2025 Outlook

2024 was a year where performance tables were dominated by larger US Companies, mostly via a small cohort of names at the top of the index with links to the Artificial Intelligence (AI) industry. Indications are that optimism around the outlook for the US remains, despite current lofty valuations, on expectations of tax cuts and pro-business policies from President Trump and a broadening of the benefits of AI. Investors cast their votes for the US through the year with US equity exchange traded funds seeing significant inflows through 2024. Going forward, the continued flow of assets to the US is expected to support valuations along with optimism around the new administration, but this will need to be underpinned by strong earnings performance.

Meanwhile, the issue of persistent outflows from our domestic equity market continues, with UK focused funds experiencing their ninth year of outflows, according to data provider Calastone. Subdued business and consumer confidence remains an issue following the Autumn Budget and this sentiment is expected to persist through the year ahead. Increases in National Insurance (NI) and the National Living Wage have had negative implications for labour heavy industries such as retail and hospitality. Price rises are fully expected with insufficient margins or rates of productivity able to absorb the increased costs. UK equities, via the FTSE All Share, now trading at nearly a 50% discount to the US on a valuation basis and, with the recent devaluation of sterling, we could see 2025 being another busy year for merger and acquisition activity. Looking through the gloom, it’s worth remembering the numerous UK listed companies, such as Rolls Royce, Marks and Spencer, and Imperial Brands, produced strong returns for shareholders in 2024.

Away from the UK and US, European equity markets have some hurdles to overcome in the early stages of 2025. Most notably within the key automotive and luxury consumer goods sectors given implications of touted tariffs and declining Chinese demand. In addressing the continued fall-out of issues within their property market, Chinese authorities are still unveiling policies aimed at stimulating the economy.

Looking into 2025, an apparent unifying theme across equity markets is the persistent uncertainty of politics.

2024 was a good year for fixed income, or bonds, with pockets of strong returns across the asset class. Recent performance of government bonds has disappointed and financial headlines have been dominated by the rising cost of government borrowing, especially in the UK. This isn’t a UK specific issue, as borrowing costs in the country have been rising in line with those of the US and Europe, albeit at a faster rate. Concerns have been raised over the remaining headroom within Chancellor Rachel Reeves’ fiscal rules, but technical moves in government bond markets are likely a lesser cause for concern than the implications of slower than expected rate of GDP growth. The Office for Budget Responsibility (OBR) forecasts linked to the Autumn Budget, expect real, or inflation adjusted, GDP growth of 2.0% and 1.8% in 2025 and 2026 respectively. Focus is likely to be on these figures throughout the year, with underperformance capable of causing more volatility. A key risk remains that Labour’s budget entirely relies on government consumption and investment to drive real GDP growth. Higher yields both reduce the amount of potential borrowing and increase the return hurdle over which the return on investment must achieve to be profitable. Then there’s the challenge of deploying capital into the economy, which shouldn’t be understated. All of which could assist in keeping upward pressure on borrowing costs and lead to either further taxation or spending cuts, or both.

In the meantime, attention is on the US, with President Trump in the early stages of his second term. Recent strong economic data in the US has led markets to reprice expectations for the number of Federal Reserve interest rate cuts to two for the calendar year. Treasury yields across all maturities have moved higher, taking other developed market yields with them, making it unlikely for UK government borrowing costs to move lower without being led by the US.

Within the corporate bond markets, the additional yield for lending to a corporate over a government for the same maturity remains tight, trading at levels last seen in 2021. The question throughout the year remains whether the compensation demanded for the additional risk increases but, with yields remaining attractive to investors and positive on an inflation adjusted basis, there is expected to be enough yield focused buying and a limited enough new supply to keep valuations at tight levels.

Bonds are expected to remain a key constituent of portfolios with more moderated risk levels given the yields on offer. Despite concerns raised in the press over UK government borrowing rates, attraction remains, with tax efficiency on offer for those trading below face value.

Other income producing asset classes such as Real Estate Investment Trusts (REITs) and listed infrastructure funds, which often feature in portfolios for their ability to access the benefits of physical assets through a liquid and diversified vehicle, are worth watching throughout 2025. Shares of these companies have trended lower as government bond yields have risen, leading to large discounts and yields on offer in the sector. For the year ahead, there may be selective opportunities, and while returns are linked to bond yields, this can be mitigated by focusing on those with durable earnings growth profiles. A combination of high starting yields and modest earnings growth could prove profitable, improved further by valuation re-ratings. While 2025 has had a rocky start, there’s a healthy level of optimism for the year ahead.

Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. The information and views were correct at time of writing but may have changed at point of reading.