Market Know-How 1Q 2025
Macro Jiu Jitsu
The prospect of a return to a becalmed investment landscape seems limited given the multitude of economic, policy and geopolitical uncertainties currently affecting financial markets. However, just as the martial art of Jiu Jitsu seeks to redirect the force of an opponent's energy against themselves – turning weaknesses into strengths – so too do we see ample prospects for investors to turn those very same macro challenges into potential investment opportunities.
A geopolitical environment in which economic security concerns are top-of-mind is creating investment needs in technology, cybersecurity, and energy. We believe that a macro backdrop in which supply-chain resiliency is a high priority is leading to a broadening diffusion of Foreign Direct Investment flows to the investable benefit of countries such as India. In many developed markets, the financing required to upgrade existing infrastructure and construct new facilities for a rapidly evolving economic and security landscape is presenting a wider range of prospects than has been seen before. These are not merely fleeting opportunities but rather secular changes reflecting a shifting geoeconomic landscape, and numerous powerful underlying, long-term trends such as demographics and the push towards decarbonization. While many of those changes may create fiscal and economic pressures, the art of Macro Jiu Jitsu seeks the potential opportunities therein.
The return of inflation after a prolonged period of post-GFC quiescence is likely to mean “normal” interest rates for many economies settle at levels higher than have been seen for a generation – requiring a reappraisal of appropriate portfolio allocations and may offer opportunities for income-seeking investors scouring the fixed income universe. Equally, as rates come down somewhat from their currently elevated levels, those equity investors holding exposure to companies with a large proportion of variable rate debt – typically many small-cap companies – may see a boost to performance in the year ahead.
Applying our concept of Macro Jiu Jitsu, we recognize that the road ahead will be neither straight nor smooth but, while accepting that, we seek to turn those twists and turns into investment opportunities. In this edition of the Market Know-How, we highlight where we see some of those more immediate potential opportunities.
Short-Term Macro Themes
We expect global growth to moderate but remain resilient in 2025, led by US exceptionalism. Inflation has made significant progress towards target, but cross-country divergence in the supply-demand imbalance may drive more differentiation in the disinflation process going forward, in our view. As a result, we expect a less synchronized and, in some instances, slower pace of monetary easing, as fiscal concerns take centre stage.
America First
We believe the US economy will remain the global growth engine in 2025, with a still-healthy labor market, steady consumer spending, strong credit fundamentals, ample liquidity in the system, and broadening of AI-related capital spending. That said, growth and monetary policy uncertainty have risen significantly following the US elections.
The implications for US growth of the incoming Trump administration’s proposed policies will largely depend on sequencing and reach. Lower taxes, deregulation and potentially lower oil prices could be tailwinds, whilst changes to immigration and (uncertain) trade policy are potential headwinds. The impact on inflation is also unclear but if implemented, lower taxes, higher tariffs on US imports, and lower immigration could pose some upside pressure on US consumer prices. On balance, we think that the Fed will continue its easing cycle, but the terminal rate could be somewhat higher than previously expected.
Europe: between a Rock and a Hard Place
The Euro area faces numerous domestic and external challenges in 2025, which are likely to see its economy continuing to grow below potential. To start with, increased trade uncertainty could keep savings rates elevated and weigh on capex. Further, ongoing structural issues in the manufacturing sector, including high energy prices and increased competition from China, could reinforce negative trade effects from tariffs. With limited fiscal space in many European economies, these structural headwinds are unlikely to be addressed in the next 12 months. Finally, Europe’s two largest economies, Germany and France, face political challenges which are likely to limit their ability to put forward much-needed reforms. With growth likely to undershoot and inflation gradually moving towards target, we expect the ECB to cut rates beyond the 2.00-2.25% estimated neutral range.
The prospects for the UK economy are mixed. The Autumn Budget was notably more expansionary than anticipated which, all else equal, raises the prospect for stronger demand in 2025. That said, business surveys indicate that the rise in the National Insurance Contributions is negatively impacting hiring intentions, and uncertainty around trade policy under the incoming Trump administration is likely to weigh on confidence, keeping growth around trend. With growth likely to surprise to the downside relative to the OBR and BoE projections, the BoE may be able to cut rates by more than is currently implied by market pricing.
