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2025 Year Ahead Outlook:
Get ready for what's next
Disclaimer:
Please read important information at the end of this program. Recorded on 11/25/2024.
Chris Hyzy
Hello and welcome. I'm Chris Hyzy and I'm pleased to be hosting this 2025 Year Ahead Outlook: Get ready for what's next.
[LOWER 3rd]
Chris Hyzy
Chief Investment Officer
Merrill and Bank of America Private Bank
So, what's "next?" We see several positive trends gaining momentum in the year ahead, with long-term implications for the economy. Forces like U.S. corporate earnings resilience, more companies contributing to equity returns and the benefits of ongoing interest rate cuts, even if it's more moderate pace. We also expect to see the bond market normalizing after years of volatility. And, finally, we believe disruptive innovation will drive productivity gains across industries.
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Potential positive themes for 2025
- U.S. corporate earnings resilience
- Expanding base for equity returns
- Ongoing interest rate cuts
- Bond market normalization
- Disruptive innovation
Over the shoulder box: "Asset-light" economy
It all adds up to 2025 as a launch pad into a new era of what we're calling an "asset-light" economy — companies less-burdened by heavy fixed costs, such as labor and equipment, with a more nimble workforce and greater flexibility to respond to opportunities and risks.
But there are plenty of questions along the way, such as how the election and the power shift in Washington could affect the economy and markets, the risks of rising geopolitical tensions, and concerns over U.S. debt and deficits.
Today, I'll be speaking with some experts who can help you better understand these and other issues and how best to position your portfolio.
[Graphic card with Aditya Bhave's headshot / title]
Aditya Bhave
Head of U.S. Economics
BofA Global Research
First, I'll be joined by Aditya Bhave, head of U.S. Economics for BofA Global Research.
We'll get his thoughts on the changing policy environment in Washington, geopolitical risk, and the outlook for corporate earnings and the economy.
Chris Hyzy
Aditya, welcome. Thanks for joining me.
Aditya Bhave
Thank you for having me.
Chris Hyzy
Let's first talk about 2024. What were the main drivers of the backdrop? We went into the year with a little bit of consternation, if you will, about soft landing, hard landing, etc. Talk about 2024 from a framework and a foundational perspective.
Lower third:
Aditya Bhave
of U.S. Economics
BofA Global Research
Aditya Bhave
If you start two years ago in 2022, you had about 1% GDP growth, 4.5 million jobs added and 5% inflation. So the conversation back there was stagflation. Are we adding a bunch of unproductive jobs? Since then we've grown at almost 3%, even with slower job growth and inflation has come down that whole time. So, the narrative has really, really changed now to has in fact labor productivity picked up, has it picked up from a structural perspective?
Aditya Bhave
And we've just been very, very impressed with the resilience of the economy driven by the consumer, but also by other parts of the economy where you would want to see growth, such as CapEx.
Chris Hyzy
What does the framework look like for 2025? All things considered?
Aditya Bhave
So we think it's going to be a pretty good year for GDP growth. I mentioned earlier that productivity growth might have picked up, and we think that as a result of that, actually, trend growth is now north of 2%, which is where we expect actual growth to print as well. So, we're looking for 2.3% growth next year on a four q over four q basis.
Lower third:
Expecting 2.3% GDP growth next year on a 4th quarter over 4th quarter basis.
Source: BofA Global Research: Year Ahead 2025, 11/24/24
Aditya Bhave
Inflation might be a little bit above trend. We think it get stuck between 2.5 and 3%. The exact trajectory of inflation will obviously depend on the timing of policy announcements. And there's a lot of things to juggle there, particularly with tariffs and fiscal policy, and we can get into that.
Chris Hyzy
Tariffs.
Aditya Bhave
Yeah.
Chris Hyzy
Let's talk a little bit about that. What kind of impact could we see? Is it still too early?
Aditya Bhave
So thinking about the policy outlook at this point we have to be honest that there is still a lot of uncertainty around tariffs. We would think that the incoming Trump administration means what it says: that tariffs are going to go up significantly.
And that is one of the reasons why we expect inflation to be somewhat elevated next year. But we're looking for a solid year on the growth front with slightly elevated inflation, but not to the point where it's hugely worrying for the fed.
Chris Hyzy
What are the drivers of that overall growth? Is it still the consumer?
Aditya Bhave
Well, the consumer is almost 70% of the economy. So, the consumer is definitely going to be party of the story.
