Capital Markets Outlook 1Q 2025: Mind the Gaps

The investment landscape for active investors is shaped by upcoming policy changes and the current macroeconomic environment, offering opportunities for outperformance. As economies transition through the normalization process, investors must consider the implications of potential policy changes, particularly in the US, which could impact market dynamics. Bond yields remain attractive, especially in municipal bonds, due to high yields and improved valuations, suggesting a favorable entry point for active investors.

The macroeconomic picture is influenced by three primary drivers: inflation, growth, and labor. Inflation has decreased but remains a concern, while economic growth has been unexpectedly strong, raising questions about its sustainability. The labor market is stable, and the Federal Reserve may prioritize maintaining employment over aggressive inflation control, potentially leading to rate cuts in 2025.

For bond investors, opportunities arise from elevated real yields and the evolving US yield curve, which now presents more typical characteristics. High-yield credit remains attractive due to strong fundamentals and technical conditions. Globally, active investing is encouraged as economic normalization varies by region.

Equity investors should anticipate a broadening of earnings beyond a few dominant large-cap stocks, offering potential rewards in diverse sectors. Opportunities exist in growth stocks outside popular sectors and in value stocks tied to infrastructure investment. Dividend-paying stocks may offer income growth as the Fed cuts rates, while small-cap stocks present a chance to shift towards higher-quality options.

Overall, the intersection of policy changes and the macro backdrop, along with healthy bond yields, provides a landscape ripe with opportunities for active management, despite potential volatility.