China: Policy Showtime
The Chinese economy faced significant growth headwinds in 2024, and policymakers finally started more forceful easing in late September. Recent stimulus has reduced downside risks to Chinese growth by addressing structural debt imbalances among local governments. But new risks have emerged from uncertainty around US-China trade relations. Encouragingly, policymakers have strengthened their pro-growth stance in late 2024. We are monitoring policy measures to address debt imbalances and spur domestic demand.
RoW: Tariff Uncertainty Clouds the Outlook
While US exceptionalism has generally been positive for global growth as US demand boosts global trade flows and asset prices, the net impact of expected US policy changes following the election could be negative this time. Among emerging economies outside of China, nations such as Mexico, Vietnam, and South Korea are the most vulnerable as they account for a sizeable amount of US imports. India remains a bright spot among EMs. Not only is the country relatively insulated from global shocks emanating from a potential tariff escalation, but favorable demographics, combined with a still positive economic reform momentum, could maintain growth in the mid-6% range in 2025.
Elsewhere in Japan, the latest data suggest that a virtuous cycle between wages and prices is being established and we expect this trend to firm up in 2025. While the BoJ is likely to hike rates further, US policy uncertainty, coupled with fewer expected cuts by the Fed, might keep the Japanese yen under pressure, providing a boost to exporters to the benefit of economic activity and the stock market. However, more uncertainty surrounds external demand than domestic demand, given the prospect of US tariffs.
Long-Term Macro Themes
In our view, the next economic cycle will be characterised by higher inflation, elevated interest rates and heightened macroeconomic volatility, driven by 6 key factors. Thus, we believe investors need to position their portfolios for CHANGE.
CHANGE
Climate transition – High level of debt – Ageing demographics – New finance – Global fragmentation – Evolving technology
Source: Macrobond and Goldman Sachs Asset Management. As of January 3, 2025. Latest is November 2024.
- China remained the world's largest vehicle exporter in the first eleven months of 2024 after surpassing Japan and Mexico in 2023, Germany and South Korea in 2022, and the US in 2020. A slowdown in domestic demand over the past few years has increasingly prompted Chinese auto makers to look overseas to deal with excess production.
- But China’s rise as the largest auto market has also been propelled by the increasing popularity of electric vehicles (EVs) following stricter emission regulations in many countries and incentives towards EVs. The world’s second largest economy has become a leader in this segment, exporting more than any other country and holding a 69% share of global sales1, thanks to the “Made in China 2025” strategy, which pinpointed key sectors upon which the country aimed to expand its industrial base.
- China’s growing influence in such a strategic sector, which is closely connected with national security, has been met with resistance by many governments. The US, Canada, and the EU all imposed significant new tariffs on EVs from China in 2024 to protect their own industries, a trend that we think is likely to continue in 2025 and that exemplifies a general move towards global fragmentation.
- With geopolitical conflicts and tensions rising, governments and corporations look set to continue prioritizing supply chain resiliency, resource safeguarding, and national security in the years ahead. Global fragmentation is likely to be costly, potentially leading to higher inflation, tighter monetary policy, and lower economic growth. While the cost for the global economy is high, winners will likely emerge, with significant implications for long-term investing, in our view.
Market Themes
We maintain a preference for pro-risk assets and believe government bonds could provide a much-needed hedge against the risk of a growth-led equity drawdown.
Market Concentration & High Valuations: How Big of a Worry?
Many equity benchmarks are highly concentrated. This is especially true for mega-cap tech stocks that account for over one-third of the S&P 500’s total weight and have been a key driver of its stellar performance in recent years. A phenomenon that is also evident outside of the US. Unusually high concentration and valuations in many equity indices warrant investor concern as they have historically been associated with lower long-run returns.
Key Implications: We believe investors should add exposure to non-tech sectors especially in the US, diversify internationally and move down in cap in order to reduce concentration risk.
