Real Return outlook 2025: Opportunities in a new market regime

Will the global economy experience a hard or soft landing, or a rebound?

We need to be careful when talking about the global economy as different regions have been operating at different speeds. For example, China has been particularly sluggish, with the consumer exhibiting pronounced weakness, although the export side of the economy has been more resilient. Europe has suffered from the contagion effect from China, as manufacturing had been reliant on Chinese demand, while consumers are still experiencing the aftermath of the inflationary wave.

The US has demonstrated continued exceptionalism and has topped the league table of the major economic blocks in terms of resilience. While the consensus is for a soft landing, the resurgence of inflation is a growing risk as the new political regime is likely to deploy fiscal stimulus as a key tool and the agenda is decidedly pro-growth.

In our view, the bigger risk for the US is in fact ‘no landing’, with the possibility of inflation overshooting. Interest rates are likely to stay higher for longer, and markets have already priced out a number of rate cuts that had previously been pencilled in for 2025. This could impede a recovery in the US housing market. On balance, however, we still think that the US economy is likely to remain buoyant and would attribute a low probability to a recession at this juncture.

What is the impact of the US election? Is US equity market leadership set to continue?

For the time being, the US is the only show in town, while China and Europe are decidedly out of favour and mired with challenges.

In terms of equity market leadership, technology has been relatively unchallenged at the top of the league table, but this could change if artificial intelligence (AI) hopes disappoint, or should the sector come under pressure from rising bond yields. We could see a broad range of sectors among the future winners, with areas such as domestic cyclicals, financials and small caps playing catch-up. US-dollar strength could also be a drag on technology stocks, as well as negatively affecting the performance of areas such as health care, which tends to be dominated by those companies deriving their earnings from overseas.

Is China investable again? Will stimulus revive the economy?

The Chinese economy has struggled for the last few years on the back of government intervention, which was perceived by markets as unhelpful, as well as distress in the real-estate sector as a result of excessive investment. The Chinese government had not been active on the stimulus front throughout 2023 and in the first half of 2024, but with the announcement of stimulus plans in September, it does seem to have pulled some levers to kick-start the economy.

Although there are tentative signs that the consumer is stabilising, the stimulus currently appears insufficient to engineer a full-blown recovery. We may see some drip-feeding of further stimulus which could be positive at the margin, but the significant structural issues in the real-estate market are unlikely to be resolved overnight.

China enjoys the biggest trade surplus it has ever had, giving rise to pockets of optimism. A potential recovery is, however, difficult to play from an investment perspective, and we have sought to gain exposure to the more positive sentiment on a tactical basis.

AI-related spending: will the investment pay off?

AI has remained a key focus for investors in 2024 and there has been huge excitement around its potential to increase productivity following decades of scant progress on this front. Companies can be more intelligent in the way they manage their businesses in areas such as supply-chain management and identification of consumer trends.

We are now getting to the ‘show me’ phase: considerable investment has been deployed and there is a desire to monetise it. There is a genuine risk that the market has got ahead of itself in terms of expectations, as reflected in lofty price earnings multiples, and there is the potential for a hangover if disappointment ensues. The gold-rush mentality of upping the investment ante has set some companies up for a fall if an increase in demand does not justify the scale of the investment made.

We remain alert to the broadening out of the AI trend and there are a range of companies in peripheral areas that could partially benefit from related productivity gains.

We continue to have significant investment in this theme in the strategy. Exposure is skewed towards the ‘picks and shovels’ through semiconductor names. While we believe in the long-term trend, we are mindful that we could see some pullbacks along the way. We also remain alert to the broadening out of the AI trend and there are a range of companies in peripheral areas that could partially benefit from related productivity gains.

Do you see fixed income returning to its role as a diversifier?

Bonds will have a role, but they are unlikely to be as dominant as they have been in the past.

Bonds have typically acted as a ‘flight-to-safety’ asset, as well as cushioning against growth shocks. They have also had the benefit of positive carry (when the benefit of holding the asset exceeds the costs). As a result of the more inflationary environment inherent in this new market regime where fiscal policy plays a more dominant role, bonds may no longer be as consistent a hedging tool and there will be a need to further diversify. The new regime appears more fragile, and the shocks of tomorrow are likely to look very different in terms of frequency, intensity, origin and their ability to spread across the system.

A portfolio’s ‘stabilising’ assets will need to be different from those used previously and could include alternative risk premia and other alternative return streams. In our view, the fact that bond insurance appeared to be ‘free’ was an anomaly, and a product of the distorted policy regime that allowed yield curves to steepen.

What is the outlook for commodities – gold/silver/oil/copper?

Gold seems to have got ahead of itself, sensing that expansionary fiscal policy was on the cards with a likely Trump victory in the US presidential election. We still like gold and consider it to be a useful diversifier, but we have reduced exposure for the time being.

We are selective about the weighting to commodities, mindful that a strong US dollar in the short-term will not be a positive for the commodity complex. Copper is an area that we still favour, as it is a beneficiary of the green transition, playing into the electric-vehicle theme, as well as being used for data centres, a key element of the AI build-out.

Elsewhere, silver is a precious metal that we like, owing to the attraction of both its industrial use and the fact that it is playing catch-up with gold from a valuation perspective. It is, however, a higher-beta commodity and does not have the same safe-haven attributes as gold. We have reduced the strategy’s oil exposure on the equity front in the expectation that the new US administration will encourage a higher level of drilling activity or may even lean on OPEC to increase supply.

Authors

Newton Real Return team

Insights from the Newton Real Return team