Chris Hyzy
Still the engine?
Aditya Bhave
Absolutely.
Chris Hyzy
You talked about solid growth for 2025. Consumer still stable, decent job market.
Aditya Bhave
Mmmm hmmm
Chris Hyzy
Now let's talk about how could the Fed be cutting in an environment like that? What are your thoughts?
Aditya Bhave
So the fed is still somewhat concerned about the labor market. They've said this many times that they don't really preempt policy. So they're not going to assume a certain tariff rate. They're not going to assume a certain fiscal stance. So for now it's business as usual.
Chris Hyzy
Still data dependent.
Lower third:
Further rate cuts would be based on data, not assumptions.
Aditya Bhave
Yep. Yep. So we think they squeeze in a December cut. Although that's now a very close call. It's going to depend on the jobs report as well as the inflation data that come in during the blackout period. Thereafter we have two more cuts in March and June of next year, for a terminal rate of 3.75 to 4%.
Lower third:
Projecting a terminal Fed rate of 3.75 to 4%.
Source: BofA Global Research: Year Ahead 2025, 11/24/24
Chris Hyzy
So, a more moderate pace than what was originally expected. But that's basically what being data-dependent means, making sure that you are paying attention to the most recent data, but also keeping your eye on their dual mandate.
Aditya Bhave
Right. And the activity data have been remarkably impressive, right?
Chris Hyzy:
Let's talk a little bit about some disruptive technologies. We often talk about generative artificial intelligence to get your quick thoughts on that?
Aditya Bhave
So in terms of AI, what we'd say is just the prep work for AI is very stimulative for the economy. That's so you can look at data around what it takes to build a data center, right? The speed at which the U.S. has been building data centers, and that's probably going to continue.
Lower third:
Prep work for AI, such as building data centers, could be stimulative.
Aditya Bhave
So that's has been stimulative will continue to be stimulative going forward. And then on top of that once we start using AI that could be another leg up in productivity. That's something we don't expect to show up in the macro data in our forecast horizon through the end of 26.
Aditya Bhave
Of course, stocks are already going to price that in, right? And then in terms of onshoring, I think it's something that will continue over time, right. That that seems to be the way global trade is headed. You're going to see more nearshoring to Mexico, particularly, as well as more onshore.
Lower third:
Global trade may see more nearshoring in Mexico and onshoring in the U.S.
Chris Hyzy
Are we still looking at a world where the U.S. stays dominant over the next few years?
Aditya Bhave
I think so. In fact, the divergence between the U.S. and the rest of the developed world has been really, really remarkable since the start of the pandemic. The U.S. had a V-shaped recovery and then some.
Chris Hyzy
Yeah
Aditya Bhave
Right? So if anything trend growth, productivity growth has increased by us, whereas the rest of the world has kind of decelerated relative to its pre-pandemic pace.
Aditya Bhave
The rest of the developed world, I should say. So that, that divergence has, if anything, increased.
Chris Hyzy
That's a great place to end right there, Aditya. Thanks for joining me.
Aditya Bhave
Thank you.
Next, we'll be hearing from Marci McGregor and Matt Diczok, two of our top strategists with the Chief Investment Office.
[Graphic card with Marci McGregor and Matt Diczok headshot and title]
Marci McGregor
Head of Portfolio Strategy, Chief Investment Office
Merrill and Bank of America Private Bank
Matthew Diczok
Head of Fixed Income Strategy, Chief Investment Office
Merrill and Bank of America Private Bank
They offer perspectives on specific asset classes and implementation ideas for your portfolio.
Chris Hyzy
Marci, Matt, thanks for joining me today. Marci, let's start with you. Talk about the base case for 2025 as it relates to the stock market. But also, what are the some of the bigger drivers leaving 24 heading into 2025 that we should expect?
Lower third:
Marci McGregor
of Portfolio Strategy, Chief Investment Office
Merrill and Bank of America Private Bank
Marci McGregor
Yeah. The number one driver I think of market returns as we look ahead to 2025 is corporate profits.
Chris Hyzy
Right.
Marci McGregor
We're in an environment, if you look back to 2023, you had 0% profits growth. This year, in 2024 we're tracking like 9% profits growth. We're expecting that to accelerate into 2025 into double digits. I think that's the anchor of our positive outlook on equities.
Lower third:
Profits may broaden beyond the Magnificent Seven tech companies.
