Transamerica Asset Management, Inc. 2025 Market Outlook

Source: Bureau of Economic Analysis, as of 9/30/24. Second estimate released 10/30/24.

Overall economic growth, as measured by GDP, is looking to conclude CY 2024 tracking at about 2.5%, a pace we see as likely to continue through 2025. At the current time, the economy is experiencing a combination of headwinds and tailwinds, though we see a net advantage to positive growth factors, such as upcoming federal reserve rate cuts, declining inflation, and rising corporate earnings growth. In addition, we believe the prospects of a less onerous tax and regulatory environment following November’s election will also help to boost consumer confidence. Potential headwinds include rising credit card debt and uncertainty in the labor markets pertaining to the pace of future jobs growth. All considered, we believe the economy is capable of approximately 2.5% cumulative GDP growth, which we view as a favorable environment for stocks and bonds. 

Source: Bureau of Labor Statistics, as of 10/31/24

As of 9/30/24; Revolving Consumer Credit Outstanding; Source: Federal Reserve; Household Savings Rate; Source: Bureau of Economic Analysis

Perhaps the largest headwind facing the U.S. economy continues to be the inverse cross correlation of rising aggregate credit card debt and declining household savings rates. This somewhat ominous combination of less money to spend and more bills to pay could wind up creating an incremental net drag on economic growth in the year ahead. 

CPI Source: Bureau of Labor Statistics, as of 9/30/24; PCE: Bureau of Economic Analysis, as of 10/31/24

The four most closely watched inflation metrics — consumer price index (CPI), CPI core inflation (ex food and energy components), personal consumption expenditures (PCE) and PCE core inflation — have all shown precipitous declines since they reached cycle peaks more than two years ago. Looking forward, we believe these measures are likely to continue declining into 2025 and we expect core inflation to conclude the year at a lower pace of about 2.4% on a year-over-year basis, as defined by the average of CPI core and PCE core rates. 

As of 9/30/24; Source: Bureau of Economic Analysis

One reason why we believe year-over-year rates of core inflation will continue declining into 2025 can be seen in the three-month pace of PCE core inflation (the Federal Reserve’s preferred metric), which is declining faster than the most recent year-over-year reading. Much of this can be attributed to the lagging impact of housing services (leases and rents), which includes contracts initiated in previous years when inflation was higher. More recent rental and leasing terms are yet to be fully incorporated into year-over-year reports, leading us to believe annualized core inflation rates are prone to decline in 2025.

Finally, the likelihood the Tax Cuts and Jobs Act of 2017 is extended to a permanent status for many provisions, including personal income and capital gains tax rates and potentially lower corporate tax rates, is, in our view, an important economic tailwind in terms of longer-term consumer confidence in the economy. This scenario is now a more distinct probability following the election of President Trump and Republican victories in the Senate and House of Representatives.

Source: "President Trump's Tax Proposals at a glance," Crowe.com, Nov. 7, 2024

With a “lower for longer” tax rate environment, it is more probable, in our view, that consumer spending and corporate profitability post-2025 are likely to exceed previous expectations and their actual results over the past several years. Final reconciliation regarding an extension on personal and capital gains rates and a potentially lower corporate rate (perhaps from 21% to as low as 15%) is expected to be determined by Congress by the end of 2025.

As of 11/7/24. Source: Fed Funds Target Rate: Federal Reserve Board of Governors. Forecast: Transamerica Asset Management, Inc.

Following the Fed’s historic rate hike tightening cycle from March 2022–July 2023, we believe the Fed has established a new objective to calibrate the federal funds rate to a lower level more representative of expected inflation rates and positive economic growth. Looking forward, we estimate the Fed will conclude 2025 with a fed funds target range of 3.50%–3.75%.

Source: Federal Reserve Board of Governors; core PCE as of 9/30/24; fed funds rate as of 11/7/24

The key reason why we believe the Fed will continue reducing rates in 2025 is the inflation-adjusted real rate of interest, as calculated by the upper bound fed funds rate less PCE core inflation, currently at just above 2.0% (4.75% minus 2.7%). We believe the Fed views this current real rate as being overly restrictive in nature and will seek to bring it down to a level of approximately 1.25%. Therefore, should PCE core inflation fall further to the mid-2% range, as we believe is likely to be the case by year-end 2025, this would imply a federal funds target range of 3.50%–3.75%. 