Diversification Alternatives
We see more value in being balanced in multi-asset portfolios, with bonds likely to buffer growth shocks owing to lower inflation. That said, investors remain concerned about a potential pick-up in inflation, especially in the US, which, coupled with continued fiscal risks, could put some pressure on core fixed income.
Key Implications: Trend-following strategies or private assets, such as infrastructure, may help limit the impact of reaccelerating inflation on portfolios.
Still Living in a Dollar World
We expect tariffs to feature prominently in the US policy mix this year, along with continued US economic and financial exceptionalism and some fiscal changes that might prevent the Fed from cutting interest rates as much as other major central banks. That is a powerful combination for the US dollar that is likely to remain well supported. The euro and the Chinese renminbi look especially vulnerable, given recent data weakness and the prospect of US tariffs. By contrast, the Japanese yen may appreciate slightly as the BoJ normalises policy further, however fewer rate cuts by the Fed might limit the upside.
Key Implications: A strong dollar is generally good for dollar-denominated assets but might be a headwind for emerging market assets, especially equities and local-currency bonds.
What Could Possibly Go Wrong?
Given our expectation for solid, albeit slowing, global growth, continued disinflation, and further easing by central banks, we remain mildly pro-risk in 2025. That said, uncertainty around global growth and monetary policy has risen significantly following the US elections. There are also fewer tailwinds from inflation relief and more elevated valuations for risky assets, making for a more challenging backdrop compared to 2024, in our view. We believe that US trade policy and the extent to which China will stimulate its economy further in response to potential tariffs will be key to market performance this year.
Key Implications: While investors may be faced with a multitude of economic, policy and geopolitical uncertainties this year, we believe they can turn those challenges into potential opportunities, by protecting their portfolios against growth risks with core fixed income which now offers attractive income potential, going down in cap to reduce valuation and concentration risk, and leaning into infrastructure to hedge against upside inflation surprises.
Implementation Solutions
Core Fixed Income
Global Monetary Easing Amid Growing Fiscal Risk: After about two years of monetary tightening, major central banks began to ease policy in 2024 following cooling inflationary pressures. We anticipate more rate cuts in 2025 which should be supportive for core fixed income. That said, we believe that the pace of these adjustments will likely diverge. Some countries have more convincing disinflation trends (e.g. Canada) while others are faced with stickier inflation (e.g. the US). This sets the stage for a more diversified approach to duration. Furthermore, we see more evidence that fiscal expansion and surging government bond supply matter to bond markets. Public debt is elevated in most DM economies and is likely to grow further unless governments undertake significant fiscal consolidation. For example, we estimate that France and the US must reduce their primary deficit by 4.6pp and 4.0pp, respectively, to stabilize their debt by 2029. This is why investors are asking to be compensated when taking greater duration risk, in our view.
Greater Term Premia, Steeper Curves: On the fiscal side, there are many unknowns, including the sequencing and reach of the policies proposed by the new US administration, the viability of France’s new government and the possibility of a more expansionary stance in Germany following the elections. Bond investors are likely to pay close attention to fiscal policy, penalizing governments that are unable to show a sensible path towards debt sustainability. We believe this shift will lead to higher term premia and steeper yield curves. While yield curves in key DM markets have now dis-inverted, they remain flatter than in the past. For example, the spread between 10- and 2-year Treasury yields ended 2024 at 0.3pp, largely below the 20-year average of 1.0pp. As yield curves steepen, flexible bond strategies and active management will become even more critical, in our view. Despite growing fiscal risk, we believe core fixed income remains an attractive hedge against growth shocks, strengthening the case for balanced portfolios at a time of elevated equity valuations.
Source: Haver Analytics, IMF and Goldman Sachs Asset Management. As of December 31, 2024. The required primary deficit reduction is calculated as the difference between the primary deficit that stabilizes debt from 2025 to 2029 and the IMF’s estimated primary deficit for 2024. The stabilizing deficit is computed assuming nominal growth forecasts produced by Goldman Sachs Global Investment Research and a constant cost of debt proxied by the 10-year government bond yield as of December 2024. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved.
