

• While the US dollar may stay well bid in the near term and could rally strongly if the Trump administration’s approach to tariffs is more aggressive than expected, we believe its valuation is now stretched, and upside surprises in Europe could support a stronger euro. We recommend investors use periods of further dollar strength to reduce US dollar exposure through strategies such as hedging dollar assets, switching USD cash and fixed income exposure to other currencies, and through options.

Go for gold

With political and geopolitical risks likely to stay high in the year ahead, and interest rates coming down, we expect gold to build on its gains in 2025, further supported by ongoing central bank reserve diversification. We also see long-term opportunities in copper and in other transition metals as demand increases alongside rising investment in power generation, storage, and electric transport.

Time for real estate

• We believe the outlook for global residential and commercial real estate investments is bright. With constrained supply and rising demand, we see opportunities in sectors including logistics, data centers, and multifamily housing. Investors should focus on quality assets and strategic diversification to capitalize on these favorable market dynamics.

New Year’s portfolio resolutions

1. Put cash to work

A new year is a great time to engage in a portfolio review and put spare or idle cash to use. Since 1945, stocks have outperformed cash in 86% and 100% of all 10- and 20-year holding periods, respectively, and by more than 200 times overall. And with interest rates poised to fall further, the imperative to put cash to work is likely to increase in 2025. Investors can make portfolio income more durable by switching excess cash into quality fixed income, diversified fixed income strategies, or equity income strategies.

2. Strengthen your core

We recommend that investors establish a well-structured “core” portfolio, diversified across asset classes, geographies, and sectors, which can deliver compounded returns over time. We expect positive returns across all major asset classes over the next 12 months, and such a core can provide investors with the confidence that their financial goals are accounted for while freeing up time and mental energy.

3. Diversify with alternatives

A new year often involves trying something new, and including an allocation to private equity, private debt, private infrastructure, and/or private real estate in portfolios can enable investors to diversify sources of return and potentially enhance portfolio growth. Exposure to alternative assets can also help smooth overall portfolio returns, as these investments may exhibit lower correlations to traditional assets. They also feature unique risks, however, such as illiquidity and a lack of transparency.

4. Optimize your leverage

Classic lists of New Year’s resolutions often include paying down debt. But while borrowing is risky, for high-net-worth investors, we believe that proactive, prudent, and strategic borrowing can enhance an investor’s financial plan, especially as interest rates fall. If managed correctly, borrowing can improve financial flexibility, reduce the need to hold excess cash, manage currency risks, and boost return potential.

5. Be active

The investment industry has undergone a passive revolution in recent years. But being more active in the new year can improve potential returns. In equities, passive investments may be too broad to navigate some markets, including small caps, emergent growth themes, or emerging markets. Meanwhile, in bonds, the complexities of managing weights, maturities, cash flows, duration risk, interest rate risk, and credit risk mean that actively managed funds can often offer greater convenience and superior risk management than single bond portfolios.

6. Go sustainable

Investors can also consider going sustainable in the new year with some of their portfolio. All major asset classes, including equities, bonds, hedge funds, and private markets, now offer sustainable options, which have historically shown similar risk and return characteristics to traditional investments. While some politically induced volatility is likely, we believe that the longer-term performance of diversified sustainable investing strategies will be driven more by investment fundamentals and the macro environment than by politics.

Whatever your aspirations for the coming year, I hope these resolutions can help you build a robust portfolio for 2025 and beyond.

We wish you a happy holiday season and a prosperous year ahead.

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