Entering a Year of Transformation and Adaptability
Dec 31, 2024
In its 1Q 2025 Outlook, PGIM Quantitative Solutions sees the Year of the Snake bringing lower returns and higher volatility as inflation remains a key trend.
ECONOMIC TRANSFORMATION UNDERWAY
Despite high policy rates, the U.S. economy has performed well with GDP growth modestly above the post-Global Financial Crisis (GFC) average. Higher frequency coincident economic indicators, like personal income excluding transfer payments, job growth, and manufacturing and trade sales, are growing at a pace consistent with economic expansion. However, interest rate sensitive sectors have seen some weakness in the elevated rate environment, and recent strikes and hurricanes have also temporarily impacted production. The post-COVID inflation surge has been one of the defining macroeconomic trends in recent years. With inflation falling but not yet fully under control, the Fed isn’t resting on its laurels. While the initial 50 bps Fed rate cut in September was significant, the pace of subsequent cuts has been measured, a policy expected to continue into 2025.
The post-COVID recovery has been more muted outside the U.S. Eurozone economic activity struggled in 2023 and 2024 with GDP growth averaging below 1%. Factors such as higher energy costs, elevated policy rates, burdensome regulations, and political uncertainty have hindered growth and are likely to continue doing so in 2025. Nevertheless, expectations are currently for a modest improvement in the pace of growth in the year ahead, supported by European Central Bank (ECB) rate cuts and robust global demand.
The Japanese economy also struggled in 2024, starting with an auto safety scandal disrupting production in Q1 and consumers struggling with rising living costs. However, activity quickly rebounded mid-year despite the fallout from political scandals and yen volatility. Looking ahead to 2025, growth is expected to recover, albeit at a modest pace. Strong global demand and household consumption will help underpin 2025 growth, along with increased investment in human capital and business fixed investment.
In contrast to the Eurozone and Japan, the Chinese economy has reported much higher growth rates, although the pace of growth has slowed post-GFC. The economy continued to struggle in 2024 with real estate sector disruptions. The government responded with a variety of fiscal and monetary stimulus measures, which may temporarily boost GDP growth but may not be sufficient to restore past trend growth, particularly with the new U.S. administration threatening further trade restrictions.
BRACE FOR VOLATILITY AS POLICY RISKS HEIGHTEN
As global investors brace for President Trump’s return to the White House in 2025, several key policy risks could disrupt markets. Trump's "America First" foreign policy, characterized by tariffs, trade wars, and skepticism toward international agreements, could escalate tensions with major trading partners such as China, the EU, and Mexico. Although campaign promises of imposing tariffs up to 60% on Chinese imports and 10-20% on goods from other nations are unlikely to be fully implemented, tariffs are expected to be used as a negotiating tactic and are likely to rise to some degree.
Meanwhile, a renewed focus on restricting both legal and illegal immigration could lead to labor shortages in critical industries such as agriculture, construction, and technology. On the campaign trail President-elect Trump promised the largest mass deportation of undocumented migrants in U.S. history. While an immigration crackdown may boost domestic wages in the short term, it could also hinder long-term productivity growth by disrupting the flow of highly skilled workers to the U.S. from other countries.
Beyond domestic policy risks, several geopolitical developments could cause significant market turbulence. The ongoing conflict in Ukraine remains a key concern, with the potential for further escalation that could disrupt global supply chains, particularly in energy and food markets. Similarly, failure to reach a ceasefire agreement in the Israel-Gaza conflict that leads to the release of the remaining hostages could lead to an escalation, with the potential to draw in Iran and its proxies, driving oil prices higher and impacting the global economy. Additionally, tensions in the Taiwan Strait, exacerbated by an already fraught U.S.-China relationship, could trigger sharp volatility in global equity markets. Any instability in this region could prompt a flight to safer assets such as gold and U.S. Treasuries, further weighing on risk assets.
ADAPTING EXPECTATIONS FOR RISK ASSETS
According to the Chinese zodiac, 2024 was the Year of the Dragon. The Dragon is considered to be the most powerful and auspicious animal, symbolizing, among other things, prosperity. Financial markets aligned with these expectations, as risk assets performed strongly, with stocks reaching several new record highs over the course of the year. As the new year approaches—the Year of the Snake, known for transformation and adaptability, our base case for the macro environment during 2025 and into 2026 remains benign and supportive of risk assets. Resilient economic growth has kept the U.S. economy on track for a soft landing. However, January’s Presidential inauguration likely brings both opportunities and challenges for financial markets. While the details and the timing of the Trump administration policies remain uncertain, we anticipate a combination of tax cuts, deregulation, and supportive financial conditions to bolster risk assets throughout 2025. Thus, our expectations for risk assets are for modest returns for the full year, accompanied by increased volatility.
A STRATEGIC CASE FOR COMMODITIES ALLOCATION
Commodities have had a relatively poor year in 2024. The bull case for commodities in the new year lacks strong conviction, largely depending on the extent of China’s economic stimulus. Meanwhile, President-elect Trump has signaled that he may use tariffs as a tool to negotiate bilateral issues, which could dampen risk appetite and market sentiment for commodities. The outlook for energy is even murkier. Relaxation of restrictions in the U.S. could result in positive surprises in U.S. crude production, even as the global supply outside the U.S. remains abundant at a time when demand growth is slowing. However, commodities are likely to perform well if there is an inflation surprise, outpacing other inflation hedges such as REITs and TIPS. This suggests that investors could benefit from maintaining their strategic positions in commodities.
References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. The securities referenced may or may not be held in the portfolio at the time of publication and, if such securities are held, no representation is being made that such securities will continue to be held.
The views expressed herein are those of PGIM investment professionals at the time the comments were made, may not be reflective of their current opinions, and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. Neither PFI, its affiliates, nor their licensed sales professionals render tax or legal advice. Clients should consult with their attorney, accountant, and/or tax professional for advice concerning their particular situation. Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy.
Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
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