Source: Macrobond and Goldman Sachs Asset Management. As of December 31, 2024. Past performance does not predict future returns and does not guarantee future results, which may vary.
Global Small Caps
Small Cap, Big Expectations: The small caps segment is often overlooked. But we believe today’s macro backdrop and low valuations relative to large caps make the current opportunity set hard to ignore, particularly for investors looking to complement and diversify their large-cap allocations. To start with, we believe global small caps will be key beneficiaries of the increased trade uncertainty following the US elections, given their greater domestic sales exposure and their more domestically oriented supply chains. In the US, small caps could also benefit from more America-first policies, the prospects of regulatory changes and a proposed tax reform. This is reflected in the increasing gap in 2-year forward earnings-per-share (EPS) growth expectations of small caps over that of large caps across all regions at the end of 2024, relative to the average of the previous three years.
Diversification Edge: Small caps’ lower valuations and concentration relative to large caps make them an even more attractive proposition at this point in the cycle, in our view. A noticeable portion of equity returns have been driven by a few stocks in only a handful of sectors recently, including technology, and therefore concentration has become top of mind for investors. We believe that global small caps can address the rising equity concentration risk in investors’ portfolios. In the MSCI World Small Caps index, the top ten stocks by weight make up only 2% of the total market capitalization of the index, while the largest 10 stocks of the MSCI USA index account for one-third of the total index weight. Additionally, the MSCI World Small Caps index includes 3,984 stocks, offering a far larger universe than the MSCI World index’s 1,397 stocks. While global small caps started the year under pressure, as investors recalibrated their expectations for a slower Fed easing cycle, we believe that they will catch up later in the year offering a good entry point.
Source: Bloomberg and Goldman Sachs Asset Management. As of December 31, 2024. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved.
Source: MSCI and Goldman Sachs Asset Management. As of December 31, 2024.
Private Infrastructure
Structural Tailwinds: Infrastructure, the backbone of society, is being redefined, as the ways we live, move, and communicate continue to evolve. These changes are being driven by some of the most important megatrends. One of these trends is the surge in data center demand, driven by the rise in cloud computing and AI. Currently, data center energy consumption represents 1-2% of power demand globally. But this is likely to rise further as some AI innovations require greater energy needs. For example, a ChatGPT query needs nearly 10 times as much electricity to process as a Google search, according to the International Energy Agency. Goldman Sachs Global Investment Research (GIR) expects data center power demand to increase by 160% through the rest of this decade. This means that power grids will need to be upgraded and extended to accommodate this surge in power demand. In Europe, the power grid is one of the oldest in the world, so keeping new data centers electrified will require more investment. GIR analysts expect nearly €800 billion in spending on transmission and distribution over the coming decade, as well as nearly €850 billion in investment in solar, onshore wind, and offshore wind energy.
Inflation Hedge: This trend, coupled with other ongoing shifts such as increased defense spending and the push for decarbonization, is expected to drive significant infrastructure investment over the medium-to-long term. This should act as a major tailwind for the asset class. Furthermore, in a world of more elevated inflation and greater macro uncertainty, we see infrastructure as an attractive diversifier as infrastructure businesses tend to be more resilient through economic cycles and higher inflationary periods. In the US, private infrastructure has outperformed traditional assets when core inflation exceeded 2.5% since 2000. Specifically, it has outperformed public equity and public fixed income by 4pp and 11pp, respectively.
Source: Goldman Sachs Investment Research and Goldman Sachs Asset Management. As of November 3, 2024. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved.
Source: EDHEC Infra300, NFI-ODCE, S&P 500, Bloomberg Barclays, BLS and Goldman Sachs Asset Management. As of September 30, 2024. Past performance does not predict future returns and does not guarantee future results, which may vary.
1 According to the China Passenger Car Association, between January and October 2024, sales of electric vehicles reached 14.1m units, with 69% of those sales in China alone.
