1Q:2025 Capital Markets Outlook Video

30 January 2025
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1Q25 Outlook
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      | Market Strategist—Client Group
      Transcript

      Hello everyone and welcome, and a belated happy new year.

      In 2024, returns were strong across stocks and bonds, but push out to two years, and the S&P 500 produced its highest return since the go-go ‘90s. And while we’re here, note high yield, something we've talked about for a while, up 23% cumulatively.

      But zoom in on just the last three months around the election, and that’s a different story. Challenged markets, particularly within bonds, reflected the question in markets today: how to marry current conditions to potential policy.

      Look, I know it sounds simple, but my take is to first focus on the current state of the economy and markets. That’s hard enough. Then, filter it through the potential impact of policy and see where that leaves us.

      So let’s begin with the trinity: growth, the labor market and inflation. Growth is moderating from a place of strength. That’s captured really well by the household paycheck proxy, which in turn is reflected in the Fed’s consistently solid growth expectations.

      And since the driver of the paycheck proxy is labor, it's the same data story from jobs added and job openings, solid and moderating to trend. And here as well, the Fed has been pretty consistent on unemployment rate forecasts, but the Fed has also been clear of its concerns of further weakening. Here's a little contest for you: Keep an ear out for how often Federal Reserve members use the word cooling, as in concerned about too much cooling, when it comes to the labor market.

      Keep that in mind for a moment as we move on to inflation, which has fallen significantly from its COVID highs, and though close, I mean tantalizingly close, remains above target. Amongst the four headline categories, food, energy, and goods are back to pre-COVID norms. The culprit, of course, has been services. And within services the dominant driver has been shelter costs. But even there, more recently, we've seen it coming down in the data. And yet, despite the fact that it appears as if inflation is poised to come down further, the Federal Reserve has increased 2025 expectations and has taken the number of rate cuts down, which brings us squarely to the potential impact of policy on prices and the Fed. And it's not just the Fed. Market estimates ping-ponged throughout 2024.

      Look, as a starting point, we do have recent history as a guide for tariffs and inflation. The first Trump administration tariffs increased prices, which increased inflation. But, and this is a big but, since it was effectively a one-time bump, it exited CPI a year later. And importantly, inflation expectations, as a result didn’t move. Tariffs then, for the most part, were also between just the US and China, with some other asides. The big question is whether or not this is a similarly contained experience, or if it becomes much more involved and multi-party. If more like the former, the impact could be very much like we saw. If the latter, it could take years to play out, and make the economic impact more complicated.

      So if we try to put all of this together, we have the economy cooling back toward trend and inflation a bit higher on the back of policy -by the way, the rule of thumb is a 10% tariff equates to a 1% inflation bump, with three rate cuts on the back of a Fed that we believe -should inflation expectations remain well anchored, will be protective of that so-called further labor cooling.

      And as investors, first for bonds, the thought is “back to the future”, and that's four things. One, real yields are elevated, with some number of rate cuts coming. As an investor, the opportunity to lock in real yields at that level is still very material. Secondly, bonds globally will not be moving in lockstep. Divergent monetary policy means varied bond opportunities throughout the world.

      And number three, the return of positively-sloped yield curves. We've lived in inversion for quite some time, but somewhat quietly the curve's been assuming its normal shape. As any card-carrying bond geek, that would be me, would tell you, that opens up roll and carry, effectively a gain in a bond’s price as it ages, to lower yields down the curve. And lastly, credit remains attractive. I mentioned high yield’s two-year returns. Yields are still attractive at 7%. They are historically predictive of forward five-year returns, and fundamentals and technicals remain well-supported.

      In equities, the dominant theme for some time has been historic concentration in US large cap stocks and the expectation of a broadening out of returns across stocks. If you squint really closely at this line, we saw some healthy broadening recently, only to see it retreat in the fourth quarter to the warm embrace of the MAG-7. However we still believe that heavily concentrated US large caps, just as it has historically, will broaden.

      So putting it all together, if I combine fundamental conditions, relative valuations, and the impact of policy—like tax cuts, deregulation, and potential onshoring, etc, that suggests areas such as value, large-cap quality, dividend growth, small-cap stocks.

      Look, in the end, I believe there is performance potential in policy, in the macro backdrop, and in the concentration that's there for us to take advantage of. It's going to be bumpy, but bumpy classically means opportunity, especially as concrete policy takes shape.

      There will of course be much more to come on this through the quarter and beyond, but for now, thanks for joining, I wish you a happy, and healthy 2025, and we'll see you next quarter.

      The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.


      About the Author

      Richard A. Brink is a Senior Vice President and Market Strategist in the Client Group. Previously, he served as a managing director in the Alternatives and Multi-Asset Group. Prior to that role, Brink was a senior portfolio manager in Fixed Income, and before that an investment director for fixed-income investments within the Global Retail Investments Group. Before joining AB in 2004, he was senior product manager at the Dreyfus Corporation, covering both retail and institutional fixed-income offerings. Brink was previously a senior trainer, dealing primarily with the design and delivery of product training to financial advisors and mutual fund sales representatives. He holds a BS in applied mathematics and economics from Stony Brook University, and is a CFA charterholder. Location: New York