Boom or bust? A look ahead to 2025

It might appear churlish to point out that 2025 looks exactly the same as every other year from a similar vantage point – profoundly unknowable. It is true, nonetheless. It would be true even if the next President were less famously capricious. Or indeed the sparks of the next major industrial transformation were not beginning to fly. With that in mind, we sketch out below some of the currently visible threats and opportunities for investors to consider for the year ahead.

Bond market dyspepsia

Most of the debate on government debt levels is a red herring. The relationship between debt and growth is over/mis-stated for a start. Meanwhile, the bond market’s tolerance for deficits and levels of debt relative to gross domestic product (GDP) is time-varying. The credibility of the would-be borrower is an important influence on that variation, which, in turn, hinges on a wide range of factors well beyond just levels of debt.

For the last several decades, in the absence of inflationary threat, central bankers have been free to liberally sedate bond markets with ever-escalating quantitative easing (QE) programmes and basement (even negative) policy rates. During that period, there seemed very little, if any, punishment for fiscal largesse, and rapid and sustained debt accumulation.

The problem now, as former Prime Minister Truss and Chancellor Kwarteng found out, is that bond markets are in a much less forgiving mood. After decades without any unexpected inflation to worry about, we all now have very recent and painful memory.

Meanwhile, the US seems to be testing its exorbitant privilege¹ to the extreme, with the government now routinely spending 6 – 7% more than it collects in taxes each year, all while the economy hums at full employment. There are no credible plans to reduce this. In fact, a further moderate expansion is expected now that Congress is lined up Republican.

So, a stroppier bond market, likely suffering some QE withdrawal symptoms, is about to meet a President with big, expensive, and quite unorthodox plans. In the benign case, the administration opts for more surgical tariffs and deportations than advertised on the campaign trail – if, for example, tariff increases are contained to a selection of substitutable Chinese goods, and perhaps some European and Mexican car imports, the effect on markets will likely be minimal.

However, trade is one area of significant unilateral Oval Office clout. We will no doubt hear a lot more of sections 232² and 301³ in the months ahead. The world’s capital markets are certainly better prepared for another isolationist insurgency. However, the closer to universal tariffs the administration dares, the worse the potential economic blowback for the US and for all.

The demise of King Dollar and the Magnificent Seven?

It is not just bond markets that appear in a different mood to President Trump’s last time in office. The S&P 500 index has returned 70% since 6 January 2021 and the now infamous transition of power. (Note that past performance is not a reliable guide to future performance.) Absolute and relative valuations provide less wriggle room, and the market has become significantly more concentrated around a few key names (Figure 1).

Figure 1: Markets have changed a lot since 2016

Source: Bloomberg, Datastream, Barclays

Stepped-up anti-trust scrutiny and the ever-unpredictable path of technological change, alongside the valuation starting point, should make us wary of extrapolating the success of these titans’ remarkable success into the year(s) ahead.

The next AI breakthrough may not come from expensively stuffing ever-greater quantities into large language models, which may already be replete. Instead, it could come from improvements in algorithms, which may not inherently favour the mega over minor caps. Besides which, the beneficiaries of technological change of the past often sit well beyond the site of breakthrough.

Meanwhile, the US dollar has accumulated its legendary status over a much longer time period. The US dollar system and its enablers on Wall Street have dominated the best part of the last century, taking the baton from sterling. The attraction of US capital markets assets in both fair and foul times contributes to a phenomenon known as ‘the dollar smile’ – heads I win, tails you lose.

This incredible period for US stocks, bonds, and her currency will likely come to an end at some point, as with all things. Perhaps both policy and jawboning from this next administration could provide the kick. If say, US central bank independence and credibility were meaningfully undermined at the same time as inflation heat was added via tariffs and deportations, it is possible that US assets could lose lustre even as interest rates headed higher. Those higher interest rates could, in turn, knock lofty equity valuations, much as we saw in 2022.

Many will rightly counter that the US economy’s claim to global economic primacy looks as strong as ever on a range of metrics. The incredible dynamism⁴ of the corporate sector and society at large has been on display these last few years in particular. Besides which, there remain no credible pretenders to the throne. President-elect Trump’s appointment of the highly respected Scott Bessent to Treasury should also lower pulses on the potential for self-harm from the next administration.

However, the reminder here is that there are several paths ahead which do not belong to US assets alone, in spite of their current appearance of inevitability/invincibility. Such paradigm shifts are always only obvious in hindsight.

Festive conclusion

All in all, stay positive. The mess of the present may tell us less than you think about the path ahead. Productivity is finally coming back to life in the US and may well follow elsewhere. A growing economic pie may help with some of the struggles we’ve recently endured with dividing it up. For investors, the message is stick with it, but be sure not to bet too hard on a precise repeat of the last decade plus (in capital markets terms). There are plenty of other ways this next period could play out.

Appendix: Discrete annual returns (USD, %)

Source: Bloomberg, Barclays