As of 11/15/24; source: Bloomberg

Over the past year, the 3-month to 10-year Treasury bond yield curve has normalized from a deeply inverted slope (short-term rates higher than longer-term rates) toward a more traditional upward slope. Given what we believe will be more rate cuts in 2025 pressuring the 3-month yield lower to approximately 3.5%, combined with the 10-year yield remaining close to its current level, we expect this curve to further steepen to an upward slope in the year ahead.

As of 11/15/24; sources: Yield Curve — Bloomberg; Forecast — Transamerica Asset Management, Inc.

Taking these forecasts into account, we see the 3-month to 10-year yield curve steepening to a slope of just below 1% by the end of 2025. Under such a scenario, we would see the most logical position on the curve to be in the 6–9 year maturity range to lock in current yields in a declining rate environment while mitigating reinvestment rollover risk at the short end of the curve as well as duration-based price risk at the longer end (10 years or greater).

Source: Bloomberg, as of 11/15/24. A-Rated Bond Yields represented by the Yield to Worst on the US Aggregate Bond: A Index; BBB-Rated Bond Yields represented by the Yield to Worst on the US Aggregate Bond: BBB Index

We believe corporate credit spreads will likely hold stable and strong risk-return opportunities remain for intermediate-term, investment-grade bonds in the 6–9 year maturity range. We see opportunities for A-rated and BBB-rated corporate bonds in the middle of the curve where investors can lock in recently elevated yields that could prove particularly attractive given the prospects of further Fed rate cuts and declining inflation.

Source: Bloomberg, as of 11/14/2024
Indexes are unmanaged and an investor cannot invest directly in an index. Past performance does not guarantee future results.

In looking at the past six bear markets (defined as a 20% or worse decline in the S&P 500), history suggests it has not only proven advantageous for investors to own stocks after they have bottomed and a new bull market has been initiated, but also after stocks have fully recovered  their bear market price losses (as was the case in January 2024), which is a far more identifiable and actionable milestone. 

Source: Bloomberg
Indexes are unmanaged and an investor cannot invest directly in an index. Past performance does not guarantee future results.

We are currently about one year past the full recovery of the 2022 bear market, and we believe stocks remain in a longer-term bull market cycle that’s likely to continue through the upcoming year. The S&P 500 fully recovered its 2022 bear market price losses in January 2024, and though it has appreciated more than 25% since then, it’s still comparably positioned to previous post one-year bear market recoveries, such as in November 1983, July 1990, and March 2014. In those cases, the S&P 500 went on to post multi-year periods of well above historically average annualized price returns.  

As of 11/15/24. Source: Bloomberg; Forecast: Transamerica Asset Management
 Indexes are unmanaged and an investor cannot invest directly in an index. Past performance does not guarantee future results.

When looking at the recent path of the S&P 500 since its full recovery of bear market losses in January 2024, we view its technical profile as similar to the historical patterns of November 1983, July 1990, and March 2014. There also appears to be several identifiable catalysts capable of driving stocks higher in the year ahead. These include positive economic growth, rising corporate earnings growth, Federal Reserve rate cuts, declining inflation, a “lower for longer” federal tax environment, and a less onerous regulatory backdrop. When taking this history and current catalysts into account, we view a fair year-end price target on the S&P 500 to be 6,500. 

Source: FactSet Earnings Insight; as of 11/15/24

Of all the current catalysts for stocks, we view rising corporate earnings growth to be the most important. When looking at past S&P 500 annual net operating earnings growth since 2020 — on all underlying companies as gathered, weighted and calculated by FactSet Earnings Insight — a case can be made for a meaningful corporate profits breakout now being underway. Following three years of close to flat earnings growth between 2021–2023, aggregated analyst estimates are forecasting about 9% earnings growth for soon to be completed CY 2024 and about 15% earnings growth for CY 2025. Should these estimates come to fruition, we believe it is fair to expect total returns on stocks of similar magnitudes and consistent with our year-end 2025 price target on the S&P 500 of 6,500. 

Source: Internal Revenue Service

Corporate earnings growth for 2025 and beyond could be further strengthened by the recent presidential and congressional elections, which will likely lead to a less burdensome regulatory environment and the extension of and/or revisions to the 2017 Tax Cuts and Jobs Act that is set to expire by the end of 2025. Prior to the election, there was widespread concerns of an increase to the marginal corporate tax rate from 21% to 28% which would have taken effect in 2026. However, given the somewhat unexpected election results of a Republican-controlled White House and that party’s majorities in Congress, a corporate tax increase now looks, for the most part, off the table and a potential corporate tax reduction perhaps to as low as 15% range could be back on. 

