Looking back at 2024, the year exceeded expectations despite early concerns about a potential recession. U.S. equities delivered impressive gains, driven by strong corporate earnings and optimism over the start of a rate-cutting cycle by the Federal Reserve (Fed). Bonds provided solid income to investors but ended the year only slightly higher, as long-term rates rose in response to inflationary pressures.

The year was not without challenges. A soft patch in economic data during the summer, including weaker employment numbers, sparked volatility and briefly raised concerns about the health of the economy. However, conditions rebounded in the fall as the labor market stabilized, and investors were reassured by the Fed’s rate cuts and renewed optimism following Donald Trump’s election. His pro-growth policy platform, including tax cuts and deregulation, further boosted sentiment among businesses and investors.

Overall, S&P 500 earnings grew for a fifth consecutive quarter, helping to sustain economic momentum and propel markets higher through year-end. While challenges emerged throughout the year, 2024 ultimately underscored the resilience of the economy and markets in the face of uncertainty.

Inflation remained stubbornly high in 2024, driven by services like housing and auto insurance, and underlying pressures suggest it may not decline as quickly as policymakers had hoped. Core inflation (as measured by CPI ex food and energy) has remained above 3% for 45 consecutive months, underscoring the persistent challenges in bringing inflation closer to the Federal Reserve’s 2% target.

The Federal Reserve’s pivot at its December 2024 meeting acknowledged these challenges, as officials scaled back their expectations for rate cuts in 2025. Inflationary pressures are being driven by resilient economic activity and a tight labor market, which continue to support demand. Bond investors, too, appear skeptical about the Fed’s ability to rapidly curb inflation, as reflected in the significant rise in long-term rates, including the U.S. 10-year Treasury yield nearing 5%. These higher rates are already impacting key areas of the economy, such as housing and corporate refinancing, and pose challenges for equity valuations, particularly for sectors dependent on future earnings, such as technology.

In this environment, investors should focus on overweighting credit within fixed-income portfolios to capitalize on higher yields while remaining flexible to adjust strategies as inflationary dynamics evolve.

Trump’s proposed policies, including tax cuts and deregulation, have bolstered sentiment among small businesses and regional manufacturers since his November victory. The probable extension of the 2017 Tax Cuts and Jobs Act (TCJA) and the creation of the Department of Government Efficiency (DOGE) have contributed to optimism about future economic growth.

However, several proposed measures could introduce challenges. Tariffs, likely to be used as negotiation tools, could disrupt supply chains if broadly applied, while anti-immigration policies, including mass deportations, may reduce the labor force by millions, curbing productivity and economic growth. These policies also pose inflationary risks, adding complexity as the Fed works to navigate a soft landing. The uncertainty surrounding their implementation is expected to create volatility in risk assets throughout 2025. Investors should monitor developments closely and prepare for shifts in market sentiment.

Building on the valuation disparity between U.S. and non-U.S. equities, foreign stocks offer compelling opportunities for international diversification. Emerging markets, in particular, are poised to benefit from stronger economic growth driven by private consumption and investment. Additionally, a potential weakening of the U.S. dollar during periods of improving global growth could provide an added tailwind to foreign stock returns by enhancing the value of non-dollar-denominated assets.

Bonds face a mixed outlook in 2025, with rate uncertainty likely to create volatility in the fixed-income market. Inflationary pressures and economic growth could push long-term yields higher, presenting challenges for bond prices. However, higher starting yields provide a cushion to returns, making the outlook for bond investors more favorable than in recent years, even in the face of potential price declines.

In this environment, an active approach to fixed income can help identify opportunities in undervalued sectors and regions globally. By focusing on areas like higher-yielding credit instruments, including corporate bonds, emerging market debt, and securitized products, investors can enhance returns and diversify portfolios beyond traditional bond indices. Such strategies enable investors to adapt to shifting rate dynamics while managing risks effectively.

To mitigate equity and fixed-income volatility, alternative investments will remain crucial in 2025. In recent years, higher correlations between equities and fixed income have reduced the diversification benefits of traditional portfolios, making alternatives even more attractive for achieving stability and uncorrelated returns.

Private credit is poised to deliver strong returns as short-term yields stabilize, offering compelling opportunities for income-focused investors. The secondary private equity market is also gaining traction as managers navigate challenges posed by higher interest rates, creating attractive entry points for long-term investors. Additionally, sectors like data centers within private real estate present promising opportunities despite the impact of higher financing costs.

Diversifying into these areas can provide portfolio stability and enhance risk-adjusted returns, particularly in an environment where traditional asset classes face increased volatility.

The economic outlook for 2025 remains positive, with global growth expected to improve modestly, driven by stronger momentum in emerging markets and steady performance in advanced economies. While returns on global equities and balanced portfolios may moderate, thoughtful portfolio positioning will be essential to navigating the year ahead.

In equities, a selective approach focused on high-quality companies and opportunities in international markets can help investors balance growth potential with risk management. Within fixed income, credit offers appealing opportunities for income and diversification, while alternative investments can provide stability and uncorrelated returns. Flexibility and adaptability will remain critical as investors position portfolios to capture opportunities and manage risks in an evolving market landscape.