January 2025 Investment Outlook

Solid fundamentals should help drive positive credit and equity market performance into 2025.

One of the most bullish themes in the US economy is the broadening of earnings growth across sectors. Looking back, it was essentially mega-cap growth companies in the technology and communication sectors that generated nearly all of the S&P 500’s earnings growth in 2024.¹ Recently, earnings growth for large-cap technology has been slowing and formerly lagging sectors have begun to experience growing earnings.

In our view, this broadening in sources of earnings growth implies that the credit cycle has plenty of room to progress in the mid-expansion phase. We think US investment grade and high yield corporate credit look attractive because we anticipate limited downgrades and a very mild default rate of approximately 3.2%. Yields across global credit markets appear attractive and we believe they could drift lower as central banks pursue cutting cycles.

Investment Themes

Our take on macro drivers and major asset classes at a glance.

Our Views on Macroeconomic Drivers

Lower short-end interest rates, slightly lower long-end rates and decent economic growth should continue to support investor risk appetite. However, valuations are already fair if not somewhat richly valued.

• We think the Federal Reserve (Fed) will undertake four 25-basis-point cuts—one at every other 2025 meeting.
• The US labor market is likely to soften at the margin.
• With personal consumption expenditures being two-thirds of US gross domestic product, record household net worth should fuel demand.
• We see the Bank of England’s (BoE) Monetary Policy Committee in a position similar to that of the Fed.
• Euro area inflation should come down faster than that of the US because demand is much less robust.
• Conditions are different in Japan, where inflation is around 2.0% and small rate hikes are possible.

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With Inflation Essentially Under Control, Central Bank Policies Are Becoming Less Restrictive
Globally, inflation has been heading lower for several quarters. We see room for further decline.

Our Views on Corporate Credit

Credit investors have the potential to outperform US Treasurys given higher yield levels and the possibility of tighter spreads.

• Based on bottom-up fundamental analysis, our credit research team suggests 93% of Bloomberg US Aggregate Index industries are in the expansion phase of the credit cycle.
• Of the industries under our credit analysts’ coverage, 36% had positive credit outlooks, a significant rise from 13% in June of 2024.
• Our analysts’ upgraded outlooks are predominantly based on better expectations for margins and free cash flows.
• Our risk premium framework estimates credit losses within investment grade and high yield credit to be below historical averages in expansion/late cycle regimes. That could be a key reason why spreads are so tight.
• Yield spreads for high yield credits rated BB and B appear historically very tight, while CCC credits only recently started to look rich.
• Our favored US markets, ranked by expected total return, are leveraged loans, investment grade and high yield. Within global credit, the emerging market space has higher return potential than euro or sterling markets.

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Globally, Earnings Growth Should Lift Overall Corporate Health in 2025
We recognize tight spreads and skinny risk premiums, but yields are still compelling to us.

Our Views on Government Debt & Policy

Disinflationary trends should remain in place near term; therefore we see downside for government bond yields. 

• Under the new US administration, we think existing and possibly increased tariffs, tax cut extensions and adjustments to current policies appear likely.
• Lack of clarity on potential US fiscal policy makes it nearly impossible to accurately model economic outcomes. However, we created a range of scenarios that suggest inflation may run a bit hotter than expected pre-election.
• Policy changes are not likely to interrupt the economic expansion.
• The US yield curve is likely to steepen as the Fed trims the short-rate and longer-term yields do not decline as much. By the end of 2025, the federal funds rate could reach approximately 3.5% and the 10-year bond yield about 4.0%. 

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A Global Rate Cutting Cycle Is Underway, but It Has Been Shallow Given Still-Decent Economic Conditions
Central banks, excluding Japan, will likely reduce rates since recent data indicates inflation is largely under control. 

Our Views on Currencies

US dollar valuation is rich relative to emerging and developed market currencies. If the tide turns, we could see foreign currencies improve quickly.

• With limited divergence in central banks’ policies, short-term interest rate differentials are less likely to influence US dollar performance.
• Factors like relative economic growth, trade policy, risk appetite and expected performance of US assets could buoy the US dollar in the very near term.
• Globally, relative US economic performance may attract overseas demand for dollars.
• Oftentimes, the dollar is perceived as a global safe-haven asset and there is no shortage of geopolitical risk.
• Risks associated with US government deficits are rising, and we do not see major changes to the path forward.
• We remain cautious on China, but view upside economic surprises as possible, which would benefit the country and its emerging market neighbors.
• Latin America and South Africa are attractive regions to add foreign exchange exposure.

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The US Dollar Index Has Traded in a Tight Range Since Early 2023, Offering Few Trading Opportunities
Recent dollar strength could reverse course depending on trade negotiation outcomes.

Our Views on Global Equities

The macro landscape could be more challenging for equity markets, particularly after such strong 2024 performance.

• Bottom-up consensus earnings expectations suggest the MSCI Europe Index could rebound from flat growth to a mid-single-digit pace in 2025. The S&P 500 Index and MSCI Emerging Markets Index are expected to grow earnings by more than 10%.
• We are conservatively positive about corporate earnings growth relative to consensus.
• US equity outperformance has been significant over recent years. But the S&P 500’s price-to-earnings (PE) multiple has also expanded, helping to drive total return.
• Annual total returns are more likely to be in line with the rate of earnings growth that the S&P 500 Index delivers.
• In the global indices, trailing PE multiples are slightly beneath their five-year averages.

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Us Equity Outperformance Driven by Large Exposure to High-Growth Companies Where Earnings Have Been Exceptional for Years
We think positive earnings growth rates and relatively cheaper valuations could boost global equity performance in 2025. 

There is a tremendous amount of market optimism regarding the new US administration, however the implications of potential trade policies have yet to play out.

• Global credit and US equity valuations are historically expensive. Most markets are priced for solid economic and corporate earnings growth.
• Many consumer and business sentiment measures surged after the US election. It is possible that sentiment has become too frothy.
• Inflation has been trending lower globally; economies need that to continue.
• Most government bond yields could turn higher if inflation returns in a meaningful way.
• The US has been a beacon of economic strength over the past three quarters, but we expect some slowing is on the horizon. The extent of the slowing and how it impacts the labor market will guide risk appetite.
• Escalating military conflict is never positive for investor sentiment, so we are monitoring developments closely.

Asset Class Outlook

There is potential opportunity in non-US markets where valuations are compelling and sentiment is more muted, especially relative to the US.

Endnote

¹ FactSet, 13 December 2024. S&P 500 CY 2024 Earnings Preview: Analysts Expect Earnings Growth of 9.5%.

Disclosure

This marketing communication is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis do not represent the actual or expected future performance of any investment product. Information, including that obtained from outside sources, is believed to be correct, but Loomis Sayles cannot guarantee its accuracy. This information is subject to change at any time without notice. Intended for institutional investors and investment professional use only.

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