All else being equal, this could create additional upside to CY 2026 corporate earnings estimates as they materialize over the upcoming year. In summary, the corporate tax environment looks as though it is now in a “lower for longer” profile and has therefore shifted from a headwind to a tailwind for stocks.   

Source: Bloomberg as of 10/31/24
Indexes are unmanaged and an investor cannot invest directly in an index. Past performance does not guarantee future results.

Over the past decade, growth stocks have meaningfully outperformed value stocks, as can be seen in the comparative returns of the Russell 1000® Growth Index versus the Russell 1000® Value Index. During this time frame, Russell 1000 Growth has posted total returns more than double that of Russell 1000 Value.

We believe both value and growth stocks can generate positive returns in the current market environment. However, as we enter 2025, we believe there is a strong probability of a shift in market leadership during the year ahead, providing for an upside regression to the mean and new cycle of relative outperformance for value stocks. As a result, we believe investors may want to consider shifting relatively higher equity allocations from growth to value as the year moves forward. 

Source: Bloomberg as of 10/31/24
Indexes are unmanaged and an investor cannot invest directly in an index. Past performance does not guarantee future results.

At the forefront of this case for value stocks is the widening valuation discounts they currently trade at versus their growth counterparts. At more than a 40% discount to growth stocks on trailing 12-month price/earnings multiples (Russell 1000 Growth versus Russell 1000 Value), this valuation gap is now close to historical levels. With the economy likely to remain strong in 2025 and Fed rate cuts potentially concluding in 2H 2025, we view such an environment as one setting up value stocks extremely well for strong absolute and relative performance, particularly in the second half of the year.   

As of 10/31/2024. Source: Bloomberg
Indexes are unmanaged and an investor cannot invest directly in an index. Past performance does not guarantee future results.

Entering 2025, international developed stocks continue more than a decade of underperformance relative to their U.S. counterparts, as seen in the comparative returns of the MSCI EAFE versus the S&P 500. 

As of 10/31/2024. Source: Bloomberg
Indexes are unmanaged and an investor cannot invest directly in an index. Past performance does not guarantee future results.

However, this underperformance by international developed stocks has also resulted in a meaningful valuation differential versus U.S. equities approaching historic levels, as seen in widening trailing 12-month price/earnings ratios between MSCI EAFE and the S&P 500. We believe this could provide for an opportunistic profile for international developed stock portfolios and particularly those with a focus on the eurozone and Japan.

As of 10/31/2024. Eurozone CPI Source: Eurostat; ECB Deposit Facility Rate, Source: European Central Bank

Having seen inflation peak in October 2022 at higher than 10%, the eurozone has managed to reduce consumer prices at a faster pace than in the U.S., reaching an annualized rate below 2% in September 2024. As a result, the European Central Bank (ECB) has cut the deposit facility interest rate from 4% to 3.25% since June 2024. We believe more rate cuts from the ECB will be forthcoming in 2025, which, when combined with declining inflation, could provide a favorable opportunity for global investors.  

Source: Bloomberg, as of: 11/15/24
Indexes are unmanaged and an investor cannot invest directly in an index. Past performance does not guarantee future results.

Despite an intense sell-off this past August driven by a large short-term yen carry-trade unwind, we believe certain catalysts could be at work in the Japan market responsible for multi-decade highs recently established in the Nikkei^SM 225. This includes a rebounding economy (actually welcoming of inflation following a lengthy period of deflation), as well as corporate governance reforms encouraging corporations to more profitably manage their balance sheets and returns on capital. We view these changes as potentially representing a longer-term shift in Japan’s overall market environment attracting a growing base of international investors.   

A risk wild card could quickly emerge regarding the degree to which the Trump administration might impose additional tariffs on China and other nations. Key points of consideration on this uncertainty include:

• Escalating tariff-based trade policies could have inflationary impacts as well as effects on global trade.
   
• Depending on the number and specific terms of additional tariffs, markets could react negatively and in a similar fashion to when the first Trump administration announced tariffs on China in 2018.
   
• We view a key variable in this wild card as being whether President Trump’s administration uses the prospects of tariffs mostly for tactical trade negotiations on a case-by-case basis or as longer-term strategic policy. 
   
• A potential silver lining could be a favorable market reaction if it becomes apparent that tariffs are applied to a lesser degree than most might currently anticipate.

The above strategy overview is intended to illustrate major themes for the identified period. No representation is being made that any particular account, product, or strategy will engage in any or all of these themes.