Magnificent Seven includes Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms and Tesla.
Marci McGregor
But I also think it's going to be a year where this profits party broadens out and you get more participation beyond just the Magnificent Seven tech names. And that's a real positive for investors.
Chris Hyzy
And here we are going into another year where we're expecting solid corporate profits. What else, from your perspective, could also drive equity returns in 25? Multiple expansion or are we basically there already?
Marci McGregor
When you actually look at this bull market, profits and dividends have done the heavy lifting for market returns. So that's a good thing for investors. But what else could go right? I think we have a solid economic backdrop and a Fed that, while they're going to be data-dependent, is still an easing mode.
Lower third:
Easing financial conditions could help market returns.
Marci McGregor
So, easier financial conditions I think will also help market returns when we look ahead to next year.
Chris Hyzy
That's a great point. Marci talked about the Fed. Take us through the adjustments that are currently happening on a go-forward basis in 2025, from the Federal Reserve's perspective and what the market is thinking.
Lower third:
Matthew Diczok
Head of Fixed Income Strategy, Chief Investment Office
Merrill and Bank of America Private Bank
Matthew Diczok
So, Chris, bring it back towards you've been using all year: normalization. Yeah, we're seeing a normalization of fixed income markets and particularly normalization of the yield curve. Meaning, right now we're in a place where shorter rates are actually higher than long term rates, an inverted yield curve, as we call it. That is likely to change. The Fed is on a path now to start cutting short term rates.
Full screen graphic:
Inverted Yield Curve Chart
Chart titled "U.S. Treasurys — Daily Yield Curve." The y-axis is labeled "Yield %." It starts at 3.9 and increases until 4.8.
The x-axis along the bottom is labeled "Bond Maturity." It reads, "2M, 6M, 1Y, 2Y, 3Y, 5Y, 7Y 10Y, 20Y, 30Y."
The chart has a blue line showing the course of the Yield Curve. It starts in a column labeled "Short-term" at 4.7 and slopes downward through another column labeled "Intermediate-term." It then slopes up into a column labeled "Long-term," peaking at 20Y, and then slopes down slightly again and ends at 30Y.
Source: U.S. Department of the Treasury, Bloomberg. Data as of November 29, 2024.
Matthew Diczok
Long term rates are generally slower to move than short term rates. So, we're probably can get back to a more normal yield curve where long term yields are higher, meaning cash rates are probably coming down potentially substantially.
Matthew Diczok
Cash as an investment will probably just keep pace with inflation. While longer term bonds can give you a yield, usually above inflation, and also protect you from equity volatility.
Chris Hyzy
Marci, Matt talked about cash yields, more normal fixed income type of yield curve approach. What type of impact on certain sectors are we expecting that could potentially outperform?
Marci McGregor
Yeah, absolutely. When I think of the backdrop that Matt talked about with rates, I immediately think of small cap stocks, right? So we talk about this broadening. And I do think earnings are ultimately the catalyst, not just rates. But I think that brings small caps in a more sustained way into this bull market. We've seen some fits and starts.
Lower third:
Small-cap stocks could see growth in 2025.
Marci McGregor
Small caps have been breaking out. I think 2025 is the year. They're undervalued with some stability and interest rates, less volatility in the rates side. And corporate profits turning positive. I think that's going to be a positive story.
Chris Hyzy
What about mid caps now? Mid-caps sometimes fall themselves into the small cap arena, sometimes into the large. But let's talk a little bit about the M&A cycle. Our thoughts there?
Marci McGregor
Yeah. So, we're going to have some policy change in Washington, come January. And I think one of the areas you're going to see a shift in policy is around the regulatory environment. And deregulation can benefit a merger and acquisition cycle. Mid caps can be a beneficiary of that. And small caps, too. And that that can be a real driver of mid caps and small caps.
Lower third:
Deregulation may spur an M&A cycle, potentially benefiting mid-cap and small-cap stocks.
Marci McGregor
I would also point out if we think about the big picture themes like geopolitics, right, leads to defense spending, infrastructure investment. The small caps are also the building blocks, the U.S.-based companies that are going to be the drivers of those.
Chris Hyzy
We've talked a lot about this advancement era, that we talk about the advancement of asset light. I want to talk a little bit about the equity in the fixed income markets. What is the advancement of the asset-light era from your perspective? Marci, any thoughts on that?
