Investment Outlook

While most major economies will likely avoid recessions over the next 6 to 12 months, a low-volatility regime is not guaranteed. However, despite potential bumps along the way, we believe global credit markets will generate positive excess returns in the next 6 to 12 months.

• The Federal Reserve (Fed) moved away from its restrictive policy stance with a 50-basis-point (bp) rate cut. We expect inflation to continue trending lower toward the 2% target over the next few quarters.
• The US labor market is still strong, but the average payroll gain in each of the past three months has declined. Unemployment ticked up from a very low level. We believe the Fed was correct in cutting rates before labor conditions weakened further.
• With personal consumption expenditures being two-thirds of gross domestic product, healthy consumer spending is essential for continued expansion.
• The Bank of England’s Monetary Policy Committee voted to reduce the bank rate to 5%. We expect further reductions to be gradual and limited in size.
• Within the euro area, we see inflationary risks persisting, which informs our expectation of a relatively limited European Central Bank rate-cutting cycle.
• If the Bank of Japan’s confidence grows regarding the achievement and sustainability of 2% inflation, we expect increased bank tolerance for higher 10-year yields.

If a soft landing plays out as we expect, credit spreads have room to tighten a bit.

• Based on their bottom-up fundamental analysis, our credit research team suggests approximately 85% of industries within our proprietary corporate health index are in the expansion phase of the credit cycle.
• The percentage of industries with a positive credit outlook jumped to 38% from 13% in June. Two very large and important sectors of the economy, banking and technology, received outlook upgrades from our analysts.
• Upgraded outlooks are predominantly based on better expectations for margins and free cash flow. Industries with stable outlooks equaled 55% while only 7% of industries carried deteriorating or moderately deteriorating outlooks.
• Our risk premium framework estimates credit losses within investment grade and high yield to be below historical averages in expansion/late cycle regimes. We believe that is one reason why spreads are tight.
• Spreads for high yield credits rated BB and B look very tight relative to history, while CCC-rated credits look more fairly valued.
• Within global credit, we believe the emerging market space has a higher return potential than that of euro or sterling markets.
• Our positive stance on global growth prospects with more rate cuts ahead keeps us overweight credit.

We believe disinflationary trends should remain in place near term, which should keep interest rates in a downward trend. 

• Elections have been a market-moving factor in 2024. Transitions of power and potential policy reforms will likely remain key considerations for investors, in our view.
• Neither US presidential candidate appears focused on fiscal austerity, which we believe means the US government budget deficit is not likely to improve over the near term.
• Increased government spending can boost economic growth and to some extent employment. However, it can also widen budget deficits with more debt being issued at higher interest rates.
• While tough to time, the market should eventually begin weighing the consequences of the deficit. Until then, we believe the global monetary policy easing cycle should keep interest rates trending lower.
• Developed market long-term yields can potentially slide lower throughout 2025. As the Fed trims the short rate and longer-term yields do not decline as much, the US yield curve will likely steepen.
• We see value in local emerging market fixed income based on relatively higher yields and prospects for US dollar weakness. There is potential for foreign currency appreciation plus interest income.

We believe that financial conditions could grow easier within the US, especially if the Fed is able to keep trimming the policy rate as markets head into 2025.

• While short-term interest rates are coming down, the dollar is likely to remain under pressure. Downside risk should be modest since several central banks will also be cutting, in our view.
• Oftentimes, the dollar is perceived as a safe haven. While geopolitical risks exist, most regions of the world are expanding, albeit at varied growth rates.
• Risks associated with US government deficits are rising, and we do not see major changes to the path forward.
• The US economy is still performing quite well relative to developed market peers. We believe domestic investments in credit and equity markets could be particularly attractive for overseas investors, therefore we only see modest dollar downside risk.
• The fed funds rate appears to be declining faster than that of its UK or euro zone counterparts, which could keep the euro and pound range bound.
• We remain cautious on China, but view upside surprise as possible, which would likely benefit emerging market neighbors.
• We believe Latin America and South Africa are attractive regions to add foreign exchange exposure.

Bottom-up consensus estimates for 2025 could prove too optimistic. However, we believe markets could absorb some downward revision given how rosy the starting point appears to be.

• Several markets are near 52-week or all-time highs. We believe most markets could see high-single-digit 2025 total returns as long as recession is avoided.
• Despite elevated valuations, we would not be surprised to see price-to-earnings multiples grow to lofty levels.
• Earnings growth should accelerate within industrials, healthcare, materials, consumer staples and energy in 2025, in our view, while remaining firm for information technology and communication services.
• As fundamentals improve, we expect the equity market rally will broaden.
• Global equities may not outperform the US, but we believe could likely still do well. According to Bloomberg consensus, earnings-per-share growth for the MSCI All Country World Index excluding the United States indicates a nearly 10% growth rate for 2025.
• MSCI emerging markets could be a top region with approximately 16% year-over-year growth expected, while Europe and Japan could see mid-single-digit growth.

Payroll growth has been moderating to levels consistent with a soft landing. At some point, we believe, labor market weakness would have to abate for such a scenario.

• Data consistent with a soft landing has been reported, but we wonder where the bottom is, and when the economic momentum will begin to level off or turn higher.
• Does corporate health indicate the cycle can advance in expansion? By most indicators, balance sheets appear to be healthy. However, earnings estimates for 2025 could be too high, particularly if an economic slowdown arrives.
• Real 2024 GDP is on pace to conclude above trend, near 2.75%. That is unlikely to be repeated in 2025, even with rate cuts. A softer growth backdrop could pressure corporate revenues and margins.
• Our top concern is a potential growth scare. Our estimated probability of that is approximately 30%, which we believe is meaningful. Such a scenario would weaken our expectations for modestly tighter credit spreads and rising equities.
• An escalation in ongoing global military conflicts would shake sentiment.
• In our view, we see risk in being underallocated to equity or high-yielding asset classes.