2025 – Brace for uncertainty

It is hard to think of another year that has begun with as wide a range of plausible scenarios ahead for the global economy and her capital markets. Somewhere in the middle of that range is the usual muddle through, where growth, inflation, and investment returns thread the needle. However, on either side of that benign base case are paths dominated by escalating trade wars, bursting bubbles, or (further) inflating booms.

This week, we begin the year by sketching out a few of those scenarios to help investors orient themselves in amongst the escalating sound and fury.

Boom

Measured US productivity growth took off in 2024. It is highly unlikely that this has anything to do with rapidly advancing generative AI models, that may be still to come. Instead, this is probably best chalked up to some of the implementation of previous advances in machine learning and other areas. There are even mutterings within the techbro-verse of general artificial intelligence being a lot closer¹ than previously thought.

Such claims should obviously be treated with heavy scepticism. However, we only need to ascribe a non-zero probability to general AI within the next 5 – 10 years for it to have a major influence on today’s stock market valuations.

Even without this, there is now a chance for the rest of the world to catch on to US economic coat tails and use the technological advances of the last decade plus to boost corporate efficiency. There is a good chance that the world economy is finally waking up from the post-Great Financial Malaise.

Perhaps the pandemic-era spending splurge (both private and public sector) was the necessary stimulant just as the New Deal and WW2 rearmament woke the US from the great depression?

Muddle through

This, as usual, covers many paths somewhere in the middle of the distribution and should be seen to command the highest probability by a distance. The incoming Trump administration’s bark turns out to be worse than its bite.

Perhaps stock and bond markets provide a disciplinary influence on an Oval Office focused on style over more dangerous substance. Even so, Europe and China use the threat of a more transactional US administration to usher in some necessary reforms.²

US government bond yields trade between 4 – 5%, with inflation remaining well behaved. US stock markets hold their valuation multiple but roll higher on still decent earnings growth.

Other stock markets around the world perhaps perform more strongly as global growth spreads. Returns to a diversified batch of capital markets assets are perhaps a little lower than seen in 2024, but still beat inflation comfortably.

Bust

As ever, this batch of paths will be the easiest for us all to colour in. Here, you can imagine a Trump administration where the more orthodox voices of Scott Bessent, Kevin Hassett, and others are marginal. Tariffs are implemented and trade partners respond in kind.

Meanwhile, Oval Office jawboning undermines central bank independence. The bond market takes fright, with interest rates surging through 5% across maturities. The higher discount rate wipes out a chunk of present value of S&P cashflows and earnings. As in 2022, it is growth stocks that are hit hardest given their longer duration cash flow profiles.

We can add to this a messier downturn for China, which perhaps pokes the administration into geopolitical distraction of one sort or another. Perhaps also we see a continuation of Europe’s stagnation, which in turn ratchets up the political temperature another notch. The populist insurgency reaches critical mass at the European level, re-awakening redenomination risk.

Investment conclusion

Interesting times as the curse suggests. We need to remember that the set-up for this year is mostly constructive for risky assets. You have a US and world economy growing, in some parts briskly. Meanwhile, central banks have more leeway to cut interest rates. These factors alone have tended to be good for equities in particular.

Some of this good news is certainly priced, particularly in the US. However, those lofty expectations are far from universal, and we must remember that there is usually a gap between word and deed in our political leaders. That is especially the case in economies with so thoroughly designed restraints as we see in the US.

Get invested, stay invested and don’t look too much.