Marci McGregor
Yeah. When I think about this debate between an asset light and asset heavy, composition in the market, we have to acknowledge the S&P 500 has changed, a lot. You rewind 40, 50 years ago, about 70% of the index was manufacturing-focused, really asset-heavy. Now if you look at sectors like technology, health care, about half of the market is what we call asset light.
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Asset heavy:
Manufacturing
Transportation
Infrastructure
Asset light:
Technology
Healthcare
Intellectual property
Lower fixed investment
Marci McGregor
Really focus on intellectual property. Lower fixed investment. It's more about people and adding productivity around those people. The impact to the equity market is I think it's a challenge to value some of these assets. So valuation is something I think we need to think about in the lens of this new asset-light world and index.
Chris Hyzy
Matt?
Matthew Diczok
For the fixed income markets, what it means is that essentially there are two major drivers of economic growth: It's how much is the population growing and how much more productive is every hour worked in the economy? So, when you ask about an asset-light economy that can lead to higher productivity. So that can lead potentially to higher economic growth, which might mean that this level of rates we're at right now, around 4.5%, approximately, on a 10-year, might be a kind of new normal here.
For clients who are expecting that, oh, we're going to definitely get back to a 3% or 2% rate, that might not be the case. Asset light is good for the economy. It could lead to higher productivity and might lead to a higher baseline rate, which is again good for savers, good for people with capital that can deploy to earn those higher yields. So, we think the opportunity might be here for some time, we hope, but again, we want to make sure our clients take advantage of it now because you don't perfectly know the future. But, in general, asset light economy should be good for relatively high and stable long.
Chris Hyzy
Those are great points. Now let's end on any final thoughts. Matt, you go first on 2025.
Lower third:
Don't worry about headlines. Focus on valuations.
Matthew Diczok
Final thoughts are to try and separate the signal from the noise. You're going to hear a lot as a new administration of this policy, that policy might be inflationary. Might be this, might be that. Don't get overly worried about the headlines. Take a step back. Look at where valuations right now are in fixed income. And overall, yields look good.
Chris Hyzy
Marci, how about you?
Lower third:
Corporate profits in a strong economy could be a fundamental driver of markets.
Marci McGregor
You know, to Matt's point about signal versus noise, I think about what's going to drive markets and what we need to maybe mute a little bit because it can create noise. And when I think about the fundamental drivers of markets, it's corporate profits accelerating in an environment where a Fed is easing and the U.S. economy is strong. That, to me, is what matters most for us as investors.
Marci McGregor
So, that reinforces our positive outlook on equities, our preference for U.S. equities relative to the rest of the world. And I also often tell our clients, take a step back, look at the big picture and how the world is changing, that disruptive innovation that is fueling our economy and investment cycle right now. These themes may move slowly, but they're really important for us to pay attention to as investors.
Lower third:
Pay attention to long-term themes and the big picture.
Chris Hyzy
And stay invested for the long haul and take advantage of capital market opportunities and volatility.
Matthew Diczok
Absolutely.
Marci McGregor
Diversification.
Chris Hyzy
Diversification. Marci, Matt, I want to thank you for joining me today.
Matthew Diczok
Thanks for having us, Chris.
Marci McGregor
Thank you.
CHRIS OUTRO
Chris Hyzy
And thanks to all of you for joining us today. We hope you've come away with some ideas you can put into action in your own portfolio.
I'd like to leave you with a few final thoughts:
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Investment ideas to consider
- Invest for the long term
- Diversify against volatility
- Speak with an advisor
We think there are good reasons for long-term optimism about the U.S. economy and markets. Strong corporate fundamentals, a resilient U.S. consumer and the extraordinary power of emerging technologies all point to an ongoing transition from post-pandemic uncertainties to an era of extended prosperity and growth.
We've also talked about risks that must be taken into account, whether geopolitics, rising government debts and deficits, or some unforeseeable event that temporarily disrupts markets.
What does this mean for investors? First, plan and invest towards your long-term goals. The themes we've discussed could be a good place to start building out a balanced portfolio designed for potential growth. And, to help manage volatility, stay invested across a broad array of stocks, bonds and other assets.
Finally, a new year is a good time for a conversation with an advisor. They can help you better understand potential opportunities that make sense of your situation, how to invest for specific goals, and how to stay on course in 2025 and beyond.
Thanks again for watching. We'll see you again soon.
Important Disclosures
The opinions expressed are as of the date of this video and are subject to change.
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