Market overview: Equity balancing act

The last two years were about valuation multiple expansion more than earnings growth. Over this period, the S&P 500 rose by 68 percent while earnings grew a mere 12 percent. That left the trailing price-to-earnings multiple at 24.7x, up from a lowly 16.4x at the time of the U.S. market trough in October 2022.

This valuation seems stretched to us—but it could get richer. So long as consensus earnings growth of 14.6 percent in 2025 is met, new index highs in 2025 are possible, as equity markets tend to keep moving in the prevailing direction until something forces a turn.

Such a turn can come in two varieties: corrections, which come and go unpredictably and usually don’t last long, or a bear market due to a recession. Such an economic outcome is a low probability event in 2025, in our view, but one which should not be entirely ruled out.

Therefore, we think the bull market probably has further to run. Two measures can be used to gauge whether the market may be running out of steam: market breadth, which indicates whether the majority of stocks are moving in sync with the broad averages, and investor sentiment. When the former starts to deteriorate and the latter is frothy for an extended period, equities tend to fizzle out. Both measures were healthy for most of 2024 but are now deteriorating. If this trend is maintained, a temporary pullback is not out of the question.

The road to higher equity prices will likely require earnings to hold up and for investors to contend with the occasional pullbacks along the way. Our mantra has been and continues to be “watchful, cautious, but invested.”

For more details on these views, as well as forecasts for commodities and currencies, please have a look at our complete Global Insight 2025 Outlook.

The “Unstoppables”

Beyond the 2025 time horizon, four powerful longer-term trends are set to play out further that can provide an attractive way to plug investment portfolios into the future:

• Unremitting AI spending by both tech and non-tech companies will continue to grow, in our view, driven by the unacceptably high cost of being left behind.
• The cost of caring for and financing the “gray wave” will escalate as the world’s population ages.
• The unabating march of renewables means they will become the dominant source of power, in our opinion, as they have already become the cheapest source of energy in some regions.
• The “electrification of everything” is spurring the construction of utility-scale storage facilities that are game changers for ensuring reliable energy infrastructure and the increasing trend of using electricity as the primary energy source.

United States

Unusual complexities could generate both volatility and opportunities in 2025. In addition to the likely pro-growth tax and deregulation policies in Washington, markets will potentially have to contend with the most aggressive tariff policies in almost 100 years. This makes the Federal Reserve’s job of forecasting inflation and GDP growth, and properly calibrating interest rates, more complex.

We believe the Fed will continue its rate-cut cycle into Q1 before pausing at a policy rate around 4.25 percent to assess the impact of the Trump administration. Thereafter, the Fed could remain in a relatively constant state of calibration based on how the economy develops, and a rate hike can’t be ruled out.

We’re constructive about U.S. equities, although the more complex environment calls for being nimble and keeping return expectations in check. GDP growth of 2.3 percent in 2025 seems possible, and we think it would take this level of growth or better to achieve the robust 14.6 percent S&P 500 consensus earnings growth forecast. We recommend starting the year without major sector Overweights as pullbacks should provide opportunities to reposition.

In fixed income, we expect yields to remain well above historical averages. We would remain biased toward increasing duration, and reducing credit risk exposure, throughout 2025.

Canada

The Canadian economy will likely be sluggish in 2025. We are mindful of the dramatic slowdown in productivity, the recently announced reduced immigration targets, and the possible new tariffs on Canadian exports to the U.S.—headwinds which the Bank of Canada’s (BoC) aggressive rate-cutting cycle can only partially ease.

That the BoC is cutting its policy rate faster than the U.S. Fed should keep Canadian fixed income returns from significantly lagging those in the U.S., though we expect less outperformance in credit versus 2024. Despite potential economic headwinds, we believe the equity market will be driven by strong consensus earnings growth expectations and supported by a reasonable valuation, particularly compared to the U.S.

United Kingdom

We suggest an Underweight position in UK equities despite valuations remaining close to all-time low levels compared to other markets. That is because the FTSE All-Share Index tends to perform relatively well during global downturns—not our base case forecast—thanks to its high relative exposure to defensive sectors. By contrast, bonds appear attractive as Gilt yields are at one-year highs and pockets of opportunity in credit still exist, in our view.

Europe

A Trump presidency brings additional headwinds to Europe, dimming the outlook for the region’s already challenging economic environment. Solutions are not easy, and while much seems to be factored into the equity market given lowly absolute and relative valuations, we believe the challenges warrant a modest Underweight position.

Asia Pacific

Asia’s equity outlook is likely to be shaped by China’s additional stimulus measures, the magnitude of Trump’s tariffs, and economic growth brought by Japan’s structural reforms. We remain cautiously optimistic about Chinese equities as many economic headwinds appear to be priced in and we see more upside potential than downside risk in 2025. Our constructive view on Japan equities is underpinned by our belief that a sustainable two percent inflation target is in sight and the prospect for corporate governance reforms, among other factors.

As for Asian credit markets, which face trade and geopolitical pressures in 2025, we believe stable fundamentals and targeted stimulus support a cautiously optimistic outlook for investment-grade bonds.