2025 Research Investment Themes & Scorecard

OUR PREDICTION

U.S. Economic Growth Outpaces International Markets

“U.S. exceptionalism” is set to continue as strong economic fundamentals at home contrast with widespread market uncertainty abroad. Investors should expect the US economic growth to outpace that of other global economies. Most forecasts predict that U.S. GDP will grow by 2-2.5% in 2025,¹ driven by a resilient labor market and robust consumer spending, expanding productivity, deregulation, infrastructure spending, greater industrial activity, and easier financial conditions. Abroad, Chinese GDP growth is projected at 4%–4.5% for 2025,² significantly below pre-pandemic levels, and thus far, fiscal policy stimulus has underwhelmed investors, ultimately limiting its role as a global growth driver. The eurozone economy is set to decline relative to the U.S. next year.³ Persistent deficits, and weak consumer spending point toward weaker economic growth, suggesting that low valuations may be justified across European equities. It is prudent to remain overweight to U.S. equities.

OUR PREDICTION

Equities Normalize from Recent Outsized Returns but Finish the Year Positive

Despite continued earnings growth, S&P 500 profit margins have relaxed from near-record levels – exceeding 12.0%. Most earnings growth for 2025 has already been priced into equities, setting the bar higher for companies to beat lofty earnings projections. Margins may come under pressure from significant capital expenditures for Artificial Intelligence (AI) adoption and development. Corporate bond yields average 5.5%, up from 3.5% in 2022, increasing interest expenses and putting pressure on net income growth. However, non-financial corporate business net interest payments have actually declined since the Fed began hiking.4 This is unlikely to continue as interest rates should remain higher into 2025. So economic growth is moderating, but still solidly positive, and the Trump administration’s policy goals – including deregulation, lower energy costs, and tax cuts – could boost an already growing economy.5 Investors should realize that 25%+ returns for the S&P 500 are not the norm, despite back-to-back banner years, but normal U.S. equity market returns are still likely to be one of the best allocation options next year, particularly as market leadership broadens.

OUR PREDICTION

Small Caps are Poised for Outperformance

Attractive valuations, resilient earnings, and insulation from global tariffs along with favorable cyclicality and improving operating leverage set up small caps for potentially significant outperformance. The S&P SmallCap 600, an index of profitable small-cap companies, trades at a forward price-to-earnings (P/E) ratio of ~ 13x, compared to ~ 22x forward P/E for the S&P 500,6 signaling a significant relative value opportunity. Deregulation in sectors such as financials, energy, and manufacturing supports higher margins for small-cap companies, which are projected to achieve stronger earnings growth than large-cap companies in 2025. Small-cap firms generate over 80% of their revenue domestically, reducing their exposure to international trade disruptions and tariffs. Although interest rates may remain higher than originally anticipated next year, which will negatively impact the financial leverage of smaller companies, higher nominal growth will spur operating leverage and further accelerate marginal profitability. History suggests smaller companies’ positive operating leverage generally wins versus their negative financial leverage.7

OUR PREDICTION

Interest Rates Are Likely to Remain Elevated

The Federal Reserve’s (the Fed) funds rate will remain higher for longer than originally anticipated. The Fed’s December Summary of Economic Projections (SEP) now forecasts just two 25-bp cuts next year.8 Core services inflation remains elevated at 4.5%, driven by labor market strength and demographic trends. Meanwhile, the US budget deficit exceeds $1.8 trillion,9 necessitating higher interest rates to attract investment and stabilize debt levels. A flattening yield curve and lack of term structure make long-duration assets less attractive – investors are not rewarded for taking on interest rate risk. Stable yields limit potential fixed-income price appreciation but provide investors with a higher starting yield. A flat yield curve means short- to intermediate-term bond allocations appear attractive. Areas where spreads are wide, like securitized credit, exhibit better valuations. Adding structure to fixed income exposures should enhance yields and add downside protection – critical improvements amidst higher rate volatility

OUR PREDICTION

Housing: The Obstacles of Tight Supply & Record-Low Affordability

Affordability remains a significant problem for the housing market. Median home prices are projected to increase by 5% in 2025, while 30-year mortgage rates remain elevated at 7%, keeping home ownership about as prohibitive as it’s been since the early 1980s.10 Supply is also constrained, as the number of housing starts remains below 1.5 million units annually, well below demand levels, exacerbating the inventory shortage. Costs may increase given policy changes to tariffs on lumber and immigration which may affect the cost of materials or availability of labor. The two largest generations, Baby Boomers and Millennials, are driving both supply and demand. Boomers are retaining homes for longer periods, while millennials account for over 35% of home-buying activity, intensifying market competition.

OUR PREDICTION

Energy, AI, and Crypto are Key Areas to Watch in 2025

While these are not economic or market predictions, they highlight key areas to watch for valuable insights into emerging trends and market dynamics. Rapid growth is expected in and around AI as adoption and integration expand across all manners of businesses and yet untapped industries.

AI has the ability to increase productivity which can be a strong disinflationary force as well as an impetus for growth. There is a substantive demand for energy given the level of power that AI consumes. Nuclear energy made a resurgence in 2024 with both Uranium futures rising, and companies exposed to operating or developing nuclear plants seeing strong returns. Renewable energy, which was anticipated to struggle under Trump’s first administration, flourished on the back of lower taxes and yields, but can green policy remain relevant given the voracious consumption expected from AI? Traditional energy faces volatility from geopolitical tensions but remains critical for global energy security.

Crypto had an impressive climb in 2024 driven by the approval of spot bitcoin ETFs and hopes of a more pro-crypto incoming administration, which were ultimately realized, further boosting already exuberant market action. Look for additional ETF approvals for other crypto assets and a swath of crypto-related IPOs to impact the digital asset markets next year